Policy surrenders on the rise

Hot on the tail of the recently proposed changes to life industry commission structures the news on an increase in policy lapse and surrender rates should cause financial intermediaries some concern. Among the suggestions contained in National Treasury’s document titled Regulatory Reforms: Commission Scales & Minimum Early Termination Values is “an increase from 2 years to 5 years in the period from the commencement of the policy contract during which commission payments will be reversed, on a sliding scale, should a policy be stopped or made paid-up, to act as a disincentive against intermediary miss-selling.”

The final phrase in the above extract is worrying… Did Treasury, before proposing an amendment to regulations on the basis of combating intermediary miss-selling, conduct a proper audit of the reasons for early policy surrenders? How significant will the extension of the ‘claw back’ period prove to be if the economy heads into a severe recession? And why would it take more than two years for a policyholder to realise he had been incorrectly advised on a policy?

Affordability is a major issue

We can only think of a few reasons why a policyholder would lapse a policy Appropriateness of the policy is the fist that comes to mind. If the consumer holds a policy that makes sense – and was properly explained at inception – then he’s going to want to keep it. So it does make sense that miss-selling gets a mention. But once a policy is properly sold and the consumer is happy with it there are only two things that should influence the decision to lapse or surrender it. One is affordability and the other is changed circumstances. And both these eventualities are beyond the control of the financial intermediary. We venture that the longer the policy is active (beyond two years for example) the more likely any surrender or termination is due to the latter reasons.

Let’s set this debate aside for a moment and consider recent indications that policy lapses and surrenders are on the rise. San-Marie Crause, a risk development actuary at Old Mutual, told Business Report that while it was difficult to pinpoint reasons for high surrender levels, policyholders almost always sited affordability as the reason for surrendering their policies. She was commenting on reports that the industry was struggling with higher surrender rates. “We cannot say whether it is the economy or high interest rates. But we can certainly say that it is likely to have an effect when policyholders come under financial pressures,” she said.

This view is shared by most insurance companies. In the same article, Metropolitan head of retail business communication Marque van der Walt agreed that it was incredibly difficult to pinpoint the reason for higher incidences of policy lapses. He said: “We cannot say Metropolitan is experiencing a rise in policy lapses as a direct result of the economy.” The industry will have to accept that as disposable income fails to keep pace with inflation consumers are forced to cut expenditure. And one area they can cut without too much tangible repercussion is the long-term insurance policy.

Lapse and surrender risk at Discovery Life

What we like about Discovery’s 2007 Annual Report is it includes a comprehensive discussion on the group’s management of the financial risk associated with policy lapse and surrender risk. The group experienced higher than expected lapses in the year to 30 June 2007. They acknowledge the risk in their clients’ right to discontinue or reduce policy contributions at any time saying this risk is greatest in the first few years of policy life… From their perspective early termination is not the only concern. “There is also a risk of lower than expected withdrawals at late durations of the policy since no surrender value is payable on withdrawal from a risk policy.” Product design is imperative to protect Discovery’s shareholders. One of their strategies is to offer new products to existing policyholders to combat lapse and re-entry risk.

And tucked away in the 155 page report we discovered a gem the broker community will really appreciate. Discovery Life says they distribute predominantly via independent intermediaries. And “the intermediary sales channel typically experiences lower lapse rates than a direct channel.” Why then must the intermediary bear the burden of product lapses and surrenders in the third, fourth and fifth year after a policy inception date?

Editor’s thoughts:
Reading through Discovery’s 2007 Annual Report it struck me that what is good for the policyholder is not always good for the Discovery shareholder and visa versa. How do large insurance companies balance their responsibility to shareholders with the concept of ‘fit and proper advice’ as mandated in various Acts and regulations? Add your comments below, or send them to gareth@fanews.co.za