CPI, it's simple, right?

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Most reading this in context of insurance would agree.

Thursday, October 10th 2024, 10:31AM 2 Comments

by Jon-Paul Hale

Maybe not if you're in the financial planning space, but that's not my area of expertise so I'm ignoring the much larger picture in that direction.

I'm talking about CPI with respect to life insurance and, more specifically, income protection claims.

Sure, the simple answer is to tick the box for CPI increases on the policy anniversary and tick the box for CPI increases on claims for disability benefits.

My dive into the weeds here is from looking at the anniversary schedule for a large-sum client on a claim with Asteron Life and scratching my head on why their lumpsum benefits had CPI increases but their disability cover did not.

They have been on claim for some years, and their monthly benefit has been inflation-adjusted, so this wasn't a problem with the claim. However, it did make me scratch my head and go hmmm...

Digging in further, this is covered in the policy wordings; the CPI for the disability benefit is suspended while on a disability claim.

When the claim ends, the policyholder can remain on the policy benefit level of cover or continue with the CPI-adjusted claim value with the commensurate increase in premiums.

No harm, no foul, right? Well, for the client, yes. For the adviser looking after that client and their claim, less so.

Also, the client needs to involve the adviser when coming off a claim to manage the situation and the typical reaction of maintaining the lower cover level because of budget constraints. If this has been a long-term claim, potentially snookering them for their next claim on a much lower benefit than they finished with.

Clients on disability claim still have a policy paying renewals.

• Those renewals are a factor of the policy premium.
• Suppression of the policy CPI on the claim effectively suppresses the policy premium increases. It reduces the renewal income for the adviser business compared to what it would have otherwise been.

Before we get carried away, the quantum is around (CPI) 3-8% of the renewal, $50-60 per annum on a 5% renewal basis.

• The quantum of the problem is the compounding nature of long-term claims. Over 20 years we're talking around $6,500 in reduced renewal revenue.
• For one client, it is not a massive deal over 20 years; however, if you are a larger advice firm with a lot of claims and you're employing people to manage claims, this has an impact on your ability to maintain wages.
• 10 claims like this and you’re talking $66k over that same time frame, or $130k if the renewals are 10% and not 5%.

Thinking about this, there are a few things here to consider:

• For the adviser not managing the claim, particularly long-term claims, there's less front-end work as you can't change a policy under claim, and the cost of managing the client falls on the claim manager. So, the unrealised renewal is less of an operational concern.
• For the adviser that is managing the claim they are now more active with that client on a far more regular basis. Monthly to three monthly depending on what's required by the claim manager.
• That loss of earnings has an impact over time.
• The client I have for this example is in their 40s, and they have a to-age 70 policy with expectations that they will live a long and healthy life despite their condition.
• As I mentioned above, for the large firm employing claim managers, this has a somewhat more significant impact on revenue streams at scale.

Ok, so that's what I found with Asteron Life, and I'm writing this for awareness not to have a crack at them. This is likely wording that has evolved over time and hasn't been considered in relation to market changes. I'm waiting to hear more from them.

What about the rest?

I've named Asteron Life because, from what I can ascertain, they are the only ones to apply this in this way.

I've used the current agreed value policy wordings for the providers, being that agreed value policies maintain their value relative to income if CPI increases faster than the underlying client's income.

• The area where CPI on policy benefits has a real advantage with this type of policy

With AIA, if you have CPI ticked and inflation on the claim ticked, then both the policy and the claim benefits will increase with CPI, including the resulting renewal commissions.

• The interesting insight here is the client could select not to have CPI on the benefit but have it apply to the claim. (I think from memory they have system constraints with requesting this, but the wording suggests it's possible.)
• AIA also has a 2.5% increase option if inflation is lower or negative; this option cannot be exercised when on a claim.

Chubb Life has this section in their umbrella policy wording, not the benefit wording, and they apply CPI to both benefit and claim. They would be expected to pay renewals on the inflation-adjusted premiums.

• Reading the policy wording, this area needs to be clarified about CPI on claim if CPI on the benefit is not ticked.
• The gap in a paragraph in the wording would suggest that you can have a level benefit and still have an inflation-adjusted disability claim.
• Reading through the Chubb Life wording, I did find there wasn't enough clarity in the policy wording around the treatment of inflation on claims compared to the rest of the providers.

For Fidelity Life, like AIA and Chubb Life, if CPI is ticked, then CPI applies to both the policy and claim and flows through to renewals.

• The interesting bit is Fidelity Life claims apply CPI increases to the monthly claim every quarter. Unique in the policy wordings I have reviewed.
• The wrinkle for Fidelity Life is the CPI benefit ceases to be applied from age 65. A bit early when we have to age 70 benefits?

Partners Life, like the rest, if CPI is on, increases both policy benefits and claim payments by CPI. Like Chubb Life, Partners Life has the CPI/Indexation section in the umbrella wording.

• Partners Life will continue to apply the 5% increase option both in negative inflation and on claim.

CPI is an area where the FMA has had some focus, most visibly with the AIA remedial CPI module we all had to do not too long ago.

The reality here for life insurance advice is largely tick the boxes and carry on because we don't have as much control over this aspect of advice as some people think.

• We rely on the insurers to get CPI right, and their system should be pretty tidy with this, so this is not a significant advice concern.

Ticking CPI on income-related risks means that coverage can reasonably maintain its value over time.

• If you are insuring a debt, then CPI is less of a concern, as debt is a number that is not subject to inflation.
• Yes, it is subject to human behaviour and clients' increasing debt, but that's another story using special event increases.

Ticking the box(s) on CPI increasing claims applies for the same reasons. Once on claim, you can't change the policy, up or down, so CPI on claims is the appropriate approach to managing the future value risk.

Over the years, I have had many discussions about CPI, future values, and future projections with modelling, which is technically excellent but mostly unnecessary.

When discussing the future, the simple facts for clients are income today and inflation. Today's income and the future buying power of that income subject to future inflation.

We can get cute with projections of need with trauma and TPD covers, yet they are all dependent on the disability event triggering those claims, which don't work to the plan most of the time.

• When you are insuring for the maximum cover available for the income the client has, you have no options for "adding" to the cover with disability benefits, outside the CPI options and the TPD increase option. 
• Provisioning for loss of future income on death is very much appropriate. Though in many two-income with mortgage households, it is also a questionable need once paying the mortgage down with one passing away.

My claim stats: for every 1 TPD claim, I have had 6 Trauma claims and 44 disability claims.

• Cute future planning at best is 1/7 effective based on my claims experience. Tick the CPI boxes, simplify your client conversations and implement more income protection!

As I have mentioned before, as Einstein said, if you can't explain it simply, you don't understand it well enough.

KISS, Keep it simple...

Tags: Jon-Paul Hale

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