With the UK still behind the US on underwriting stringency, is it time to up the tempo and introduce a non-contestability clause as a remedy to non-disclosure? Edward Murray reports
There is little doubt that changes need to be made in the contracts offered by the UK protection market, however, agreeing on its options is not proving quite so easy. While the market has been discussing the way forward for a number of years, the subject has recently been prioritised on the back of proposals issued by the Law Commission.
Contract law is an evolving area although the pace of change is rarely fast and often lags behind up-to-the-minute practices and procedures. Indeed, the Law Commission makes reference to the many calls for reform over the last fifty years and comments: "Reports recommending reform were published by the Law Reform Committee in 1957, the Law Commission in 1980, the National Consumer Council in 1997 and the British Insurance Law Association in 2002."
Whether wholesale reform is needed is another argument. The main focus in this article is whether or not the introduction of a non-contestability clause, as suggested in the Law Commission's proposals, would deliver benefits to the UK protection market and what lessons and comparisons can be drawn from the US model.
Certainly, there seems to be little doubt the introduction of a non-contestability clause would repair some consumer confidence. However, for maximum effect, life offices would need to make a steep change rather than slowly edging towards such a scenario. If insurers refuse to make such a wholesale change then by the time they manoeuvre themselves into offering such a clause a lot of the goodwill it could generate would be lost. If life offices are slow to move it is also likely they will be forced into a timeframe of change by legislators, and consumers will resent the industry more for not having the gumption to introduce changes voluntarily.
Consumer confidence
Not only is there potential for improved consumer confidence in the industry, but according to Andy Milburn, IFA market manager at Royal Liver, there is also scope to reduce claims administration with fewer claims being disputed. However, Milburn is not entirely convinced that all of the effects would be positive and he comments: "Not being able to challenge claims will result in higher premiums as providers pay for the increase in their liabilities."
He is not alone in thinking premiums will rise, many believe this is simply inevitable. Jason Hurley, head of sales and marketing at RGA, UK and Ireland, says: "I think problems could be created with a more long-winded, extensive and intrusive underwriting process and it will definitely become more difficult and take longer for people to get cover." In turn, he feels this will shrink the size of the market and adds: "I think it would probably result in a rise in premiums."
Johnny Timpson, head of protection market development at Scottish Widows, also believes premiums will rise and the market may be looking at jumps in the region of 20% if a non-contestability clause were introduced. Certainly, he believes the underwriting process would have to change, commenting: "There will be a completely different application process, potentially different shapes in product and products becoming more expensive." He says the insurer would also need to hire more underwriters, which in itself would be an expensive part of the process and an increase to bottom-line operating costs.
But is it necessary for premiums to rise if a non-contestability clause is introduced? Is it a simple case of there being a greater liability to the insurer under such a clause and so the need for higher premiums? Well not everyone agrees. Some have claimed that a non-contestability clause would see policies staying on insurers' books for longer, which would put a downward pressure on claims. Others believe that by underwriting more stringently and accurately at outset, insurers would decline more cases and begin to rate policyholders on the liability they offer. Not only would this bring down the number of payouts made by life offices in doubtful situations to avoid bad publicity, it would also see it charging appropriately for the cover offered. By dint of the better claims performance this would deliver, James Brook of Anand Associates believes insurers would actually be in a position to lower premiums.
He explains: "Currently, life assurance companies are insuring people but aren't sure if they should have at all or at that premium. Life offices work on an 'if in doubt we'll pay out' philosophy and are currently paying out on claims they would never have insured in the first place or done so at standard rates if they had done the underwriting process properly at the outset." The savings delivered by this underwriting performance should be more than enough to compensate for increases in cost associated with changing the application processes and increasing the level of underwriting done at the point of sale.
Brook believes such an argument negates protests some have made about protection becoming more expensive and so widening the protection gap. However, he is in no doubt that unless underwriting processes change then a non-contestability clause on its own will not solve the problems of non-disclosure. He comments: "If there is the non-disclosure clause and life offices are as lax as they appear to be about underwriting correctly, then I am sure you will have people trying to play the system, but it does not occur in the US because the life offices are not lax about underwriting."
Underwriting in the US is much more stringent and there is no concept of 'utmost good faith', as Hurley comments: "In the US there is an industry-wide fraud register that insurance companies check before they put someone on the books. They will send round a nurse to do a medical exam if you want £100,000 of life cover for a 40-year-old male. The culture of the underwriters is not to believe a word that is written on the application form."
The UK market has not been keen to accept full medical underwriting as its default setting as many believe it is unnecessary. The key to non-disclosure - the problem non-contestability clauses are trying to solve - is all in the application process.
Nicki Lundy, communications manager at Bright Grey, says: "A lot of it has to do with the application form and working closely with intermediaries to make sure information is disclosed. I think some advisers think non-contestability clauses will help them argue against the perception that certain protection products do not pay out, but I think it will mean people who do not disclose information and should be paying higher premiums or not be covered at all could get away with it, and that would impact on everybody."
Downsides
There is no doubt there are downsides to a non-contestability clause and Brook believes insurers do not even have to go down this road and have another option.
He feels they should be offering clients the option of full medical underwriting at the outset in return for a guaranteed payout or allowing them to be underwritten with the possibility of repudiation if problems come to light.
Brook says such an option already exists in the health insurance market and says: "In private medical insurance (PMI) we already have the option of the client taking PMI with full medical underwriting or with effectively no underwriting on a moratorium basis and the policy is underwritten at claim." Brook says he knows of one insurer currently investigating bringing such an option to market, and believes this would answer many of the problems around non-disclosure without the downsides some associate with it.
While there seems little doubt the protection market is moving towards greater certainty at the point of underwriting and the possibility of changes to legislation, how much will be put in place in the coming months is a moot point. A real difficulty for insurers looking to act unilaterally and generate competitive advantage is that such a trip into the unknown may be difficult to get reinsurance support for. Around 90% of the risks insured by life offices are passed on to reinsurers and Timpson comments: "For anyone who wanted to do something now, I think it would be highly unlikely they would get a reinsurer to support them and so the amount of capital would be significant if not prohibitive." This is why the market has been so slow to adapt and why product innovation has not been as marked as in other areas of the insurance market.
Without definitive figures on the impact the various changes will make to the market, getting anyone to take a leap of faith will be difficult. However, as the issue of non-disclosure is very much at the top of the pile, and proposals remain under review by the Law Commission, some more pronounced movement in the market must now be a certainty.
Edward Murray is a freelance journalist
