Insurance - working out your PECs

Col Fullagar examines the topic of pre-existing exclusion clauses in risk insurance policies.

What is a ‘pec’ and where can it be found? After posing this question to a group of people, a number of different answers might be forthcoming:

• Those who workout in the gym, might suggest that a ‘pec’ is a muscle found around the chest region;
• Those with a keen knowledge of geography might disagree, citing that Pec is a village in the Czech Republic near the German border; but
• Those involved in the financial services industry might point out that a PEC is a pre-existing condition exclusion.

The last group might then add that PECs are a necessary component of insurance policies for which few, if any, underwriting questions are asked at the time of application – for example, direct insurance and some group insurance facilities.

When there is little or no requirement for underwriting information to be provided, the insurer is limited in their ability to make an assessment of the risks associated with the insured.

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The presence of a PEC is therefore an important protection for the insurer against anti-selection. For example, someone with a material, pre-existing condition might otherwise seek to put in place insurance with prior knowledge that a claim is likely to ensue.

The protection that a PEC provides is to exclude claims arising from medical conditions that existed prior to the policy starting.

An example of a PEC is:

“You are not covered for an insured event arising from any injury, sickness or disease contracted prior to the commencement date – unless you were not aware of, and could not reasonably be expected to have been, aware of the condition.”

A PEC can also exist by virtue of the definitions of sickness and injury:

“Injury means an accidental bodily injury which is sustained after the commencement date”; and

“Sickness means a sickness or disease which first becomes apparent after the commencement date.”

By reducing the insurer’s reliance on the underwriting process, the use of PECs enables insurance to be put in place quickly and inexpensively.

However, the trade-off is that a proportionally higher level of assessment occurs at the time of claim with, one would expect, a higher rate of claims being declined and disputes arising.

In essence, underwriting occurs at the time of claim rather than at the time of application.

The latter position generally occurs with retail risk insurance. The insured completes an application form and the insurer undertakes a comprehensive assessment process – such that an appropriate premium rate can be charged, exclusions offered, or the risk declined.

Rather than the insurer simply asking questions and trusting the insured will respond appropriately, the position of the insurer is protected by the insured’s duty of disclosure found in section 21 of the Insurance Contracts Act (1984).

The duty of disclosure places a legal obligation on the insured to disclose all matters they know – or a reasonable person in the circumstances of the insured would be expected to know – is material to the insurer’s decision to accept the insurance.

It would, in turn, be reasonable to expect that the insured’s obligation under the duty of disclosure would require disclosure of, quoting from the above PEC:

“…any injury sustained or sickness or disease contracted prior to the commencement date;”

Unless, of course, the insured was:

“…not aware of, and could not reasonably be expected to have been aware of, the condition.”

Not only does the Act place obligations of disclosure on the insured, but it also provides the insurer with remedies if the insured fails to meet their obligations.

The remedies are found in section 29 of the Act – in brief, the policy can be cancelled within three years if the matter not disclosed is material to the insurer’s assessment, and at any time if the non-disclosure is fraudulent.

With this type of protection being provided to the insurer, there would appear to be no reason for the policies subsequently issued to include a PEC.

Notwithstanding the apparent soundness of this logic, which may possibly be in line with popular perception, PECs are in fact alive and well in retail life insurance policies where the full application and underwriting processes are similarly alive and well.

Consider the following examples taken from currently available retail products:

“We are not liable to pay a benefit … in connection with a condition which first occurred or a condition, the circumstances leading to which first became apparent, before the cover under this policy came into effect unless:

• You were unaware and could not reasonably have been aware of the condition or circumstances before the cover came into effect; or
• You disclosed the condition or circumstances to us before your policy came into effect and we have not excluded cover for the condition or any condition resulting from the circumstances.”

And:

“We will not pay a benefit for any disability, condition or loss arising from or contributed to by sickness or injury that first appeared, happened or was diagnosed before this insurance started unless disclosed to, and accepted by, us as part of the application process.”

If PECs are present in these policies, it should be assumed they are there for a reason, with the reason possibly being the insurer feels these clauses will provide protection over and above that of the duty of disclosure.

As previously noted, PECs generally exclude from cover known pre-existing conditions, whilst the duty of disclosure obliges the insured to reveal details of known pre-existing conditions.

Is it therefore possible that an insured could meet their duty of disclosure but still fall foul of a PEC? In other words, the insured is suffering from a condition at the time of application which was of a nature that did not require disclosure in the application form.

Logically, the answer must be ‘yes’, otherwise there would appear to be no point having both a PEC and a duty of disclosure co-existing in the policy.

Case study

Jeff is feeling a little bit run down as he has been working longer hours than normal over the last two weeks, and to make matters worse, it appears he is suffering from the flu.

He has a prearranged appointment with his financial adviser to implement some insurance previously recommended to him.

Whilst Jeff’s preference would be to defer the appointment, he decides to go ahead as he needs the cover in place so that he can affect an investment loan.

Jeff meets with his financial adviser, and subsequent to Jeff being advised of his duty of disclosure and confirming he understands it, Jeff completes the application with his adviser’s assistance.

He mentions that he is suffering from (what appears to be) the flu, and asks whether or not he should mention this on the application.

Consider two scenarios:

(i) Jeff advises that he does not believe the condition warrants seeing his doctor;

(ii) Jeff advises that he saw his doctor who did not prescribe any treatment as it was not considered sufficiently serious to warrant it.

Both Jeff and his financial adviser agree that, in the circumstances, it hardly warrants disclosure.

The application is submitted online and is completed immediately. 

Jeff’s financial adviser congratulates Jeff and informs him that he is now on risk. 

Again, consider two scenarios:

(i) A week later, Jeff’s condition deteriorates;

(ii) Jeff’s condition improves, and all appears okay, but several months later it flares up again.

Jeff is rushed to hospital, where he is diagnosed as suffering from a serious viral illness.

If Jeff’s policy contained either of the clauses detailed above, could his claim be reasonably contested?

Section 47 of the Act provides the following protection to Jeff:

“Where, at the time when the contract was entered into, the insured was not aware of, and a reasonable person in the circumstances could not be expected to have been aware of, the sickness or disability, the insurer may not rely on a provision included in the contract that has the effect of limiting or excluding the insurer’s liability under the contract by reference to a sickness or disability to which the insured was subject at a time before the contract was entered into.”

Uncertainty may arise in regards to matters such as:

• Because Jeff was unaware of the precise nature and underlying severity of the sickness, does section 47 protect him?
• Does the reference to “sickness or disability” suggest that a PEC might only apply to the specific condition that pre-existed, as distinct from a related condition?
• Would the fact that Jeff was suffering symptoms prior to the policy starting mean that awareness is deemed to exist?
• Does a medical attendance complicate or assist Jeff’s position in that the doctor’s medical notes and opinion may influence the outcome?
• Is it necessary for the subsequent claim to be linked to the pre-policy symptoms?
• Is it necessary for a diagnosis to be made in order for the condition to be deemed a sickness?
• Would the timeline from symptoms, policy start, and claim materially influence the outcome?

Irrespective of the above, if the insurer reasonably believed that Jeff was more aware of his condition than he indicated to his financial adviser, the presence of the PEC within his insurance policy would give the insurer a lever to contest the claim separate to the rights that exist under section 29.

An insurer invoking a PEC may be able to avoid the claim, but PECs do not give rights in regards to cancellation of the policy.

On the other hand, if the condition was sufficiently far-reaching, the policy might be rendered all but useless as it can be asserted that all future claims are linked to the now ‘excluded’ pre-existing condition.

Depending on someone’s outlook, the existence of PECs in underwritten policies might either be seen as:

• A good thing that provides insurers with an additional layer of protection from fraudulent claims which would otherwise damage the insurer’s claim experience and increase rates for other insured persons; or
• A little-understood clause that could be used to disadvantage an otherwise genuine claimant, and in the process, expose the financial adviser to personal and business risk for recommending the policy in the first place.

Section 37 of the Act places the following responsibility on insurers:

“Notification of unusual terms – an insurer may not rely on a provision included in a contract of insurance … of a kind that is not usually included in contracts of insurance that provide similar insurance cover unless, before the contract was entered into the insurer clearly informed the insured in writing of the effect of the provision (whether by providing the insured with a document containing the provisions, or the relevant provisions, of the proposed contract or otherwise).”

PECs are not present in all retail risk insurance policies, but they are present in some. Whether this is sufficient to render them an unusual term, time may tell.

The other risk for the financial adviser, however, comes in the way the client is briefed regarding the duty of disclosure.

It may be that the presence of a PEC in the recommended policy will require the financial adviser to appropriately brief the client in regards to these as well.

Consider the position of Jeff, who decides to take legal action against his financial adviser for recommending the PEC policy instead of one without a PEC.

Financial advisers should be aware that PECs currently exist in some retail underwritten risk policies, and they can – and have – been invoked at the time of claim.

Financial advisers may not need to know all the technical and legal complexities of these clauses, but irrespective of whether an adviser is representing the insurer or the insured, it may be prudent for them to know what a PEC is and where it can be found.

Col Fullagar is the national manager for risk insurance at RI Advice Group.