Insurance lawyer Andrew Hooker on how to make sure your insurance broker or financial adviser doesn't pocket more of your money than they should

*By Andrew Hooker 

The insurance industry enjoys an extremely privileged position when it comes to walking away from a binding contract. This is because, despite recommendations by the Law Commission to the contrary, insurance companies can still “avoid” – or treat as if it never existed – an insurance policy if the customer fails to tell the insurance company something the insurance company thinks it should know. 

As crazy as this sounds, that is what we know as the duty of disclosure. 

If an insurance company decides for whatever reason that its client has not disclosed what the insurance company deems to be a material fact when applying for or renewing a policy, the insurance company can treat the policy as if it never existed. The problem with this old legal right bestowed upon insurance companies in the 18th century is that:

1. The insurance company can avoid the policy even if the non-disclosure is completely innocent because the insurance company gets to decide what facts are material; and
2. There is no requirement for a connection between the allegedly non-disclosed material facts in the circumstances of the claim that usually gives rise to the attempt to avoid the policy by the insurance company. In other words, if you had an income protection policy that provided a payment of a benefit should you be unable to work, but failed to disclose bout of, say, depression, the insurance company could avoid the policy and get out of paying if your claim related to an unrelated broken neck.

This old English legal privilege arose from the early days of insurance in the 18th century, largely relating to large marine and commercial insurance policies. But the law always required that if the insurance company decided to “avoid” the policy, it would have to refund the premium. That of course is common sense because it is treating the policy as if it never existed and therefore cannot keep the premium for a policy that never existed. So the consolation prize was that at least you got your premium back if the insurance company avoided the policy.

This old fossil of insurance law still exists today. The Law Commission recommended years ago that it be severely diluted, because it is grossly unfair, particularly in consumer insurance. But Parliament has not taken steps to implement the changes recommended by the Law Commission. 

It gets worse. The life insurance industry often pays gigantic up front commissions to insurance brokers. Often the commission paid to an insurance broker can be as high as 200% of the premium. Did you know that if you bought an income protection policy or a disability policy with a premium of $3,000, that your financial advisor or insurance broker may be getting paid as much as $6,000 up front by the insurance company for putting the insurance with that company? 

But here’s the catch. Recently, some insurance companies have started including in their policies a clause by which they reserve the right to deduct what they call “costs and expenses incurred in connection with the policy or the claim” from any refund of premium you might be entitled to. If, therefore, after two years you go to make a claim and the insurance company decides to avoid the policy based upon some alleged non-disclosure, you should be entitled to have your premium refunded. The insurance company may, in reliance of this piece of fine print, retain a few dollars to cover its administrative costs. But no. The insurance companies are treating these gigantic commissions as “costs and expenses incurred in connection with the policy or the claim” and deducting them from any refund of the premium. 

So if the up-front commission paid to the insurance broker is 200% of the initial premium, you are never going to get a refund because it’s always going to be gobbled up by the alleged "costs and expenses incurred in connection with the policy or the claim”. 

That creates a somewhat unusual and disturbing situation. The insurance advisor who is meant to be representing your interests, gets paid a gigantic commission by the insurance company. But when your policy is avoided a year or so later, you lose all of your premium and he or she gets to keep the commission for the policy that was useless anyway.

This practice is a recent development and not all insurance companies follow it.  But it seems to be grossly unfair that if you are going to be penalised by the avoidance of your policy, the person who was paid to advise you on that policy gets to keep his or her commission when you don’t get your premium back.

It would seem fair that if your policy is “avoided”, the broker should pay back his or her commission for a policy that was essentially useless.

People who are arranging insurance through an advisor need to check with the advisor about this point. Then, you need to consider whether you want to enter into a contract with an insurance company that pays its advisor a gigantic commission and then, when it hangs you out to dry at claim time, looks after the advisor but not the customer.

*Andrew Hooker is the Managing Director of Shine Lawyers NZ Limited practices as a specialist insurance lawyer in Albany on Auckland's North Shore. He also runs an insurance information website - www.claimshelp.co.nz