In this post I want to discuss substitute policies again, talk about cover for self-employed persons and definitions of waiting periods.
What is a substitute policy
Substitute policies are one of the few drivers of real potential competition and therefore competitive markets for credit life in South Africa. That’s probably not the definition you were expecting but nevertheless it is true.
With some exceptions, credit life is not sold in a competitive or symmetrical environment and customers have little or no bargaining power.
A substitute policy is a policy from another insurer (not connected to the lender) that covers the same or similar benefits and legally must be accepted as a substitute for the cover required by the lender under the terms of the loan.
Historically, the rate of substitute policies was tiny. Often less than 1%. Lenders and their associated insurers weren’t exactly incentivised to make it an easy process. For smaller loans and therefore smaller policies, the incremental acquisition costs can be prohibitive.
Substitute policies are gaining momentum
I am aware of several players specifically targeting existing credit life customers and aiming to switch these customers to their own products.
This has been enabled through:
- standardising of credit life policies
- bulking of many different small credit life policies into a larger one that is more cost effective to acquire and administer
- technology (digital / online especially but also call centres) that can moderate costs
- the growing awareness of how profitable these policies often are for a standalone insurer, even at the various caps imposed.
Lenders may need to supplement revenue on high risk customers because interest rate caps apply, but the stand alone insurer is focussed on a reasonable underwriting result, not the level necessary to offset costs elsewhere.
What counts as a substitute policy / minimum prescribed benefits
A substitute policy simply needs to cover the minimum benefits from section 3 of the credit life regulations. This covers death, permanent disability, temporary disability and unemployment or loss of income.
These regulations can be difficult to interpret, but ultimately are clear:
- You must pay the total outstanding balance on death or permanent disability
- You must pay the shorter or 12 months’ installments, all the remaining contractual installments, or until the policyholder returns to work in the case of temporary disability, retrenchment, or the inability to earn an income.
- you may not charge for unemployment or loss of income if the person is not employed, except that if they are self-employed then you can charge and must provide the benefit or “loss of ability to earn an income”.
- You may not charge for disability for someone who is a pensioner.
- The cost must be based on the risk, and you must be able to demonstrate that to the regulator.
- While you may not charge more than the cap, anybody who increases premiums to the cap will likely have to explain how the risks suddenly increased. (It is possible that the benefits required are richer than previously offered, so this isn’t an automatic problem.)
All of this makes complete sense to me, although the provision of loss of employment benefits to the self-employed does pose risks of anti-selection, moral hazard and outright fraud. There is no prohibition on sensible anti-fraud measures.
Some have interpreted this to say a substitute policy must offer the same benefits as the original insurer. This is not correct. Only the minimums under section 3 need to be met. Any richer benefits, under section 5 or elsewhere, are irrelevant to the substitution of the policy.
Confusion possibility on cover for self-employed persons
I have heard that one financial services provider is insisting that cover for self-employed people either may not be offered or must not be offered. If so, this is likely due to an incomplete reading of the regulations.
3 (3) says:
Subject to sub -regulation (5), where a consumer is not employed on the date that the credit life insurance policy is entered into, no cost relating to the risk of becoming unemployed or being unable to earn an income may be included in the cost of the credit life insurance.
Where a consumer is self – employed in the formal or informal sector, or employed in the informal sector on the date the credit life insurance policy is entered into, the credit life insurance policy may include the cost relating to the risk of the consumer being unable to earn an incarne other than as a result of retrenchment or occupational disability.
Last piece of the puzzle is 3(2) (c)
in the event of the consumer becoming unemployed or unable to earn an income
So, in other words, unemployment OR loss of income must be covered. And the prohibition of charging for that benefit where the person is unemployed (for obvious reasons) is relaxed if the person is self-employed (for similar obvious reasons and consistency).
Loss of income cover for self-employed persons must be provided.
Confusion possibility on waiting periods
Waiting periods are permitted on disability benefits for longer terms loans, although waiting period is not defined. It is fairly standard in South Africa to use waiting period differently in different contexts, which doesn’t help
- a “waiting period” on non underwritten death cover (like funeral) that starts from policy inception before the policyholder is eligible for natural cause death benefits. Typically only accidental deaths are paid within the first 3 to 6 months.
- a “waiting period” on a disability policy which is the time from a claim even until the benefit is paid. This is also called a deferred period. For example, you might need to be disabled for 4 or 8 weeks before benefits would then be paid. Different providers would back-pay to the start of claim or pay from the end of the deferred period. This is to decrease small claims and the associated expenses and to be sure that you really are disabled and not just “sick”.
My reading of this, including the fact that it only applies to disability benefits and that ASISA standard definitions use the second definition, is that the second definition rather than the first is the one to apply.
What does this all mean for substitute policies
Substitute policies must provide cover for the self-employed, can apply the right sort of waiting period (even if it is less generous than the original policy), and may not provide the wrong sort of waiting period.
There are clear incentives for providers of substitute policies to focus on low cost, minimum benefits to attract customers. The insurer associated with the lender similarly has incentive to design richer products. This isn’t great for comparison or competition.
Expect to see investigations and fines and findings on these topics in future. I imagine there will be tale-telling by competitors on one another to deviations from the law will be spotted quickly.