Over-insurance has been a concern to claims managers for some time, but it only hit the headlines wh...
Over-insurance has been a concern to claims managers for some time, but it only hit the headlines when the Office of Fair Trading (OFT) report on Health Insurance was published in 1997. The industry was criticised in the report for not giving sufficient warning to customers that a claim may not be paid if their income does not support their insured benefit. One of its recommendations was that annual checks should be carried out by insurers to minimise this risk. But are there already sufficient steps in place?
With life or critical illness cover, the plan is financially underwritten at outset and unless there is suspicion of fraud the sum assured is paid out. Income protection insurance on the other hand, is financially underwritten both at application and at the claims stage. This is reasonable as it is illogical to allow someone to be financially better off when claiming rather than working.
Problems should rarely arise where level benefits are chosen, unless of course, there has been misrepresentation at the start or a drop in income since the plan was taken out. The problems really start where automatic escalation of benefits is selected. The options generally are National Average Earnings Index (NAEI), Retail Price Index (RPI), or a flat percentage - typically 3%, 5%, or 7%.
Inflation proofing
There are advantages for both clients and insurers alike in allowing 'inflation proofing'. From the client's point of view it allows them to increase benefits without the bother of re-applying and being re-underwritten. An additional advantage is that such increases do not take into account any changes in health. From the insurer's viewpoint it allows modest increases to be administered without the need for manual intervention. If, however, these increases are not in line with income increases, there is a problem.
The majority of companies offer one or more of the following increase options:
National Average Earnings Index
This has varied between 3.6% and 6.5% over the last 12 months. The problem with this index is that it is based on the average remuneration of employees regardless of their standing in the company. If you look at published figures of, for example, chief executives employed in FTSE 100 companies, their average salary increase has been 11.5%. As well as basic salary, the index takes into account overtime and bonuses. These factors artificially inflate the average and it is not difficult to see that the average person on the street will not achieve these levels.
Retail Price Index
Many companies use this to determine their overall salary budget. Therefore, it is more in line with the actual increases achieved by the majority of employees. This is the most common rate of increase available on income protection plans.
Flat percentage increase
This is typically 3%, 5%, or 7%. At the lower end of 3%, it is unlikely to cause problems with over-insurance as this is currently close to RPI. Where a higher percentage is selected the same problems arise as with NAEI.
So what is the best option? This will clearly depend on the insured's occupation. For the majority of the employed, it makes sense to have some kind of inflation proofing. For 'high-flyers' expecting higher than average salary increases, it would be worth considering a plan which allows ad hoc top-ups as and when required. This does mean that increases will need to be applied for and underwritten, but benefits will at least be in line with actual salary rather than there being a shortfall.
The self-employed
For the self-employed, it may be better to look at a level plan which permits ad hoc increases. An important point that must be considered for this sector is definition of earnings. Since the introduction of the ABI Code of Practice last year, a standard industry definition has been introduced and this is 'pre-tax profits after deduction of trading expenses'. This description should eliminate the confusion that has previously arisen.
It has been common in the past for the self-employed to overestimate their level of earnings, particularly among those just starting up in business. It is far better to recommend your client goes for a lower, more realistic benefit at the start which can be increased as and when appropriate.
From an adviser's point of view, how do you stop your clients from becoming over-insured?
Obviously, the first thing to check is the maximum benefit formula and what else can be covered, for example, P11D benefits, overtime and dividends. Another important check is what deductions are made against this at claim. For example, are State benefits deducted whether received or not?
Are payments reduced by any waiver of pension contributions or other waiver benefits being credited to other insurance plans?
It is also worthwhile checking whether payments will be reduced by any mortgage payment protection insurance payments or other short-term sickness and accident plans being paid. This is particularly important, given the recent increase in the number of borrowers taking out this cover. These factors will all make a difference as to what is actually on offer.
Also check the company's attitude to over-insurance.
Company practices vary but key features documents should clearly state whether or not premiums will be refunded in the case of unwitting over-insurance.
Also find out what documentation the client can expect to receive after the plan has been effected.
If an escalating plan has been selected, a letter is sent on each anniversary advising the increased benefits and premium. This will serve as a check on whether the benefit is still appropriate.
It is also useful to check whether benefits can be changed if they become unsuitable.
There should always be sufficient flexibility in place so a plan may be altered if the benefit is no longer appropriate. This may be by policy amendment or a new plan may have to be written, but clearly the more flexible the options the better.
If when it comes to a claim the client is over-insured, do not panic. Companies do not want to cause any more distress at an already stressful time. The sooner the company is in possession of the facts, the sooner they can make a judgement. At the end of the day, we are here to pay claims, not reject them.
Diana Harding is business development manager, marketing, at Canada Life
