Do you really understand insurance?

SMSF technical expert and columnist for The Australian newspaper
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Anyone taking out insurance – and life insurance in particular – needs to fully understand how their insurance policies actually operate.

The insurance industry constantly uses the “protection” theme as a way of encouraging us to purchase their products.

I don’t think this is why we take out insurance. We buy this product to make a claim and to cover for potential economic loss in the event something has gone wrong. And when we make a claim, we want it to be assessed quickly and without any hassles.

What is insurance?

Well in simple terms, it’s a contract. And as such, the wording of the contract document is vital.

Many of us purchase the cheapest insurance available. On the face of it, this is fair enough as no one likes paying more for something than is necessary.

But the cheapest insurance product might not have the wording that suits our circumstances. A good and unfortunate example occurred during the Brisbane River floods several years ago. Some homeowners, who had purchased cheaper insurance, found their property was not covered for certain types of flood damage.

The same principle applies to life insurance. So, when buying an insurance policy, we should read the contract wording before deciding if a specific policy suits our circumstances. A complex aspect of this is the need to understand the legal terms used in insurance contracts.

The insurance application process

When you first apply for any life insurance, the insurer needs details about your health and any medical problems. They need to know your occupation and your lifestyle including alcohol intake, smoking status and recreational pursuits. In some cases, they will want financial records. Finally they need details of any potentially hereditary illness for your relatives (parents, siblings, etc).

The process that an insurer assesses all this information is called underwriting. From the client perspective, this process can be an absolute pain especially when an insurer continually asks for additional information.

Nevertheless, life insurers have to take this process seriously because under Australian law, their policies are guaranteed renewable. That is, once these policies are in place, they can’t be cancelled by the insurer unless you stop paying policy premiums or you’re aged more than a contract’s maximum age.

Your duty of disclosure

The insurance contracts legislation says you have a duty to disclose everything relevant to an insurer so they can decide to accept or reject your business.

An insurer can deny your claim if you fail to answer all their questions or provide incomplete answers to any question. This denial of your claim because of inaccurate or incomplete disclosure of information runs for the first three years of the life of a new life insurance contract.

Many financial advisers have told me that their clients continually fail to take this duty seriously.

Swannson v Harrison

Earlier this year, the Victorian Supreme Court handed down a judgment involving Mr. Swannson, an architect, and Mr Harrison his financial adviser.

Originally Swansson had a death and terminal illness life insurance policy with AXA Australia that Harrison had organised for him. Because AXA (now fully owned by AMP) wanted to increase his premiums by 25%, he asked Harrison to see if there was a comparable but cheaper product in the marketplace.

Harrison identified a policy with AIA, another life insurance company. Harrison agreed to apply for this policy.

Just before completing the application form for this policy, Mr Swansson had been to see his doctor about a stomach problem. The doctor thought it wasn’t anything serious so on AIA’s application form, the stomach problem was disclosed but it was “resolved”.

AIA’s application form says that you have to tell them all relevant information and this requirement continues until they insurer formally issues the policy.

Once AIA had the application, they went back to Harrison’s office to clarify some points. After fixing these up, it issued the policy. Whilst these issues were being sorted out, Swannson had been referred to a gastroenterologist for his stomach problem. The specialist told him to give up alcohol for a month and sent him for a scan. Harrison and AIA weren’t told about this.

Next, AIA issued the policy. A few days later, Swansson and Harrison cancelled the AXA policy because it was no longer needed (as this policy was more than three years old, the duty of disclosure rule no longer applied).

Not long after, Swannson was diagnosed with terminal cancer and claimed against the AIA policy. His claim was rejected because he hadn’t told AIA about seeing the specialist and scan. AXA also rejected his claim because his cancer was diagnosed after he had stopped that policy.

Swansson sued Harrison for negligence. Given that the two men were central to this case, it was mano-a-mano in Court. The judge found both of them credible witnesses and said it was difficult to decide overall who was right and who was wrong and said ultimately they were both equally to blame. Swannson’s terminal illness and death insurance was for $1.48 million, so the judge ordered Harrison and his co-defendants to pay half of this amount – that is, $740,000 – to Swansson.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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