Many life insurers will be familiar with the concept of a contestability period.
Typically, for two to three years after a policy is issued, an insurer can investigate and deny a claim if it turns out disclosed at application – material information that would have led to substandard underwriting terms.
Once the contestable period has expired, claims can usually only be challenged if there is evidence of fraud.
The governance of contestability periods varies. In some countries, local legislation oversees its application while in others it falls into the hands of the industry regulator, or is established by industry practice in the market. Either way, the essence of the contestability clause must strike a balance between protecting the insurer against anti-selection or predictable claims while at the same time offering consumers assurance that their claims will be paid.
Illustrated below are two sample contestability clause wordings:
“The company will not contest the policy because of any incorrect declaration or statement made in connection with it after it has been in force for two years from the date of the policy issue.”
“The Policy shall be incontestable, except for non-payment of full premium, or for fraud, after it has been in force during the lifetime of the Insured for a period of two (2) years from the Effective Date.”
Both of the above examples state in effect that the contestable period ends two years after the policy’s inception. A claim submitted during this time frame will usually trigger an investigation by the insurer to ensure that the correct information was provided at application stage. Omission of material information may result in the policy being cancelled from inception and consequently the claim being denied. Although this viewpoint may reflect the intent of contestable periods, a recent RGA review of the Asian market found that contestability clauses are not quite as watertight as we may think.
At first glance, these definitions may seem to represent the intention of the clause, but closer examination of these wordings reveal a number of loopholes. In practice, insurers may be denied the right to avoid claims and rescind policies even though a deniable claim arises within the contestability period. The two main challenges for insurers are:
- Clarity around when the contestability clause ceases to operate.
- What we mean by ”during the lifetime of the insured”.
When does the contestability clause end?
While insurers in most markets consider the claim event date the key driver for determining the relevancy of the contestability period, an alternate approach — and one mandated in markets such as Australia and Taiwan — is the claim notification date.
Neither of the contestability clause wording examples specifically mandates that the claim event must occur within two years from policy commencement. Both definitions only make reference to the age of the policy, and state that once the policy has been in force for two years the insurer will not be able to contest a filed claim.
A claimant could delay notification of their claim past the two-year point (although the event occurred within two years) in order to nullify the impact of the contestability period. However in some markets, such as North America, the determinant of whether the contestable period applies is the date of death. For example, if a death is reported 18 months after the actual death date, the insurer still has the right to perform a contestable investigation on the claim as long as the timeframe from issuance of the policy to the date of death are within the contestable period.
A further possible complication (which applies in Australia) is that if a claim is notified within the contestable period, insurers face the challenge of having to complete their investigations and reach a decision before the contestable period expires. Even though the date of the event and of the notification were within the contestable period, once the clock ticks over, insurers may lose the right to amend the policy and claim for anything other than fraud, which has a much higher evidentiary bar.
What is meant by “during the lifetime of the insured”?
The use of this phrase may create an added complication when considering the execution of the contestability clause. Consider two separate claims: one a death claim and the other a critical illness claim.
• The death of Mr. X occurs within two years of the policy going into force. Mr. X’s beneficiary makes a claim after the policy has been in force for two years. Does the contestable clause still apply?
– Yes, because the claim arose within two years during the lifetime of the insured.
• Mrs. Y suffers a critical illness within two years of the policy going into force. Mrs. Y makes a claim after the policy has been in force for two years. Does the contestable period still apply?
– Arguably no, because at the point of notification (still during the lifetime of the insured) more than two years have passed from the policy start date.
What does this mean for insurers?
What these issues highlight is that while the insurer may have a clear philosophy concerning the function of a contestable period, this could be undermined by an ambiguous wording of the clause, which might turn out not to provide the protection during the contestability period that the insurer expects.
What can insurers do to ensure they are protected?
Policy provisions have recently received greater scrutiny from legal experts and industry regulators, ensuring that the consumer is not penalized by unfair terms and practices. So, while the existence of contestability clauses in policies is beyond challenge, what is important is that the clause should specifically mention (where local laws permit) that claims will be contestable when the claim event arises within the relevant time period from commencement.
To ensure insurers are sufficiently protected against non-disclosure and misrepresentation, they should consider:
- When did your company last review its contestable clause language?
- How reliable is the language — is the wording appropriate?
- Does it clearly set out what you intend?