Covid 19 means that many household budgets are under pressure. Many of our clients are looking closely at all of their spending. For some people, this review includes thinking about their life insurances. As we will discuss below, any decision to discontinue or reduce life insurance should only be made after very careful consideration. Restorations may not turn out the way you think they will.
There are many reasons why discontinuing life cover needs to be thought through thoroughly. The most obvious is the prospect that the insured event might happen. While many people see insurance as an expense, from an ‘accounting’ point of view, an insurance policy has more in common with a ‘contingent asset.’ Accountants define assets as something that contains future economic benefit. A contingent asset is one that contains future economic benefit if a particular event occurs. Obviously, with life insurance that event is the event against which a person is insured. So, if people stop paying life insurance premiums, they lose the potential for the economic effects of a death, illness or injury to be offset by an insurance benefit.
There is also another reason why people should think twice before reducing or discontinuing their life insurance. This reason builds on the idea of guaranteed renewability.
Most life insurance agreements are guaranteed renewable. This means that, once an insurer agrees to provide cover, that insurer is obliged to continue to provide cover for as long as the policyholder continues to pay his or her premiums. Put simply, if you commenced a life insurance policy in 2019, as long as you pay the premium, your insurer is obliged to offer you the same policy in 2020. The price is allowed to change, but only due to known and foreseeable issues such as inflation or your increasing age. The nature of the underlying insurance must be retained.
Guaranteed renewability is a very important feature of most life insurances. There are very few life insurance policies that do not include guaranteed renewability. Somewhat ominously, but very accurately, these few policies are known as cancellable policies.
Under a guaranteed renewable policy, when that policy is first taken out, the policyholder needs to declare all known information that would be relevant to the insurer’s decision to provide cover. Amongst other things, this includes a full medical history. Obviously, before offering a policy, the insurer needs to make a judgement as to how likely it is that someone will make a claim on that policy. Knowing an applicant’s medical history informs that judgement.
That said, once a guaranteed renewable policy has commenced, the insurer cannot modify or reject the annual renewal of that policy if the policyholder’s health situation changes. So, if you experience a health event after you commence cover, that event cannot inform the insurer’s decision to keep offering you a policy.
Think of a very simple example: Fred experienced skin cancer at the age of 25. He was successfully treated. At the age of 30, he applied for life insurance. He declared his experience of cancer to the insurer. To cut a long story short, the insurer made an assessment and decided that they would still offer Fred a policy – but that that policy would exclude skin cancer. Put very simply, if Fred were to later become disabled or die as a result of skin cancer, his insurer would not need to pay. If Fred were to become disabled or die as a result of some other event, such as a car accident, his insurer would still need to pay. But he was not covered for skin cancer.
Now think of an alternative. Ned also takes out his life insurance at the age of 30. At that stage, he had not had any negative health events in his life and so his insurer offered him a standard policy with no exclusions. At the age of 35, for the first time, Ned experienced skin cancer. He was successfully treated. Because he had paid all his premiums, Ned’s insurer was obliged to continue to offer him the same life insurance policy with no exclusions. If, down the track, Ned becomes unwell or dies as a result of skin cancer, the insurer will need to pay.
Fred and Ned have both had skin cancer and they both have insurance cover. But Ned’s cover is ‘better’ than Fred’s. As you can see, the important thing is that the insurance policy was in place before the health event. If that is the case, and the policy is guaranteed renewable, there is nothing the insurance company can do because of the health event. The insurer must continue to provide cover for as long as the policyholder pays the premiums. However, if a health event occurs before a policy is put in place, the insurer is allowed to either reject cover completely or to place exclusions or loadings on any policy it offers. (A loading is where the insurer increases the premium, reasoning that the applicant has a higher chance of making a claim on that particular policy).
Obviously, the older we are the more likely it is that we have experienced health events that may impact on an insurer’s decision to offer us insurance. Amongst other things, this means that we need to be very careful about discontinuing or reducing an existing life insurance policy. If we try to restore the same or a similar policy again in the future, there is an increased chance that we will have one or more health events that we need to declare to the insurer. It may be that we either cannot recommence our insurance, or that any recommenced insurance will contain an exclusion and/or a loading.
We may not be able to recreate the original insurance and, like the Church that owns the portrait in this picture, we may be left with something much less comprehensive than the original.
In summary, where an insurance policy is guaranteed renewable, it is almost always better to have taken that policy out earlier in life. As a result, any decision to discontinue or reduce existing cover is quite a complex one with potentially far-reaching consequences. If you or someone you love are finding that life insurance is becoming hard to afford, please contact us immediately. Decisions about insurance need the most careful consideration.