- What is life insurance?
- Different types of life insurance contract
- Termination of life insurance contracts
- Life insurance policies are generally unsecured
|
||
| PART I - BACKGROUND |
|
|
2. THE NATURE OF LIFE INSURANCE CONTRACTS
What is life insurance? 2.1 The Life Act defines a policy of "life insurance" as:
... any contract, so long as such contract remains in force, heretofore or hereafter lawfully entered into by a company, the terms of which are dependent upon the contingencies of human life:
2.2 In the Court of Appeal case Marac Life Assurance Limited v Commissioner of Inland Revenue [1986] 1 NZLR (694) Cooke J cited the definition contained in the opening words of Bunyon on Life Assurance (5th ed, 1914) p. 1:
The contract of insurance has been defined by Tindal CJ to be that in which a sum of money "as a premium is paid in consideration of the insurer's incurring the risk of paying a larger sum upon a given contingency" ... The contract of life insurance may be further defined to be that in which one party agrees to pay a given sum upon the happening of a particular event contingent upon the duration of human life, in consideration of the immediate payment of a smaller sum or certain equivalent periodical payments by another. This consideration in money is termed the premium or premiums, and is paid either in one sum, when it is termed a single premium, or by a succession of periodical instalments.
2.3 In the same case McMullin J noted that the above definition had been cited by Windeyer J in National Mutual Life Association of Australasia Ltd v Federal Commissioner of Taxation (1959) 102 CLR at p 43, who had added:
This description covers the three forms which, historically, life insurance has taken, and which, singly or in combination, are the essence of a life insurance policy. All such policies are basically either term policies, whole of life policies, or endowment policies.
2.4 The essential elements of an insurance policy are risk and uncertainty. In the case of a life insurance policy, the uncertainty element is generally a contingency of human life.
2.5 Life insurance companies offer a wide variety of contracts, some of which involve savings or investment elements along with some risk cover and others of which involve only risk cover.
2.6 The industry classifies life insurance policies as either "conventional" policies, subdivided into "whole of life", "endowment" and "term" assurance, or "unbundled" life policies, subdivided into "capital stable" and "equity linked".12
2.7 The "whole of life" contracts include both insurance cover and a savings element. Many are "with-profits" policies. These contracts could involve payment of premiums for 30 - 40 years with payment of an accumulated capital sum on death or (as an industry practice) on reaching an advanced age.
2.8 "Endowment" policies usually involve payment of regular premiums by the policyholder and then payment by the company of an accumulated sum plus bonuses at a specified age, say 65 or on earlier death. In the event of early death there would be payment of a specified sum, plus accumulated bonuses at that time.
2.9 The conventional contracts are sometimes called "bundled" because the savings and risk components of the contract and the expenses charged to them are not separately identified.
2.10 The "unbundled" policies include fixed-term fixed-interest investments, often called insurance "bonds". The Marac case (see para 2.2) related to insurance bonds. The only insurance element in these contracts may be the provision for early repayment in the event of death during the investment period. Other unbundled policies are similar in nature to unit trusts, with a fixed investment (or single premium) being invested (at the investor's option) into a particular group of assets (for example, property, equities, fixed interest securities, or a mixture) and with the return to the investor being determined by the return on the particular group of assets
2.11 Term or "pure" life insurance contracts provide for a payment during the period of the contract only if the specified contingency occurs during that period. There is no saving or investment element. Such policies are not covered by the Securities Act and Regulations.
2.12 A common feature of the more traditional life insurance contracts is that they are long- or very-long-term contracts frequently with uncertainties as to both the timing and amount of payments to be made to the policyholders. Some life insurance policies are for fixed and generally shorter terms. We are aware that some life policies may be for periods as short as 90 days. In the past some companies have issued call life bonds. These securities differ little from debt securities
2.13 Generally speaking a policyholder is unable to sell his or her interest in a life insurance policy, although we have been aware of a small secondary market being developed in New Zealand for the buying and selling of interests in life policies.
2.14 Where a policyholder wishes to realise an interest in a policy before its termination date the main option available is to surrender the policy back to the company.
2.15 Most life insurance policies have a surrender value, defined in clause 1.9(g) of the Code to mean:
... a policy having a cash sum which may be available to the policyholder in the event the policy is surrendered earlier than expected maturity, or prior to death (but shall exclude the return of any unexpired premium in relation to a pure risk policy).
2.16 Because of the high front-end selling costs of life insurance policies (see para 3.2 onwards for further discussion on this point) the surrender values of most regular premium policies are low or non-existent in the initial years of life of the policy.
2.17 Policy surrender values for each type of policy are determined by the company. We understand the values can depend on a variety of factors including investment performance, claims experience, the level of expenses incurred in the sale and ongoing administration of a policy, the likely pattern of policy discontinuances, and, in the case of proprietary companies, the dividend aspirations of the company's shareholders .
2.18 Surrender values may or may not be expressed as being "assured" by the company, depending on the terms of the contract. The so-called "capital stable" policies generally include a commitment by the company to maintain a minimum surrender value related to the amount of the policyholder's accumulated premium payments.
2.19 Mr James Richardson-Hay, Assistant General Manager (Finance) and chief actuary of Guardian Assurance Limited (incorporated in New Zealand)13 , in a paper "Solvency Issues for Life Offices" prepared for an address given to the New Zealand Society of Actuaries ("the Society") on 3 June 1997, said:
There are a number of ways life offices can protect themselves from insolvency. They can use cop out or weasel clauses. These in effect are actions which adversely affect policyholder expectations. Main examples include:
- Expenses can be deducted from policies as and when required. Higher charges levied on existing products i.e management charges.
- Reduction in bonus declarations and/or removal of terminal bonuses. Reduction in surrender terms.
- Payments under provisions included in policy documents are deferred until conditions improve.
- Unit prices determined by life office. Methods can be both vague and unclear with wide parameters for calculation.
- Unilateral introduction and imposition of withdrawal penalties. [Original emphasis]
2.20 These observations are equally applicable whether the life company is a proprietary company, with shareholders' funds, or a mutual company, with reserves, as protection against insolvency.
2.21 In future, now that life insurance companies are required to issue investment statements for their products, we expect to see greater transparency in the disclosures to prospective investors at the point of sale of the companies' fees and charges, including those which would apply on ultimate surrender or maturity of the policy.
2.22 The protection afforded to policyholders seeking to surrender their insurance policies in New Zealand differs profoundly from the position in Australia. We discuss this issue in a later section of the paper (see para 8.24 onwards).
Life insurance policies are generally unsecured
2.23 In almost all cases the obligations arising under life insurance policies in New Zealand are unsecured obligations of the companies concerned. In a few cases policyholders have the benefit of a guarantee from a third party.
2.24 The question of security becomes relevant where a life company has borrowed funds and/or given security over its assets to a third party in competition with or in priority to the claims of its policyholders. The giving of such security can affect the position and prospects of both existing and prospective policyholders.
2.25 From the point of view of the prospective investor we think that the disclosure of such borrowings, of the giving of any prior security, and of the company's ability to undertake such borrowing and to give such security are important.
2.26 Issues may also arise with respect to the position of existing policyholders at the time a life company gives security over its assets to a third party. Relevant factors include whether existing policyholders were aware of the company's ability to pledge its assets to outside parties, whether existing policyholders were informed of the giving of the security, and the costs of terminating the policy if the policyholder wishes to surrender it back to the company.
2.27 We have observed that life companies in New Zealand can and do borrow from external parties on security which ranks ahead of or in competition with the claims of policyholders (see para 6.1 onwards). They may do so without the prior knowledge of policyholders.
3. THE SELLING OF LIFE INSURANCE CONTRACTS
3.1 Life insurance contracts have traditionally been sold on a commission basis. Companies use both "tied" agents i.e. those who are contracted to sell the products of only one company, and brokers or investment advisers, who might sell products offered by a number of companies. The amount of commission paid to agents varies between companies and products but has been in the range of 60% - 100% of the first year's premium for regular premium contracts14 .
3.2 One of the consequences of commission selling is the strong incentive for the aggressive marketing of life insurance contracts. Another consequence of this form of selling is that there tend to be high front-end costs for most policies sold (sometimes referred to as "new business strain"). This cost pattern has implications for the policyholder who terminates the life insurance contract in its early years.
3.3 We note that life companies have changed their selling practices in recent years to try and reduce selling costs and to give greater rewards to their agents for selling good business ("persistence") as opposed to just any business. Where a policy lapses in its early years a proportion of the commission which had been paid to the agent is "clawed back" by the company15. Alternatively, payments of commission are structured such that initial payments are relatively lower, with further payments spread out over the early years of the policy so long as the policy is maintained by the policyholder. Either way, there are now incentives for the agent to ensure that policies sold meet the needs of the client and are affordable.
3.4 3.4 Some life companies, particularly but not only those operated by banks, also undertake direct selling through the mail. While these policies have low or no commission costs, we are informed that, because of low take-up rates, distribution costs of policies sold by mail can be just as high (proportionately) as the costs for policies sold on commission.
The Code of Business Practices for Life Insurance Companies
3.5
The Code was developed by the Life Office Association of the New Zealand ("the LOA") in the period leading up to and following the enactment of the Securities Amendment Act 1988. The LOA had agreed to develop a suitable code of selling practice for life insurance companies to coincide with the introduction of the section 7A authorisation procedures. Compliance with the Code was to be a condition of authorisation.
3.6
The Code was approved by the Commission in June 1989 and came into force on 1 January 1990. Several amendments have been made to the Code since 1990, with significant changes covering collateral business, benefit projection procedures and establishment of the Insurance and Savings Ombudsman Scheme. The Code no longer has the backing of the authorisation procedure. Its future coverage is uncertain.
3.7
The Code set out the types of information which were to be disclosed to prospective policyholders, either on request (e.g. the company's latest audited financial statements, a specimen of the appropriate life policy, and a copy of the completed life policy) or as of right (a statement of policyholder rights).
3.8 The Code provided for a "free look" period of seven days for single premium policies and fourteen days for policies with periodic premiums. During the free look period the new policyholder was entitled to withdraw from the investment and to receive a full refund of the premium paid without penalty.
3.9 The Code also covered companies' use of benefit projections in the selling process. Life companies would frequently provide a prospective policyholder with a projection of the future benefits likely to arise for a given level of investment and on various yield assumptions. The Code included provisions designed to ensure realism in the projection rates used. Benefit illustrations were to be provided to the client in writing and were not to be misleading nor give unrealistic expectations.
3.10 Where a life insurance company, as a lender, required a borrower to take out life insurance cover in order to comply with a condition of the loan or to provide security for the loan the Code provided that the borrower must be informed that the life policy (a collateral policy) could be taken out with any company of the borrower's choice. It was also a Code requirement that the amount of the policy be no more than was reasonably necessary to protect the prospective interests of the lender and the borrower.
3.11 The Code included a complaints procedure. When the Code was introduced in 1990 the complaints procedure involved referral to the LOA's Business Practices Committee16 if the complainant could not resolve the matter directly with the company. If either party considered that the matter was not satisfactorily dealt with by the Committee there was a right of appeal to the Review Authority, who was retired chief district court judge, Mr Peter Trapski CBE.
3.12 The Review Authority had the power to refer serious or persistent breaches of the Code to us. Mr Trapski reported annually to us on the exercise of his responsibilities. He considered very few cases. He did not refer a case of serious or persistent breaches of the Code to the Commission during his tenure, which ended on the establishment of the Insurance and Savings Ombudsman scheme in early 1995.
3.13 The Code was amended in 1995 so that the primary person handling complaints about life company practices was the Insurance and Savings Ombudsman (or, if the company chose to submit to that jurisdiction, the Banking Ombudsman).
3.14 Generally all complaints relating to life insurance companies, and the administration of the Code more generally, have been undertaken without reference to us, but in the knowledge that we could review the authorised status of any life insurance company if circumstances warranted this. Where complaints were made directly to the Commission we referred them to the company concerned, to the LOA or to the Insurance and Savings Ombudsman for resolution. We undertook detailed analysis of particular circumstances in a very few cases, where there appeared to be evidence of a wider market practice on which we might wish to comment.
3.15 The commitment of life insurance companies to abide by the Code no longer has its present force as a result of the revocation of sections 7A and 7B. Compliance with good selling practices, subject to compliance with the law, is a matter of company policy, agreement between life companies and the Insurance Savings and Investment Association ("the ISI")17 if the Code or something similar continues to apply, and the determinations of the Insurance and Savings Ombudsman. The future of the Code could be influenced by what we understand is some dissatisfaction among life insurers with some of the provisions of the present Code, particularly those relating to benefit projections.
3.16
Under the newly-amended securities law18 where an advertisement for securities includes prospective financial information (including benefit projections) the principal assumptions and methods of calculation for those benefit projections must either be included in the registered prospectus for the product being offered or, if there is no prospectus, in the document containing the benefit projection. 3.17 The new investment statements17 will be required to provide details of the fees and charges imposed on life insurance policies.
3.18 We understand that most if not all life companies will remain members of one or the other of the available ombudsman schemes.
Other Securities Act provisions related to life insurance selling processes
3.19 The Commission's interest in the selling of life insurance products has not been limited to transactions covered by the Code.
3.20 Life insurance advertisements, brochures and other selling material are classified as "advertisements" for the purposes of the Securities Regulations 1983. As such the advertisement is not permitted (regulation 8) to:
... contain any information, sound, image, or other matter that is likely to deceive, mislead, or confuse with regard to any particular that is material to the offer of securities contained or referred to in the advertisement.
3.21 We have powers, under section 38B(1) of the Securities Act20, where, at any time, we :
... [are] of the opinion that an advertisement--
(a) Is likely to deceive, mislead, or confuse with regard to any particular that is material to the offer of securities to which it relates; or
(b) Is inconsistent with any registered prospectus referred to in it; or
(c) Does not comply with [the] Act and regulations made under [the] Act--
to make an order prohibiting the distribution of that advertisement or any advertisement which relates to the offer of securities.
3.22 Since July 1989 we have, on several occasions, exercised our powers under former section 44A to prohibit the advertisements of life insurance companies. We did not find it necessary to publicise those prohibitions or to issue public warnings concerning investment with any particular life insurance company. Companies have immediately withdrawn or amended advertisements where there was a problem of compliance with the Securities Act or Regulations.
3.23 We have not, however, as a matter of practice, routinely scrutinised life insurance company advertisements. Where matters arise we prefer that they are dealt with in the first instance by the Advertising Standards Complaints Board21 where it has jurisdiction. Most of our formal interventions have related to promotional material other than that appearing in the media.
3.24 In the process of selling life insurance products companies have also been obliged to comply with other statutory provisions including those in the Fair Trading Act 1986 and the Consumer Guarantees Act 1993.
3.25 In addition the Investment Advisers (Disclosure) Act 1996 applies in respect of the offer of life insurance policies to the public.
Footnotes
- These are statistical classifications used by the life industry's representative body, the Investment Savings & Insurance Association of NZ Inc ("the ISI").
- These comments were made by Mr Richardson-Hay in a personal capacity and do not necessarily reflect the views of his employer.
- See para 3.4.9 of the Commission's "Review of the Business Practices of Investment Advisers and Financial Planners - A Discussion Paper" published on 1 September 1992
- It is evident from our review of life insurance company financial statements that some companies disclose quite significant debtor accounts for moneys owing to them by their agents. These debts can arise both from commission claw-backs and from "agency development loans" made by life insurers to their agents in past years. There seems to be a relatively high incidence of bad debts among these accounts.
- The Business Practices Committee was a committee of chief executives of the life insurance companies. The chief executive of any company subject to a complaint would not participate in the deliberations of the Committee when that complaint was being dealt with.
- The ISI is the successor body to the LOA, and now administers the Code.
- New Regulation 15 of the Securities Regulations 1983, which came into force on 1 October 1997.
- See Schedule 3D to the Securities Amendment Regulations 1997 (S.R. 1997/151) which prescribes the matters to be covered in investment statements for securities offered to the public.
- Prior to 1 October 1997 these provisions were contained in the former section 44A of the Securities Act, which was revoked on that date.
- The Advertising Standards Complaints Board is a privately funded organisation established to adjudicate on advertising in the media.
INDEX || BACK || FORWARD