We operate in an era where honest and clear disclosure is a prerequisite for providing advice that enables a client to make an informed decision. Coupled to this is the need to explain material terms and conditions at the contracting stage.
The latter are extremely difficult for those of us not entrusted with a crystal ball, and the ability to read it.
Take for instance the situation that arises when a client wants to effect a section 14 transfer. This could be for any number of reasons, such as dissatisfaction with investment returns or the costs associated with older-generation contracts. The point is that customers should not face unreasonable post-sale barriers when they want to change a product, switch provider, submit a claim or make a complaint, as is clearly outlined in outcome 6 of the TCF mantra.
When the original contract is signed, none of the parties involved really considers this. In fact, the mere mention that a client may incur penalties calculated at the discretion of the insurer could easily scupper the deal, so mum’s the word.
A broker recently shared feedback from an insurer’s “internal arbitrator” after laying a complaint about what she regarded as exorbitant causal event charges when her client wanted to transfer a conventional retirement annuity to a unit trust-linked one.
How are causal event charges calculated?
Well, only the actuaries appear to know, and they aren’t telling, despite the fact that the Long-term Insurance Act provides very specific principles on which the charges must be based.
The following is an extract from the internal arbitrator’s response:
In the contract document, under Description and Provisions, it is mentioned that if early termination is requested (after age 55), the values of the policy will be adjusted as determined by the insurer at the time. It is also explained how the charges are deducted annually from the contributions received.
One has to distinguish between an insurer’s expenses and charges.
Insurers incur expenses in respect of every policy they provide. Some expenses (direct expenses), like intermediary remuneration, relate directly to each policy. But many expenses (indirect expenses) do not relate directly to each policy – for example, salaries, advertising, office rent and information technology costs.
All these expenses (direct and indirect expenses) are the normal expenses of running the insurer’s business. It follows that insurers have to recoup these expenses. They do so in broadly the same way, namely by deductions from the premiums of the policies, and from the investment funds to which policies that provide investment benefits are linked.
These deductions commonly are called charges. That is what they are called also in the regulations under the Long-term Insurance Act.
A lot of these expenses in respect of a policy – for example, remuneration of intermediaries – are incurred and paid by the insurer upfront, when the policy begins, or if and when its premium is increased. These expenses customarily are not also recouped upfront, by means of charges deducted under the policy. Instead, a lot of the expenses are recouped by deducting charges in small portions over the full contract term of the policy.
This arrangement of recouping the expenses in small portions over the full life of the policy generally is to the advantage of the policyholder. Because of this arrangement, larger amounts can be invested and “work” for the policy from the outset.
Insurers sometimes are asked to provide a full and exact account of the expenses they have incurred in respect of a particular policy. That is something they practically and commercially cannot do.
It simply is not feasible to apportion individually to every policy expenses that do not relate directly to that policy – like salaries, advertising, office rent, and information technology costs. Even many expenses that do relate directly to that policy cannot meaningfully and practically be apportioned to it individually. For example, enquiries about a particular policy obviously bring about expenses in respect of that policy. To keep track of those enquiries and their attendant expenses, for that policy individually and exactly, would not be commercially meaningful and viable.
Some policies cost more to issue and operate than others. The underwriting requirements, for example, are more complicated for some policies than for others. To work out and keep account of the issuing and operating expenses of each policy individually and exactly, simply would not justify the cost of doing so.
The commission the insurer pays to an intermediary in respect of a policy usually is the only significant expense that can be allocated individually to that policy.
The plan (policy) of the complainant is a long-term contract, which is designed and structured on the assumption and basis that it will run its full contracted term. If the policy is terminated early, before the end of its full contracted term, the insurer then has to recoup the expenses not yet recouped, by deducting a single amount from the policy, which is known as the early termination charge. This happens also when a retirement annuity policy is terminated early, to transfer the retirement benefit to another retirement annuity fund.
Many expenses are accounted for a group of similar policies (which can be many thousands of policies) and spread between all those policies. The charges of policy products, and how they are determined, are described in the actuarial basis (rules) of the policy product.
More questions than answers
- The industry is known for the huge turnover of financial advisers. What happens to commission when an adviser leaves the industry? Does the insurer just stop paying it, which means the client must reap the benefit? The commission the insurer pays to an intermediary in respect of a policy usually is the only significant expense that can be allocated individually to that policy.
- Any business has expenses. While it is understandable that unrecouped commission may be recovered, one has to wonder why the insurer is allowed, legally, to recoup future expenses, at the expense of the client.
- In most instances, no causal event penalties are charged if the section 14 transfer is internal. While one can understand that the expenses will remain the same, what about the unrecouped commission?
The internal arbitrator concludes his findings as follows:
In my understanding and respectful view, (the insurer) has calculated the early termination charge for your policy correctly, in accordance with the contractual provisions of the policy, the actuarial basis (rules) of the policy, and the applicable regulatory prescriptions.
That may very well be the case, but how does this measure up to TCF outcomes?
