BackWorking with the three-year rule
Additional risk-based verification checks at the underwriting stage will have to be introduced
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Insurance policies are based on the principle of “utmost good faith". This means that the life assured should disclose the current status of health, history of health, family history, income, occupation and other relevant details truthfully in the proposal form.
If there are any incorrect statements in the form on any material fact (which impact the decision to accept/reject/postpone/impose revised terms), it could give rise to repudiation of any policy benefit payable as per the policy terms.
Before the amendment to section 45 of the Insurance Act, 1938, the insurer had the right to repudiate the policy benefit at any time after it was issued; but for repudiations beyond two years from the date of issue or reinstatement of policy, establishment of fraud (i.e. intentional non-disclosure or misstatement) was necessary.
But now the section 45 has been amended in the Insurance Laws (Amendment) Act, 2015, to state that no life insurance policy can be called in question after a period of three years from the date of commencement of risk or date of issue of policy or date of reinstatement of the policy or date of addition of rider, whichever is later.
Beyond the said three years, even if fraud is established, the policy benefits will have to be compulsorily paid by the life insurer.
This is probably based on the premise that if a policyholder has lived for three years of a policy, and paid the premiums, the adverse state of health before signing the proposal, even if it was significant, ceased to have any impact on the mortality of the life assured.
This means that if the insurer wants to avoid the risk of paying policy benefits on policy contracts that were issued on the basis of misstatements or non-disclosure, it has to establish whether this was unintentional or intentional, within the three-year period.
Normally, life insurers issue policies based on the health declarations in the proposal form (for new policies) and declaration of good health (for reinstatement of lapsed policies). For high sum assured cases, medical examination is also done as a risk mitigation measure. But a medical examination does not reveal the full status of health of the life assured and, therefore, does not absolve the life assured from the responsibility of truthful disclosures.
So, a life insurer’s hands are tied. And it has to face further risks.
Claims in fraud cases: Systematic and organized frauds happen in life insurance. For example, taking policies on a deceased person’s name by forging signatures and documents. While such frauds by any party to the contract make the contract voidable at the instance of the party who has been defrauded, under section 17 of the Indian Contract Act, 1872, the wordings of section 45(1) state that “no policy can be called in question for any reason whatsoever" after the said period of three years. So, in the above example, the defrauded life insurer should still have the right to make the contract voidable, as nothing can justify a real fraud.
To avoid legal disputes, insurers would do well by instituting proactive verification checks such as visiting the life assured, obtaining know-your-customer documents, enquiring in the neighbourhood, and others.
Risk of nominees delaying filing of fraudulent claims: Let us take an example of a person who has a personal history of an ailment, but takes a life insurance policy on 1 January 2016 without disclosing this fact in the proposal form (Reason: Policy may be not be issued or may be issued with higher premium). This person dies on 31 October 2016. Let us assume that the nominee under the policy is aware of the above provisions and wants to take advantage of the situation. The nominee waits till 31 December 2018 (expiry of three years from the date of issuance of policy) and then files a claim. In this situation, the insurer will have to pay the claim, even if it is able to obtain evidence proving that the policyholder was suffering from the ailment and that it had not been disclosed.
What can life insurers do?
Tighten underwriting rules: Underwriting in insurance means evaluation and acceptance of a risk on a proposal form by an insurer. This is the stage at which a decision to accept a risk or otherwise, is taken. Since the life insurer will end up paying even adverse claims after three years, limits for undergoing medical examination may have to reconsidered and revised downwards, at least for medium- to high-risk customers.
Increase risk referrals: Additional risk-based verification checks at the underwriting stage will have to be introduced. For example, in respect of policyholders engaged in suspicious occupations or living in high-risk areas, additional due diligence will have to be conducted to verify their existence and health status by enquiries in the neighbourhood.
Proactive sampling within three years: After the issuance of the policy, but within the three-year period, risk verification on the life assured’s health on a sampling basis could be done so that if a misstatement or fraud is established, the policy contract can be rescinded within the stipulated period itself.
Increase litigations: Since there is a risk of fraudulent claims getting paid, if the claim is made after the three-year period, some firms may take the risk of repudiating at least the core fraudulent cases (for instance, dead person insurance or wilfully delayed claims). But this could increase the cost of litigations for the firms.
Increase premiums: Another option is revising premium rates if the insurer ends up paying more and more fraudulent claims. This is because in the pricing assumptions, the actuary would have assumed that fraudulent claims will be repudiated, while section 45 has curtailed this right. However, it will happen only if the number of claims after three years is substantially higher. Increased risk investigations, proactive checks and litigation increase an insurer’s cost of operations, and may contribute to revision in premiums.
Section 45 was intended as a measure to protect a policyholder. It had been drafted to make the life insurer honour the claims if the policyholder has paid premiums for three years and then dies. If the policyholder dies within this time, but the claim is lodged after three years, it leads to honouring fraudulent claims.
It is, therefore, suggested that section 45 be amended to state that no policy can be called in question, after three years from the date of issuance of policy or commencement of risk or date of reinstatement or addition or rider, whichever is later, provided the death of the life assured happens after the said three-year period. This will ensure that only those policies where the customer has lived and paid premiums for at least three years are honoured.
Further, a provision may also be introduced that fraudulent claims, whenever they occur, can be repudiated by the life insurer.
C.L. Baradhwaj is senior vice-president (compliance) and chief risk officer, Bharti AXA Life Insurance Co. Ltd.
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