You've just been offered a "better" life, critical illness, disablement or income protection policy. It's cheaper and the cover is superior, you're told. Should you sign up?
This is an everyday occurrence in the world of insurance. For consumers, it should be a big red flag.
Chances are you've just been approached by a new insurance adviser or salesperson, or your old one has been doing a periodic "review" of your policies. What they don't tell you is that they get a commission if they enrol you with a new insurer. This practice, called "churn", is widespread.
"The broker will tell you, hand on heart, that he or she moved the business to another insurer in your best interests," says Steve de Jong, a director of Pinnacle Life. "While this may be valid in some cases, in most instances the motive to change is the lure of a new commission. If a broker can move the client's business, say, every four years, he or she stands to earn commissions multiple times from that client."
It may just seem like a bit of paperwork, but there are big risks for the consumer. First, you'll often have a stand-down period of three or six months with no cover. What if you're diagnosed with cancer or drop dead during that time?
One of the greatest risks is that your health will change in the meantime. John Body, managing director of ANZ Wealth, points out that customers take their health with them, which means they are not generally insured for conditions they may have developed since they last took out a policy.
Let's say you have been insured for income protection with one company since 2004. In 2008, you visit the doctor because your business is in turmoil and you've been having "headaches". By early 2009, you've forgotten this when you're door-knocked by an adviser telling you that he can get you a better policy. You switch. The following year you're diagnosed with a brain tumour or multiple sclerosis. The insurer says: "Sorry, mate, those headaches showed it was a pre-existing condition when you took the out policy." Had you stayed with the original policy, your claim would have been met.
In a classic case heard by the Insurance and Savings Ombudsman, an adviser "assisted C and his wife with a review of their insurance", which resulted in the couple changing insurers on April 4 one year. Ten days later the wife underwent a routine mammogram and was subsequently diagnosed with cancer. The insurer declined the claim because cancer claims were excluded for three months under the new policy.
Time and again the Ombudsman hears cases where the adviser has filled out the health declarations or replaced cover for the sake of it, not because the client needs to change. What's more, the Ombudsman's notes are littered with cases where consumers had disclosed information to the adviser that was not passed on to the insurance company.
"Consumers need to be very sure they understand why they are changing products or product providers," says Ombudsman Karen Stevens. "We have so many unhappy people who contact us when their claims are declined or their policies avoided for non-disclosure in relation to health products."
Even large insurance companies admit the status quo is "nonsense". In an article for industry website Goodreturns.co.nz, AIA New Zealand head of distribution and marketing Darrin Franks writes that customers pay the price of churning. "If aliens were to land tomorrow and take a dispassionate view of our industry, they would surely think the consumer was the loser and that the whole operation is designed to give the advantage to every party but the policyholder," he wrote.
The commission structure also ends up increasing policyholders' premiums across the industry, says ANZ's Body. "It also places pressure on the solvency of insurers."
There are, of course, many good advisers who switch customers for positive reasons. Russell Hutchinson, director of Chatswood Consulting, a financial services management consulting firm, says switching can offer genuinely improved cover, better prices - which encourages competition - and more awareness of what people are covered for. What's more, policies have evolved since the 1980s and 90s, says David Whyte, a professional director with a background in the insurance industry, which can mean superior cover from fresh policies.
A legitimate upgrade benefits the customer, whereas churn is all about the adviser's commission.
Stevens says it's important that policies are replaced only where there has been full disclosure, risk/benefit analysis, the insurance company knows it is replacement business and the customer is fully informed and understands why he or she is making the change.
"Replacing policies is only ever good practice if it is in the best interests of a fully informed customer who wants to change."
Consumers should review their insurances every five years or after a major life change such as marriage, parenthood or retirement, says Peter Neilson, chief executive of the Financial Services Council. When you have a young family, for example, life insurance may be the main priority. As you get older, income protection could become more important.
Even so, consumers should ask questions of their advisers, says Neilson. That could include what the credit rating of the new insurance company is. It's also worth asking if the stand-down period on the new policy can be waived. Some insurers will agree to this if they know the client is being switched, says Hutchinson. Not all advisers are aware of this, which still leaves the client at risk of not being covered for pre-existing conditions.
It's the commission structure that is at fault. Advisers can make 180 to 200 per cent of your first year's premiums for selling you a new policy. If they can do this every two or three years, the pickings are rich.
Advisers are often reluctant to upgrade a customer to a new policy with the same insurance company. Yet in many cases, changes to your health wouldn't be material for an internal switch.
The trouble is that most insurers don't pay the same commission for an internal replacement of policy as they do for "new" business, even though the business is being churned back and forth from insurers.
In South Africa, says Whyte, advisers don't get commission for switching clients from one insurer to another, so there isn't incentive to churn. Here, up to half of insurers' new business is estimated to come from churning - although some argue it is more like 20 per cent.
Either way, the advisers make money and the insurers can tell their shareholders that they're getting new business. The risks are all the consumer's, however.
The Financial Markets Authority (FMA) has concerns about the practice and last year issued guidance notes outlining obligations on advisers to exercise care and diligence. When replacing an existing policy with a new one, the adviser needs to give advice on the disposal of the old product, not just the purchase of a new product.
The FMA says if no comparison is made, the adviser must inform the client and outline potential downsides of changing products. If, however, this is included in a big pile of paperwork the client may not notice it. The regulator says when considering complaints it will take a close look at the frequency with which an adviser recommends a customer replace a product.
Hutchinson has run a number of road shows for advisers over the past year and says many advisers feel the banks are more notorious churners. Bank staff usually sell only in-house products and encourage customers to move without a detailed knowledge of the product they were moving from.