CR358 Universal Life policy
Universal Life policy
Universal policy providing whole life cover with an investment component – guarantee date – review by insurer after guarantee date – whether insurer entitled to put policyholder to options for future: higher premiums for same cover, or same premiums for reduced cover
1. The complainant took out a so-called universal life policy, providing whole life cover with an investment component, in October 1993. The cover and premiums were guaranteed for 18 years, after which the insurer was entitled to review the policy.
2. The complainant was unhappy with the fact that the insurer reviewed his policy after the guarantee date and advised him that he had the option either to pay a higher premium for the same cover in future, or to keep his premium the same but decrease his cover. He maintained that his policy did not authorise the insurer to do this unilaterally. He also maintained that the policy did not provide “in clear and unambiguous terms, or even by implication, that [the insurer’s] obligation to pay the death benefit would be reduced after the date of guarantee”. In fact he argued that the terms of the policy were void for vagueness and therefore unenforceable. Furthermore he alleged that the insurer misrepresented the meaning and effect of the policy to him in order to induce him to sign the option form electing one of the two options.
3. In our view the first enquiry was whether the policy documentation explained how the policy works – including the fact that reviews would take place, and what the consequences might be – in a manner which was reasonably prominent, clear and could be easily understood. Thereafter the meaning to be attributed to the specific clause in the policy dealing with reviews must be examined to ascertain whether the insurer’s action was authorised by the policy.
4. To answer the first question one must look at the schema as a whole, and all the documentation provided at the commencement of the policy.
5. The signed application (proposal for insurance) would constitute part of the contract, but this did not contain any information relevant to this dispute. There was also a welcome letter, a policy schedule, and a Description and Provisions document, which the welcome letter confirmed was also part of the contract. A Statement of Benefits document was also provided; whether this could be considered part of the contract was moot, but in our view this document was relevant either way as it was information provided to the complainant at the commencement, and it could not be ignored.
6. The schedule indicated that the date of commencement was 1 October 1993, and the “Date of guarantee: 1 October 2011”. The cover amount (R468 000) and monthly premium (R300) were set out. Under “Benefits” the general statement was made that “the benefits set out hereunder must be read in conjunction with and are subject to DESCRIPTION AND PROVISIONS and other annexures (if any)”. The Death Benefit was then described as follows:
“At the death of the assured, the larger of the
– Balance of the Investment Account, and the
– Cover Amount
shall be payable.
The functioning of the Investment Account is described in paragraph 1 of DESCRIPTION AND PROVISIONS
The cover amount shall be R468 000”.
7. The Statement of Benefits provided illustrative death and early termination benefits at assumed bonus rates of 12% and 15%. The provisos and assumptions on which these illustrative benefits were based, were given. It was stated that actual benefits would be determined by actual bonus rates, and that inflation would influence the purchasing power of the benefits and premiums in future. It was then stated:
“Provided that premiums are paid regularly, [the insurer] guarantees that the cover amount will be maintained up to and including the date of guarantee.
In some circumstances (eg if high cover is maintained over a period of continuing insufficient investment yields) the cash value of the policy may decrease in such a way that an increase in premium may be necessary to maintain the benefits after the date of guarantee”.
8. The Description and Provisions provided under “Investment Account” that premiums (less policy fee and administrations costs) were invested in an Investment Account. Investment bonuses were added to this. The provision then stated:
“[The insurer] shall recover the annual cost of life cover … from the Investment Account”.
9. The “Cash Value” provision provided that the policy might on certain conditions be surrendered for a cash value as determined by the insurer, and that the cash value might be less than the balance of the investment account at that stage. (The cash value was thus synonymous with a so-called “surrender value”; on surrender a policyholder was effectively paid out the investment value less outstanding expenses as determined by the insurer.)
10. The “Lapse” provision, read with the “Automatic Non-Forfeiture” provision, provided for three scenarios in which the policy would lapse. The first was that if premiums were not paid and there was no cash value the policy lapses. The second was that if premiums were not paid and there was a cash value, the insurer may convert the policy into a paid up policy with altered benefits, or place the unpaid premiums and interest as a debt against the cash value – the policy would then continue (automatic non-forfeiture) as long as the cash value exceeded the debt, but would lapse when the debt exceeded the cash value. The third scenario which would cause the policy to lapse was as follows:
“if the cash value is exhausted as a result of the recovery of the cost of cover from the Investment Account (Please note: The policy shall not lapse before the date of guarantee as a result of this subclause if all premiums are paid regularly)”.
11. The “Date of Guarantee” provision explained the scope of the guarantee:
“If premiums are paid as indicated, the benefits provided for in the SCHEDULE … shall be payable at least until the date of guarantee”.
12. The “Reviews” provision stated as follows:
“The special nature of this contract could, in changing economic conditions, cause future premium payments to be insufficient to maintain the benefits in full after the date of guarantee.
[The insurer] therefore undertakes to review the level of benefits and premiums on the policy anniversary after the age of 45 and every subsequent 5 years, but not within 5 years of the date of commencement, and to inform the policyholder should any adjustments be necessary. Between these dates, reviews may also be carried out if [the insurer] deems it in the policyholder’s interest”.
13. In our view the information provided in the policy and other documents, taken together, was reasonably sufficient, and of sufficient clarity, to inform the policyholder that:
● his premiums were invested in an investment account, to which investment growth (bonuses) was added;
● the insurer recovers the cost of life cover from the investment account;
● there were thus two components to the policy, life cover and investment;
● the cash value was related to the investment account value but might be less than the Investment Account value at any stage;
● the insurer guaranteed the benefits (the cover amount) and the premiums for 18 years, from the commencement date of 1 October 1993 until the date of guarantee being 1 October 2011;
● after the guarantee date, the insurer would review the level of benefits and premiums every 5 years, and if changing economic conditions/ insufficient investment yields caused premiums to be insufficient to maintain the benefits in full, the insurer would inform him of any necessary adjustments; an increase in premium may be necessary to maintain the benefits;
● his policy would lapse if premiums were not paid and there was not sufficient cash value to keep the policy in force (unpaid premiums are offset as a debt against the cash value until the debt exceeds the cash value);
● the policy could also lapse if the cash value was exhausted as a result of the recovery of the cost of cover from the investment account, but not before the date of guarantee. The policyholder was thus put on notice that after the guarantee date there was the possibility of the policy lapsing if any adjustments deemed necessary were not implemented.
14. The complainant had made the point that “cost of cover” was not defined, nor was it explained anywhere in the policy documents that the cost of cover increases with the age of the assured, or how it was calculated. He maintained that on the face of it the cost of cover was fixed for the duration of the contract.
15. We agreed that “cost of cover” was not fully explained, but in our view it could be reasonably understood from the explication of the policy as a whole that it was the cost for the insurer of providing the cover amount (R468 000).
16. This must be determined actuarially by the insurer, and is based on an actuarial assessment of the risk, and the cost which the insurer must recover to be able to offer a particular cover amount (sum assured). If this had been a pure risk (no investment component) policy, it would be the risk premium.
17. It is a fact that the cost of cover increases as an insured grows older (with the increased risk of death). An insurer will not provide life cover to a 75-year old for the same premium as a 30-year old. The premium will be higher for the 75-year old.
18. The basic idea of the type of policy we were dealing with in this case, with a life cover and an investment component (sometimes called a universal policy), is that the overall premium remains level, for a guaranteed period. The premiums are invested, and the insurer takes the cost of life cover (less when the insured person is younger, more when he is older) out of the investment account. The cost of cover is calculated annually, and in doing this calculation the actuary also takes account of the value of the investment account. If the value has grown well, this may offset the increase in the cost of cover to some extent, as it reduces the amount at risk (ie the cover amount minus the investment account value). The expectation is that the growth in the investment account should “subsidise” the cost of life cover, to the benefit of the policyholder, but of course the extent to which this happens is governed by the actual investment returns achieved, and this cannot be accurately predicted over a long term.
19. It would be difficult to explain the above in detail in the policy documents, but the financial adviser/broker who assists with purchasing the policy should provide an explanation, or the prospective policyholder can direct questions to the insurer.
20. Nevertheless, as stated, in our view the policy documentation had set out sufficient explanation of its working, and sufficient clarity of the terms and conditions on which the insurer accepted the policyholder’s application for insurance.
21. In terms of the “Reviews” provision the insurer had sent the complainant an option letter in January 2013.
22. The option letter exhorted him to give careful consideration to the information in the letter and to respond by 1 June 2013. The information was set out as follows:
“The premiums that you pay are invested in an ‘Investment Account’ and the cost of cover is deducted from this account. This cost of cover increases as you get older and will reduce the value of your investment account over time.
Your policy contract specifies that the policy shall lapse if the cash value in the Investment Account is depleted as a result of the recovery of the cost of cover.
We expect your policy’s investment account to be depleted in the future. Once this occurs and the guarantee period has expired, the policy should lapse.
[The insurer] will not lapse your policy
It is our pleasure to inform you that [the insurer] will not lapse your policy. We wish to provide you with a once-off opportunity to amend your policy in order to maintain your cover for the foreseeable future.
You can exercise one of the following options according to your specific needs:
Option 1 Increase your premium by 5% per year, starting on 1 October 2013. This increase will ensure that you maintain your current cover for the foreseeable future…
Option 2 Decrease your cover by 5% per year, starting on 1 October 2013. In this case your current premium will remain unchanged.
[A table set out the effect of these adjustments over 15 years]
What will happen if you do not exercise any of the two options?
Once your Investment Account is depleted and the guarantee has expired your cover will be adjusted once-off as if you had selected the 5% cover decrease starting on 1 October 2013, similar to Option 2.
From that date onward we will also initiate an annual cover decrease which can be up to 15% per annum, depending on the number of years since our offer expiry date.
It is important to note that in this scenario you can lose a significant portion of your risk cover.”
23. The key to evaluating the complaint lay in an interpretation of the “Reviews” provision (see par 12 above), and an assessment as to whether the action the insurer took in terms of that provision (offering the complainant the options in the option letter) was authorised by it.
24. The policy made it clear that the benefits provided for in the Schedule would be payable at least until the date of guarantee. The “Reviews” provision dealt with what happens after the date of guarantee, in the event that premiums are insufficient to maintain the benefits in full thereafter. The clause expressly provided that the insurer would review the level of benefits and premiums (at the intervals stated), and would “inform the policyholder should any adjustments be necessary”. It was the meaning of these words in particular which was in issue.
25. The complainant contended that the words merely indicated one of the three jurisdictional preconditions which must be satisfied (the first two being the conducting of reviews, and the finding that changed economic conditions have caused premium payments to be insufficient to maintain the benefits in full after the guarantee date). In his view the “Reviews” provision did not apply if all three facts/preconditions were not established. He argued further that the clause was in fact silent as to what would happen once the insurer had informed the policyholder that adjustments were necessary. He assumed that the policyholder and insurer must therefore negotiate, but he then raised the further difficulty that the policy was silent as to what would happen if the parties could not reach agreement: “there is no mechanism for resolving a deadlock and determining a new benefit or a new premium”. He concluded that the “Reviews” provision therefore did not entitle the insurer to put to him the options set out in the letters.
26. In our view this analysis was flawed.
27. It could clearly be inferred from the 2013 option letter (even if it did not say so explicitly) that the insurer had conducted a review in terms of the “Reviews” provision, the guarantee date of 1 October 2011 having passed. It is evident that (because of changing economic conditions resulting in lower than possibly anticipated investment growth) the review indicated an expectation that the investment account would be depleted and that the policy would lapse unless adjustments were made to maintain the cover.
28. Understood in the context of the policy as a whole and the surrounding circumstances, the words “inform the policyholder should any adjustments be necessary”, must be taken to mean that the insurer may unilaterally decide what, if any, adjustments to premiums and benefits are necessary, and that the insurer will inform the policyholder of the implementation thereof. The policyholder is warned in the “Reviews” provision that changing economic conditions could cause future premium payments to be insufficient to maintain the benefits in full after the guarantee date. It is made clear that the insurer guarantees that the premium will not increase, neither will the benefits reduce, before the guarantee date; the understood corollary of this must be that after that date the insurer may increase the premiums or reduce the benefits, as it deems necessary. It was thus in our view a tacit term that the insurer had the authority to make the adjustments.
29. The fact that the insurer chose to give its policyholders the option as to whether it should increase their premiums for the same cover benefit, or hold the premiums constant for reduced cover, did not detract from the fact that the insurer had deemed one or other adjustment necessary, as it was entitled to do. Thus if neither option was chosen by the policyholder the insurer was entitled to and would, as it informed the policyholder in advance, effectively implement a variation of the second option (reduce the cover). This must be so, as the investment account value was in the insurer’s estimation not sufficient to pay for the increased cost of the same level of cover if the premium remained the same – and an adjustment was necessary.
30. In our view the option letter was in some parts not clearly expressed and might be confusing. It appeared that the course the insurer would follow if no option was selected was not that similar to option 2 as there would be a faster decline in cover (there was mention of a once-off 5% cover decrease, and thereafter an annual cover decrease “which can be up to 15%”), and the chance that in this scenario “you can lose a significant portion of your risk cover”. This was not entirely clear (but see paragraph 37 below).
31. However, the overall message of the letter was clear, and it was in line with the scheme of the policy. On a common sense reading, the insurer was informing its policyholder that the increasing cost of cover was leading to the ongoing reduction of the investment account, and of the adjustments that would therefore be necessary to avoid lapsing. The reference to the policy lapsing if the investment value was depleted (ie exhausted) in the future was a reference to the policy clause which provided that the policy would lapse “if the cash value is exhausted as a result of the recovery of the cost of cover from the Investment Account”. After 18 years of paying the same premium every month, the investment account value was simply not sufficient to support the increasing cost of the same level of cover (the full benefit cover amount).
32. To prevent the cash value being exhausted and the policy lapsing, the insurer provided two options for the necessary adjustments. The options were clearly set out. If no option was selected there was a third default action which the insurer would take. This also avoided lapsing by reducing the cover, but would not be as favourable as one of the two options presented for selection. The policyholder was invited to contact his financial adviser or the insurer if he needed help to exercise his option.
33. In our view there was no reason to suppose that the insurer’s statements in the option letter could not be relied on, ie that lapse would ensue if the policy continued without adjustment, but as the complainant had queried this we made certain enquiries from the insurer to test this.
34. We asked the insurer to provide:
• Information on the value of the investment account and the cash value, as at the date of the review and as at the current date.
• Information on the actual cost of cover recovered from the investment account for each year of the policy.
• Figures and an explanation as to why the scenario which would occur if neither option was accepted would be different to the scenario in option 2.
• Projections on which the expectation of lapse in the future was based, and the date on which this was expected to happen, if neither of the two options were offered (and no adjustment made).
35. In response to the first question, the insurer indicated that the review date was 31 July 2012. The surrender (cash) value at that date was R5 940.84, and the fund (investment) value was R9 431.06. By the current date (values for 1 April 2014 were given), the cash value was R11.33, and the investment value was R732.37. It was evident that the policy would be in imminent danger of lapsing if there was no adjustment at all (see paragraph 38 below).
36. In response to the second question, the insurer provided a fund build-up spreadsheet, indicating for each year of the policy’s life the investment (fund) value at the start of the year, the investment amount added during the year, the actual cost of life cover recovered from the investment account for each year, the investment growth added during the year, and the investment (fund) value at the end of the year. This clearly showed the actual cost of cover steadily increasing over the years, from R1 403.87 in 1993 when the policy commenced to R8 364.59 in 2012. The build-up spreadsheet also showed the fund value gradually increasing from 1993 to 2006, and thereafter decreasing each year as the increased cost of cover exceeded the growth in the investment account (fund value). (It was apparent that if economic circumstances had been more favourable than they in fact were, the favourable position of an increasing investment account could have continued for longer, but this was not the case here.)
37. In response to the third question, the insurer stated that if neither option was accepted, the cover would be decreased from the actual date the investment (fund) value became negative. This was projected (in January 2013 when the first option letter was sent) to be a year after the effective option date of 1 October 2013. Since in this scenario the decrease in cover would not have commenced at the effective option
date but only a year later, the first decrease would be at 5% but thereafter greater decreases of 7% or possibly more would be made (presumably to make up for the “lost” year).
38. In response to the fourth question, the insurer indicated that in fact the “expected crash date” if no option was accepted and no adjustment made was 1 June 2014. This was based on the actual fund value on 1 April 2014 being R732.37 (see paragraph 35 above), and the projected fund value for 1 May 2014 being R363.44, with the projected fund value by 1 June 2014 being negative at –R23.31.
39. In our opinion the insurer’s answers confirmed the import of the option letter, ie that increasing costs of cover were depleting the investment account and that adjustments would therefore be necessary, otherwise the policy would lapse. The complainant was afforded notice of the necessary adjustments more than a year before the “expected crash date”, and given options to select from according to his circumstances.
40. Since the insurer was in our view entitled in terms of the policy (see paragraph 28 and 29, above) to put to the complainant the options for the necessary adjustments, and to make adjustments unilaterally if he did not elect one of the options, there could be no question of the insurer having misrepresented the meaning and effect of the policy in order to induce him to sign the option form in which he agreed to pay the increased premiums from 1 October 2013. As the figures provided in answer to our questions demonstrated, no misrepresentations were made.
41. After setting out the above reasoning, we made a provisional ruling to the effect that the insurer’s position was justified.
42. The complainant accepted our provisional ruling. Subsequently he advised the insurer that he accepted that he was bound by the terms of the option he had signed, and that the insurer could continue to recover the increased premiums.