On red alert?

When a client buys a protection plan they hope they will not have to claim. But if the worst comes to the worst, it is absolutely essential they can rely on the plan to pay out. The majority of claims are paid promptly and we should always keep this in mind. However, if a claim does go wrong, it can have devastating implications for everyone concerned ' the client, their family and the relationship with their IFA. Not only is it bad news for the client, it is bad news for the insurer and for the industry as a whole.

By far the most successful protection product of recent years has been critical illness (CI) cover. Over the next few years, critical illness products are going to go through a 'baptism of fire' that will either make or break the reputation of the product in the eyes of the consumer. To understand why this is, and to ensure that the product passes this test with flying colours, we need to understand the dynamics of how sales and claims are related.

An exploding market

In the last two years, over 1.5 million critical illness policies have been taken out in the UK. Customers are giving critical illness cover a resounding vote of acceptance. It is estimated that there are now around 3.5 million policies in force in the UK. If we assume that around half of these policies have two lives assured and that a quarter also cover two children, we can estimate that there are over six million people on schemes with a total of around £250bn of cover.

One journalist recently reported in a national newspaper only around 2% of CI policies would pay out. Our healthcare pricing team made some calculations that proved this to be a considerable underestimate. However, if you accept the 2% figure, it would imply the policies will pay out around £5bn pounds to critically ill people.

These payouts will be a huge benefit, not just to the individuals concerned, but also to society in general. So far, one estimate puts the total claims paid so far at around £350m. Compared to the amount we expect will be paid, even on such conservative assumptions, why is the amount paid out so far so small?

The answer to this is because the sale of critical illness plans has grown exponentially. Around half of all plans in force have been taken out in the last 24 months. As a result, they have not had time to come to fruition.

When someone takes out a policy, the underwriting process screens out people whose health is already poor. This means a group of people who have been accepted for critical illness cover are less likely to claim than the same number of people drawn at random from the population. This is sometimes called 'the select effect'. Experts do not always agree as to how long the select effect lasts, but perhaps a fair estimate is about four years after underwriting. This means policies have a 'honeymoon' period which wears off after four years. In this period, claims will be less than we would expect later on in the life of the policy.

Claims will also increase as the people who buy policies get older. The average age of a person buying CI today is mid to late 30s. Currently, only about one in 25 lives assured are over the age of 50, but over time this will increase as policyholders grow older.

So as those covered become older and as the select effect on the number of policies taken out in the last few years wears off, we can expect to see a huge rise in the number of claims the industry will pay.

Make or break

Lots of policies being taken out will result in the numbers of claims following on behind. How the industry handles this explosion of claims will either make or break the reputation of the product. Every individual claim can have either a positive or a negative effect on the market as a whole.

On the positive side, every time a policy pays out without fuss as expected, it has a halo effect on the market. The family, friends and work colleagues of the person involved hear about the illness and, of course, that their mortgage was paid off by this 'marvellous CI policy'. Naturally, if the friends and family have a policy, it makes them value it and reinforces their decision to take it out. If they do not have a policy, it surely encourages them to reach for the Yellow Pages and find the nearest IFA to find them the best critical illness plan for them .

However, the reverse is also true. Each time a claim is disputed, everyone who knows the person gets to hear about it. Sometimes even the media get involved and the negative effects spread across a much wider audience. When someone reads the article or hears the story they often forget which company was involved. They simply remember that insurance companies do not pay out and, bit by bit, the policies become a little harder to sell.

When these expected claims start to arrive in the sort of volumes we expect, which of these factors will prevail? Will it be the positive influence that wins and sales will continue to grow? Or will it be the negative effects that will stunt the growth of the product?

Surely the answer lies in how we, as an industry, handle these claims. The very reputation of the product is at stake so it is up to everyone who values critical illness to protect the reputation of the product ' IFAs and insurers alike. As we are all in this together, what can we, as an industry, do?

A key factor will be to reduce the number of disputed claims. One of the most contentious reasons why a policy may not pay out is because something important was missed from the application form. This would be where a 'material fact' was not disclosed to the underwriter.

Important omissions

The way insurers should approach this is set out in the Association of British Insurers (ABI) Statement of long term insurance practice. If something is omitted from the application form, insurers should not use this to decline a claim or void the policy unless:

l It is a 'material fact' ' this means it would have affected the assessment of the risk by the underwriter.

l It was a fact known to the applicant at the time.

l It was a fact the customer could reasonably be expected to disclose ' this means in the context of the question on the application form that was asked.

Material facts that are missed when the policy is taken out will almost certainly come to light at point of claim. This is because the claims process is about understanding the medical history that resulted in the illness, so we can prove that the customer is critically ill. And, if material information about the customer's health has been omitted, this is likely to be the root of the cause of claim.

Non-disclosure attacks the heart of critical illness cover because it threatens the client's ability to rely on the cover when they need it the most. So, what can IFAs and insurers do to minimise the effects to ensure the client has total peace of mind?

Again, this is covered by the ABI Statement of long term insurance practice which demands that insurers do the following three things:

l First, draw attention to the consequences of failing to disclose any material facts. This usually means including a warning on the application form. However, it would be worth IFAs reinforcing this reminder to clients.

l Insurers need to point out, if the applicant is in any doubt about disclosing a fact, it should always be disclosed' in practice, this also helps to speed up the processing of the application form too. Often, if that extra bit of medical evidence is given, it can save the underwriter asking for more information or asking for a GP report. No claim has been turned down because too much information was included in the application. This is also an area where IFAs can encourage clients to go the extra mile.

l Finally, areas that have proved to be material in the past should be the subject of clear questions in application forms. All insurance application forms need to be clear and ask unambiguous questions. Lots of concise, but specific questions are preferable to a few open questions (even if they take longer to complete) because they prompt the customer to remember specific details about their medical history that they may have otherwise forgotten.

The application form is the most important piece of material in taking out any insurance policy. It should also be totally clear to help the customer ensure that they can rely on their cover.

Helping to reduce disputed claims is an area where IFAs and insurers share a common interest. IFAs can play a key role in reinforcing the importance of getting it right at the point of sale, and ensuring the customer will have a trouble-free claim if the worse comes to the worst.

The entire reputation of the product and its future success depends on it.