When should an option be mandatory? [CPD Quiz]

04 June 2018

Young businesswoman with glasses sits at her table in her dining room and researches insurance on her laptop

Katherine Ashby

Katherine Ashby is a Senior Product Technical Manager, Life Insurance at BT.

This article considers the most common optional benefits and ‘Plus’ style contract definitions in insurance, and which clients they may be appropriate for.

One of the most common phrases I’ve heard this year is: “Clients are more price conscious than ever.” One only needs to read a newspaper or turn on the news to hear about low wage growth, increasing expenses and a common push to consumers to continually review any products and services they have to ensure they are really necessary. The ‘second cheapest bottle of wine’ method is dictating a lot of household purchases.

So it may come as little surprise that many advisers are pushing back on additional benefits or ‘Plus’ type policies, in an effort to manage their client’s premiums.

Caution needs to be exercised when making these decisions to ensure the client fully understands the implications of these decisions. Most people aren’t familiar with life insurance policies, let alone benefits and definitions, so quite a detailed explanation and cost-benefit conversation is required.

A question to ask is: ‘Was this my client’s decision or was it mine?’ Without a detailed conversation, the client is unlikely to understand the optional benefits, and what leaving them off means for them in the event of claim.

Advisers also need to consider their obligations under the Best Interests Duty. As the advice provider, you are the one who is knowledgeable as to the client’s needs, along with the products and features that are available. Best Interest means recommending a strategy and product that will meet your client’s particular needs.

In this article, we’ll consider the most common optional benefits and ‘Plus’ style contract definitions, and which clients they may be appropriate for.

Increasing claims for Income Protection

Whether due to affordability concerns, or the expectation that some options are simply ‘nice to have’, the Increasing Claims Benefit now seems to be missing from many recommendations. This is unusual and was last seen during the GFC when investment advisers began giving insurance advice, often not aware of what the Increasing Claims Benefit was.

Since then, numerous insurers built-in the Increasing Claims benefit, as it was ordinarily selected on close to 100 per cent of policies, and where it was not, it was often a mistake. Over time, however (often to increase Income Protection pricing), many insurers have changed it back to an optional benefit. There is only one remaining insurer with the Increasing Claims Benefit built-in.

If this benefit is left out, how does the recommendation meet the Best Interest obligation?

Best Interest requires an adviser to identify their client’s needs and objectives and recommend solutions. If an objective includes maintaining the client’s family’s income until retirement, this cannot be achieved without the Increasing Claims option included.

The courts and ASIC have previously pointed out that advisers must take into account the suitability of the product over the duration of the need (i.e. if income is required up to age 65, then will this policy be suitable over that period of time?).

A policy without Increasing Claims will become less adequate, as the income remains stagnant while cost of living rises. Just imagine trying to pay today’s rates, utilities, car registration and other expenses on your income from 1995.

It is understandable that Increasing Claims may not be needed for policies with two or five year benefit periods, or where the client has less than five years to retirement. But many of the examples we’re seeing are for clients in their 30s and early 40s.

Superannuation contribution options

In general, a client can insure up to 75 per cent of their income under a monthly benefit, up to an income of $320,000 per year. After this, the ratio declines. Given this covers over 99 per cent of Australians, we’ll stick with those earning up to $320,000 for the purposes of this example.

Insurable income doesn’t just include base salary, it also includes superannuation, ongoing quantifiable allowances, regular bonuses and any other part of a salary package that is consistent and can be relied upon.

For example, with a base salary of $100,000, a consistent annual bonus of $10,000 and superannuation guarantee payments of $10,450, a client’s insurable monthly benefit is 75 per cent of $120,450, divided by 12, or $7,528.

This represents a 25 per cent reduction in income for the client if they go on claim; a hefty amount if you consider how many of us save much of our income at all, let alone 25 per cent. In the event of claim, the client will receive this full amount directly, and it is unlikely any of it will be saved into superannuation.

Superannuation contribution options work a little differently with each insurer, but the most common is to allow an additional 5 per cent of insurable income. So, for our client above, she could also insure about another $500 a month (or $6,000 a year) utilising this option. This only takes the client to 80 per cent of pre-disability income, which is still a significant shortfall, and yet superannuation options aren’t utilised in the majority of recommendations.

Why not? By being an optional benefit, it seems to have become a ‘nice to have’. Yet if this benefit was built-in, and we suddenly talked about some insurers covering 80 per cent of income versus some covering 75 per cent, many advisers would say they needed to recommend an 80 per cent insurer to meet their client’s needs and their Best Interest Duty obligations.

There’s a great deal of public discussion of the implications on retirement savings for periods of time outside the workforce, usually focusing on parental leave. Your client, with a to age 65 or 70 benefit period, could end up having decades on a claim if their sickness or injury was serious enough, and their retirement savings would suffer considerably. If the objective of income protection is to maintain their household income through to retirement, have you considered what happens when they reach that age?

Day 1 Partial

Day 1 Partial is a definition, rather than an optional benefit. Each insurer differs on which policies and occupations receive Day 1 Partial. The top Income Protection policies for white collar professionals nearly always include this definition, while it can be more hit and miss for standard Income Protection policies and blue collar occupations.

Day 1 Partial refers to the level of disability required during the waiting period. The policy may list a 30 or 90 day waiting period, but the policy also includes terms setting out how disabled the individual needs to be during that waiting period. More restrictive policies will require a period of time during the waiting period when the insured is totally disabled. Day 1 Partial means the insured can be partially disabled from Day 1, without requiring any period of total disability.

With Day 1 Partial, the waiting period will continue under any of the following situations:

  • Partially disabled during the whole waiting period;
  • Partially disabled during the first half of the waiting period and totally disabled during the second half;
  • Totally disabled during the first half of the waiting period and partially disabled during the second half;
  • Totally disabled during the whole waiting period; or
  • Any other combination of total and partial disability.

This flexibility is particularly useful for self-employed clients who need to be working in some capacity if they have the ability to do so. In fact, the Financial Ombudsman Service (FOS) pointed out in the 2011-12 annual review that policies which require periods of total disability during the waiting period are not considered appropriate policies for those who are self-employed. In other words, Day 1 Partial should be mandatory for a self-employed client.

The best way to explain the ‘why’ behind Day 1 Partial is to talk about examples where someone may not be totally disabled from the word go. Conditions like degenerative diseases that deteriorate rather than get better are useful examples, or conditions that are episodic in nature (where the person’s level of disability goes up and down).

Working out whether a policy has Day 1 Partial will require using research software or reading the PDS. This is one of those definitions that can significantly outweigh a whole host of ancillary benefits for some clients.

Partial benefits for trauma

I’ve seen more recommendations this year for standard trauma than I have over my entire career. Standard trauma means different things with different insurers.

For some it will mean only some of the full payment conditions apply, for example, 15 out of a usual 45. For others it may mean that all of the full payment conditions apply but there are no partial benefits. For some, to get all the full payment and partial payment conditions, you would need to select the top trauma and select an extra benefit option called ‘partials’.

These differences can make standard trauma policies harder to compare than Plus/premier trauma policies.

At times, we see pricing being compared between a policy with 15 full conditions and five partials, and one with 45 full conditions and zero partials. How can both these vastly different policies be suited to clients’ needs?

The pricing difference between standard and Plus isn’t large, ranging between 5-20 per cent, with most policies somewhere in between.

So, when it comes to personal cover, when do a client’s needs dictate a requirement for trauma, but only in the event of a full claim?

Take cancer as an example. Let’s say our needs analysis is made up of funds required for medical expenses and top up income. Can I comfortably say that if my client meets the definition for a partial, but not a full claim, then suddenly those medical and top up income needs no longer exist?

There are two other questions to ask at this point as well.

Did you discuss with your client the difference between cover that will provide partial claims for diagnosis at an earlier stage (for conditions like cancer) or the loss of sight in one eye, and cover that will only provide the full sum insured? And were you both comfortable that in the event they were only blind in one eye, or met the early stage cancer definitions, that no cover was required?

The second question is, will they remember? Partial trauma events are still very serious, and sometimes permanent – e.g. diseases, conditions and injuries. It will be a major life event for your client. Being diagnosed with cancer and being unable to claim on a trauma policy they purchased, is likely to lead to severe client dissatisfaction.

There’s no doubt insurance is a considerable expense in any household budget and can be considered a grudge purchase, rather than something people see immediate benefit from, but optional benefits and definition choices can be extremely important.

If clients, and in some cases advisers, aren’t aware of the differences between policies, then the obvious choice is to choose the cheapest. If those policies are like for like, then by all means, price can be a leading determinant. But beware of stripped back policies, which in many cases, are cheaper for a reason.

Katherine Ashby, National Manager – Product Technical, BT.

 

Footnote

1. ATO Taxation Statistics 2015-16.

 

QUESTIONS

To answer these questions for your 0.5 CPD hours, go to fpa.com.au/cpdmonthly

1. Which of the following is not true in relation to an Increasing Claims Benefit?

a. It is always built-in to the policy.
b. It is designed to ensure claim payments increase with CPI over time.
c. It may be built-in or optional.
d. Assists those on an income protection claim keep up with increases in the cost of living.

2. Tom earns a base salary of $150,000, receives a regular bonus of $20,000 and receives $14,250 in superannuation guarantee contributions. A 5 per cent Superannuation Contribution Option would allow Tom to insure what additional amount of his monthly income to take it from 75 per cent to 80 per cent?

a. $575.
b. $687.
c. $767.
d. $875.

3. For which of the following clients is Day 1 Partial an important definition of income protection?

a. A non-working homemaker.
b. A retiree.
c. A full-time student.
d. Self-employed.

4. A difference between standard and plus trauma contracts is:

a. Some/all partial benefits may be added with Plus cover.
b. Some full benefits may be added with Plus cover.
c. Both A and B.
d. Plus polices have higher maximum sums insured.

5. Which of the following describes Day 1 Partial?

a. Totally disabled throughout the waiting period.
b. Totally or partially disabled through the waiting period.
c. Partially disabled on day one, then totally disabled for the remainder of the waiting period.
d. Disabled for one day during the waiting period.

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