Various types of exclusions are found in life and health insurance policies. James Shattock explains why they exist and that discounts for underwriting exclusions are now here to stay
If someone asked you what is excluded from your home and car insurance, could you tell them? Some of the small print under general exclusions might surprise you.
A fairly common exclusion is for damage caused by pressure waves from aircraft crossing the sound barrier. How often is that one invoked?
Take a look at your travel insurance policy and you will probably find that all pre-existing conditions are excluded; unless you have been specifically underwritten by the provider. The point is that different exclusions have different intentions. The sonic boom one is there to cover an extreme event, whereas the pre-existing conditions exclusion is a fundamental part of the product design, intended to speed up acquisition.
Exclusions in Protection Insurance
The classic reason for using an exclusion is to control and mitigate a specific risk present in the insured pool. This could be a single extreme event, such as war or civil commotion, a pandemic risk e.g. HIV/AIDS. It could also be an antiselective risk, like suicide or self-inflicted injury.
Exclusions can also be used in critical illness definitions to control severity and future trend risk.
An example would be where a cancer definition pays out on ‘malignant tumour,' but then excludes ‘all tumours of the prostate unless histologically classified as having a Gleason score greater than six or having progressed to at least clinical TNM classification T2N0M0'.
The twin priorities of reducing underwriting expense and speeding up acquisition explain why group critical illness protection business is driven by pre-existing conditions exclusions. Guaranteed acceptance products would not be feasible without an initial moratorium period excluding all deaths other than accidents. Critical illness cover is automatically included for children within the main policy and so requires exclusions for pre-existing conditions.
In some cases it is only the application of underwriting exclusions that allows a product to be offered at all - or at anything like an affordable price. Given the risk of claims associated with certain medical conditions, for example a history of musculoskeletal problems, many income protection underwriters rely on underwriting exclusions to offer acceptable terms. It is always preferable to offer rated terms if possible. But where considerations of affordability of cover or significance of risk prevent this, exclusions can provide a valuable tool for making protection cover available.
However, exclusions can lead to accusations of hiding behind the small print. Almost inevitably, some policyholders will fail to notice exclusions or to grasp their significance. They are particularly unpopular when invoked at point of claim. This causes frustration for policyholders whose claims are denied. It can also put the insurer in a distinctly uncomfortable position - and even lead to reputation damage.
Comparing the offerings of the various providers active in today's market shows that the total number of exclusions they include varies widely, from zero up into double figures. For the purposes of this article, general policy exclusions are defined as those specifically mentioned in the most recent Association of British Insurers (ABI) statement of best practice for critical illness and income protection (see chart over).
General exclusions are not commonly invoked at the point of claim. The most frequent exception to this rule is the residency exclusion. Providers who do not employ this exclusion invariably mitigate the risk elsewhere in the contract by clearly defining the geographical limits of cover.
It is also important to consider how policyholders might interpret these general exclusions. Take the very rarely called upon ‘unreasonable failure to follow medical advice' for example. As an industry it would be understood perfectly well what risks are mitigated here, but it could look very different from the policyholder's point of view. If your GP suggests you give up drinking or smoking and you don't, then technically you are failing to follow medical advice!
Safeguards for extreme events
Just because an exclusion is rarely used, does not mean it lacks value. The ‘war and civil commotion' exclusion, for example, is there as a safeguard against extreme events. In practice it is hardly ever used but it could well be in the future.
But where does this leave a member of the armed forces who may be serving in a war zone? It is far better to ask questions upfront at the underwriting stage that will enable providers to control the risk through their rating methodology. Ask, for example, whether applicants are members of the armed forces. If so, find out what their duties entail and whether they will be travelling or deployed to a war zone - then rate accordingly, or apply a specific underwriting exclusion.
The principle applies with the ‘hazardous sports and pastimes' and ‘aviation/flying' exclusions. General exclusions do have their advantages, however. They remove the need to rate, and - should a previously unadventurous policyholder take up a dangerous pastime at some point in the future - the insurer won't be caught off guard.
It will come as no surprise many now believe the HIV/AIDS exclusion is no longer fit for purpose. It is hard to argue now that HIV/AIDS is so very different from other potential pandemic risks such as a highly pathogenic influenza.
Turning, finally to the question of the ‘alcohol or drugs abuse' exclusion: as any claims assessor will tell you, excessive alcohol in the blood does not in itself provide sufficient justification for declining a claim. Take for example a critical illness claim brought after an individual has got drunk while celebrating their birthday, fallen into a canal and ended up in a coma. While alcohol was clearly a significant factor in the accident, few insurers would refute the claim on the balance of probabilities under civil law.
But if a subsequent review of medical records indicated that the claimant had a history of heavy drinking that was not disclosed at the time of application, then the insurers would have strong grounds for refuting the claim on the basis of non-disclosure. In practice, it is more often the non-disclosure revealed by medical notes or an inquest transcript that is the key trigger for denying payment - rather than insistence on any general exclusion.
Claims are invariably complex. No two are exactly alike; so taking the decision to apply a general exclusion requires careful consideration in every separate instance.
A growing trend in the critical illness marketplace over the past 12 months has been offering premium discounts to policyholders who take out policies with certain agreed exclusions. Several companies have already publicly stated that they are taking this route, and it is something that can be expected to be seen more of in the future. Clarity is required as to the circumstances under which such discounts will be offered and to whom. What is already clear, however, is that such discounts both appeal and appear fair to customers.
Discounts here to stay
Overall, exclusions are a viable tool in protection insurance. They can play a role in mitigating risk, reducing underwriting and speeding up acquisition. They are most valuable when imposed at the time of underwriting as before cover starts the applicant is made aware of and accepts the limitation of cover. The recent practice of allowing a discount for exclusions applied at the time of underwriting for disability covers is clearly here to stay.
Unsurprisingly, exclusions are unpopular; particularly when it may appear that the industry is hiding behind the small print. In addition, many general exclusions are not always easy to enforce at point of claim. Where possible, therefore, it would be best to ask questions upfront that will enable providers to assess risk at the application stage, instead of simply applying blanket general exclusions. A reduction in the small print can only be a good thing for customers at point of claim and further improve the reputation of insurers.
James Shattock is actuarial pricing manager at Hannover Life Re (UK)
