Beware of dead-end policies

Time of article published Jan 24, 2008

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Funeral assurance is one of the most widely used financial services in South Africa, and yet it has been neglected from a regulatory point of view. In this sector of the financial services industry, abuse and fraud are rife, particularly where burial societies and funeral parlours are concerned.

Unlike most insurance, funeral assurance is bought, not sold. This means consumers actively seek funeral assurance, and for many South Africans, it often takes priority over education or daily expenses, such as food and other basic necessities.

Funeral assurance is sought after partly because of the emphasis that many people place on a dignified burial. In some communities, consumers take out several funeral policies to ensure they or their loved ones will have a funeral of what they consider to be an appropriate standard.

For most people, it is important to make provision for their funeral, if for no other reason than to spare their family the expense. Funerals can be costly.

According to a report published in April 2005 and based on research commissioned by Finmark Trust, in Johannesburg, Africans spend on average R8 000 on a funeral, whites spend R4 000, and Indians spend less than R3 000 on a funeral.

However, in a report entitled Funeral Insurance, A Perception by Judge Peet Nienaber, the Ombudsman for Long-term Insurance, and Jennifer Preiss, his deputy, say that, on average, a funeral costs closer to R10 000.

Funeral assurance fulfils a need in the market and there are thousands of funeral policyholders who don't experience any problems, Nienaber and Preiss say in their report.

But fraud is rife, irregularities abound, some funeral assurance operators function illegally and unscrupulously, and the public is on occasion exploited, they say.

Although funeral insurers are more inclined than others to ferret out clauses to avoid or delay paying out on a policy, they are not the only ones to blame.

Most claimants are honest, but some are "downright deceitful, avaricious and have unrealistic expectations from insurers", Nienaber and Preiss say.

Another problem, according to the Finmark Trust report, is that funeral insurance is often sold as an add-on product in shops and banks, and this is contributing to the mis-selling of policies.

In shops, for instance, credit life insurance, which may include funeral cover, automatically falls away when the debt has been settled. Assuming that the consumer needed funeral cover in the first place, this need continues beyond the repayment of the debt, the Finmark Trust report states.

Nienaber and Preiss go on to state that some customers pay for policies on which their estate will never claim because neither the customer nor the estate are aware of these policies.

The research by Finmark Trust reveals that consumers are most vulnerable to fraud at the hands of administrators and funeral parlour operators, and that the regulations governing these businesses are not properly enforced.

There is less fraud in burial societies because they are governed by their members.

It can happen that the treasurer runs off with the money, but such incidents are surprisingly low considering the number of burial societies and their informal structure, the Finmark Trust report notes.

Cash option

Funeral benefits can take the form of a cash payment, a funeral service or a combination of the two.

According to Nienaber and Preiss, one of the major abuses in the industry is the failure on the part of insurers to advise consumers that they have the option to take cash in lieu of a funeral service.

This is a right you have under the Long-Term Insurance Act.

When a funeral service is provided, the insurer undertakes to pay a fixed sum. When the funeral expenses amount to less than the sum insured as stipulated in the policy, the balance must be paid to the policyholder, the beneficiary or the estate, depending on the circumstances, they say.

According to the Finmark Trust report, funeral parlours structure their products and services in such a way that makes it unattractive for you to choose cash instead of their funeral parlour services.

If you don't opt for their "discounted" funeral services, the money will be paid into the deceased's estate instead of to the beneficiaries. If the beneficiaries receive the money, it is available immediately to cover the costs of the funeral. If it is paid into the estate, the family has to pay for the funeral and claim the costs from the executor of the estate. Receiving the reimbursement may take some time.

The Finmark Trust report states that parlours often use the money they collect in premiums to fund the entire business, which puts policyholders at risk of losing their benefits.

It is for this reason that funeral parlours are unwilling to provide consumers with the option of a monetary benefit - as required by the Long-Term Insurance Act - or to price the components of a funeral transparently, as this would prevent cross-subsidisation within the business.

Where parlours do allow you the option of a cash benefit instead of funeral services - which is rare - they generally deduct a certain percentage of the value of the benefit - between 25 percent and 50 percent - as an administration fee.

Value for money

Funeral parlours define their benefits in terms of the services provided at death, to which they attach a nominal value. The value applies to the whole package and is not itemised. This makes it very difficult for you to know and compare the true value of offerings from the various providers, the Finmark Trust report says.

Both insured and self-insured funeral parlours tend to express their benefits in terms of services rather than in monetary value, and if you were given a breakdown of the cost of their services, you may not consider it value for money.

With the possible exception of parlours linked to formal insurers and some larger independent operators, the option of a cash benefit is fairly rare.

Plethora of participants

In addition to you and the insurer, there are often a number of other parties to a funeral policy. These parties include an administrator (which manages the scheme on behalf of an insurer), an intermediary (who may be an independent broker or an agent of the insurer), and the policyholder (which, in a case of a group scheme, may be a burial society, pension fund, stokvel or trade union).

Nienaber and Preiss say policyholders sometimes ask how their premiums are apportioned. The response can be disconcerting.

In a case before the ombudsman, the sum assured was R5 000 and the premium was R20 a month. Of the R20 premium, R10 went to commission, R2.50 to administration and only R7.50 was spent on the cover each month.

Administrators

One of the problems with funeral administrators is the control they wield over clients. For example, it is within their power to move clients between insurers. This is only supposed to happen with the client's consent. They can also determine the final price of the product through the charges added to the risk premium without communicating this to the insurer.

As a result, the insurer has no control over the final premium charged to policyholders.

Administrators do not disclose full details of the policy (or give a break down of the premium) to the consumer because it would reveal their margins, the report states.

Set funeral package

At the time of death, the set funeral package is not negotiable downwards; you can only upgrade to a more expensive option, usually at substantial cost.

If you are unhappy with a particular component, you cannot exclude it in favour of the money. So, if you want to replace the coffin in the set package with one you bought elsewhere, you may do so, but the parlour will not refund you the money on the coffin that will not be used.

Term assurance

Under the Long-Term Insurance Act, an insurer is not allowed to cancel a policy; only you, the policyholder, can do so.

Therefore, the insurer can be tied into the policy for a long time. To get around this, insurers offer policies with a short term, in some cases, as short as a month, but usually with a 12-month term.

To exit from a policy, the insurer simply does not renew it. This also allows the insurer to increase the premium on each policy renewal.

The danger of this is that as you grow older, frailer and closer to death, your policy may be terminated at the very time when you need it most, Nienaber and Preiss say.

At this stage of your life, you may also find that no other insurer is prepared to give you funeral cover.

Watch out for policies that contain a premium escalation clause. Some policies escalate at a rate of 15 percent a year, which results in the policy becoming unaffordable for policyholders, especially in their retirement. These escalation clauses usually apply to individual cover. Group cover typically does not have escalation clauses.

Funeral policies sold under an assistance business licence (meaning the benefit does not exceed R10 000 per life assured) do not usually have a paid-up or investment value.

Usually, policies are payable for life and the full benefit is forfeited if you stop paying.

If a policyholder is ill for an extended period before death, and is unable to work or pay premiums, the policy will lapse exactly when cover is most needed.

Policy documents

The terms of the policy should be contained in a policy document. But such a document does not always exist, and if it does, it is not always issued to the policyholder, Nienaber and Preiss say.

The Long-Term Insurance Act specifies that you must receive a membership certificate summarising the core provisions of the contract.

It must also set out how much of the policy premium goes to the life assurer and how much goes to the intermediary or administrator.

If you request it, you are also entitled to a copy of the actual policy containing the full terms of the contract to which you have committed.

Another problem with funeral policies is that the wording can be bewildering, Nienaber and Preiss say.

The marketing material of insurers or administrators is sometimes misleading in what it promises, or the information may not match the actual policy terms. In such instances, the ombudsman has instructed the insurers to honour the promises contained in their marketing material.

Fraud and mis-selling

Consumers generally are trusting by nature and fraudsters feed on their trust, Nienaber and Preiss say.

Funeral parlours, loan sharks and unscrupulous insurers sometimes work in tandem to generate new business and to lure unsuspecting victims into taking out inappropriate policies, they say.

Only companies registered under the Long-Term Insurance Act may underwrite funeral assurance. Some unregistered administrators and insurers initially pay claims to lull their customers into a false sense of security. But once they have accumulated enough funds, they vanish or fold.

As Nienaber and Preiss put it, contractually, they may be bound, but factually, they can't be found.

Some illegal operators are prosecuted, but prosecution and conviction offer scant satisfaction to defrauded policyholders.

In soliciting potential customers, insurers or their agents sometimes talk customers into taking out insurance on terms that are not necessarily in their best interests, the Nienaber-Preiss report states.

Proof of claims

The responsibility for proving that a claim for a benefit is valid is that of the person making the claim, Nienaber and Preiss say.

As a claimant, you must prove that:

- The qualifying conditions for the payment of benefits under the policy have been fulfilled;

- The deceased was designated as the life assured under the policy; and

- You are entitled to payment in terms of the funeral policy.

Over-insurance

Over-insurance occurs when banks, in particular, sell funeral policies on behalf of insurers. Such policies may cover extended members of a family. Nienaber says it often happens that one family member is covered in more than one policy with the same insurer.

For example, a person may be covered by both his brother and his son in different policies. Policies may either have a limitation on the total amount of cover that the insurer would pay to any one life assured or limit the number of claims to one per life assured.

In either case, the person covered under two policies would not receive two payouts.

According to Nienaber and Preiss, the practice of insurers is to pay out in full to the first of the claimants who can prove that he or she is a beneficiary of a policy and to refund whatever premiums they may have paid for the second policy or the balance of the cover up to a limit, as specified in the policy.

Exclusion clauses

Exclusion clauses in policy documents are sometimes not adequately explained to the policyholder.

Funeral policies are typically sold without the insurer having any knowledge of the policyholder's personal or medical history.

Nienaber and Preiss say to protect themselves, insurers frequently insist on contractual waiting periods and specific exclusion clauses.

At issue is not whether a specific exclusion clause exists in a policy, but rather whether the applicant was or should reasonably have been aware of the particular exclusion, and if the applicant was, whether he or she fully appreciated its significance, they say.

Waiting periods

Waiting periods usually apply only to death by natural causes. During a waiting period, you have to pay your policy premiums but do not enjoy cover for death by natural causes.

All policies have waiting periods, which vary from three months to 12 months for the core family, and up to two years for the extended family.

Waiting periods are potentially problematic for policyholders for the following reasons:

- Nienaber and Preiss say that while waiting periods are an acceptable form of risk protection for insurers, the length of the waiting period may be unreasonable.

The ombudsman's office cannot state what is a reasonable waiting period. It boils down to the extent of the risk and the amount of the premium.

The greater the risk to the insurer, the greater the premium, and the converse is also true.

Waiting periods reduce the risk for the insurer because the insurer does not pay out for death that takes place during the waiting period, Nienaber and Preiss say.

- When an insurer waives its right to underwrite (assess your health for the risk of you dying), so too does it waive the right to repudiate your claim on the basis of non-disclosure.

For example, you have cancer and do not disclose it when you apply for funeral cover, which has a 12-month waiting period. If you die after the 12-month period, the insurer will have to pay the claim (to your estate) unless there is a specific exclusion for cancer.

- If a policy lapses and is reinstated, the waiting period generally starts again.

Forfeiting benefits

Funeral parlours generally do not offer services outside of their geographic area unless they are national or linked to formal insurers.

In some instances, consumers are left with no choice but to forfeit their benefits if the funeral must take place outside the geographic area in which the funeral parlour operates.

So, if members move away or if the dependants of members live far away, funeral parlours will typically refuse to perform the services, or to provide transport beyond limited distances. When the parlour does not offer the option of a cash benefit, the policyholder forfeits his or her benefits.

Payment of premiums

Premiums are normally payable in advance and you only enjoy cover for as long as your premiums are paid. Policyholders sometimes believe that their funeral policies are savings schemes, Nienaber and Preiss say.

The insurer can turn down a claim the moment you fall into arrears with your premiums.

However, the Long-Term Insurance Act gives you a grace period of 15 days to get your payments on track again and most policies give you 30 days. During this grace period, you will have funeral cover even though you may be in arrears.

Late claims

Insurance contracts commonly contain clauses requiring that claims be made within a set period of the claim arising. Nienaber and Preiss say such a requirement is not objectionable and you need to be aware that the insurer will normally enforce it.

Underwriting risk

The Finmark survey found that while, in theory, administrators serve as intermediaries, in reality many assume the role of product supplier. In some cases, the administrator - and funeral parlour - illegally self-insure and carry the risk of paying out the pool of policyholders when deaths occur.

Similarly, some funeral parlours and administrators self-insure to a certain extent and only partially underwrite their insurance business with a formal insurer.

The lack of underwriting poses a danger for policyholders, who may lose their benefits if the risks are not properly managed and/or these organisations fold.

Watch out

The funeral assurance market can be treacherous. Profit margins are small, premiums are low, operators are many, competition is fierce and various players insist on a share of the premium pie, Nienaber and Preiss warn. It is not easy to find ready solutions to the problems that consumers encounter with funeral assurance. Certain issues are being addressed by the Financial Services Board (FSB) and the National Treasury.

In the meantime, the Ombudsman for Long-Term Insurance helps wherever and whenever possible.

The ombudsman can deal with complaints about insurance contracts involving formal insurers and the FSB focuses on catching operators offering illegal insurance .

Understanding funeral assurance

Funeral assurance is an undertaking by an insurer to a policyholder to provide a benefit on the death of the life assured.

To obtain the benefit, the policyholder must pay premiums on a regular basis, usually monthly. The proceeds of the policy may be used for purposes other than funeral expenses.

How funeral policies pay out

It is important to understand that the policyholder (the person who enters into a contract with an insurer and who is entitled to the benefits) and the life assured (the person whose life is insured) need not be the same person. In other words, you can take out a funeral policy for your spouse or parent - in which case, you are the policyholder and your spouse or parent is the life assured.

The policyholder can nominate a beneficiary to receive the benefits that are due on the policy when the life assured dies, or to receive ownership of the policy when the policyholder dies. The beneficiary can be someone other than the life assured. The nomination of the beneficiary can take place when the policy is taken out or thereafter, unless the policy forbids it.

A policy can allow for more than one life assured. For instance, the policy may cover close family members in addition to the principal life assured.

When the policyholder who is also the life assured dies, the policy proceeds will go to:

- The nominated beneficiary (if there is one); or

- The policyholder's estate.

When the policyholder and the life assured are not the same person and the life assured dies, the proceeds of the policy will go to:

- The nominated beneficiary (if such a nomination has been made); or

- The policyholder if there is no nominated beneficiary.

When the policyholder and the life assured are not the same person and the policyholder dies, the policy will go to:

- The person nominated to become the owner of the policy (if there is such a nomination); or

- The policyholder's estate.

What funeral parlours offer

Funeral parlours offer two distinct financial products. The first product is an insurance policy in terms of which a defined benefit is paid in the event of death, irrespective of the amount of money that has been paid in premiums. The second product funeral parlours offer is a funeral savings plan.

- Insurance.

Funeral parlours offer insurance in three ways:

*Insured or underwritten insurance.

The parlour sells its own products which are underwritten by an insurer. In this case, the parlour acts as an administrator for the insurer.

*Self-insured insurance.

The funeral parlour sells its own insurance products which are not underwritten by an insurer. This is illegal.

Only organisations that are registered under the Long-Term Insurance Act may underwrite insurance. However, one of the major problems in this industry is the lack of law enforcement.

Research by Finmark Trust indicates that most insurance offered by funeral parlours is either fully self-insured (the risk is not passed on to an insurance company) or partly self-insured (some of the risk is passed on to an insurance company).

*Intermediary.

The parlour acts as an intermediary and sells the products of an administrator or an insurer.

- Funeral savings plan.

This is a savings plan you take out with a funeral parlour and put aside money to make provision for a funeral for yourself and/or your loved ones.

You may pay the funeral parlour at defined or undefined intervals. The parlour may issue a coupon for each payment made.

When there is a death, the parlour assesses how much money has been paid in contributions.

If enough money has been paid for the funeral you request, the parlour will perform the services.

If insufficient money has been accumulated, you or a relative will have to pay the balance to cover the cost of the funeral.

For example, a funeral parlour may require a minimum contribution of R50 a month towards a funeral savings plan. Assuming you paid R50 for 20 months, you would have collected R1 000 worth of coupons.

If someone on your designated list dies, and the funeral costs R7 000, your family would have to pay an additional R6 000 to cover the costs of the funeral.

The savings plan usually offers you a discount on the cost of a funeral.

In other words, without the savings plan, the funeral may cost R8 000 instead of R7 000.

These savings plans are often provided by funeral parlours to burial societies.

You are usually free to "withdraw" your savings at any time, but the parlour does not pay interest on your savings.

Where to get funeral assurance

There are various ways to provide for funeral expenses. You can buy funeral assurance from a life assurer, funeral parlour or burial society, or use a stokvel, burial society or funeral parlour to save for a funeral. But if you haven't made provision for your funeral, your family will have to pay for it - and if they can't, they may have to borrow money from a bank, microlender, funeral parlour or burial society.

Formal insurers.

There are several insurers that provide funeral cover. Some are licensed life assurers, while others hold what are known as assistance business licences.

An "assistance policy" is the regulatory term for funeral insurance, and an assistance business licence restricts the insurer to selling funeral policies with a benefit of no more than R10 000 per life assured.

Assistance business insurers (insurers that sell funeral cover only) operate under either the Long-Term Insurance Act or the Friendly Societies Act. The main incentive for writing funeral policies as assistance business is that there is no cap on the commission that can be charged. This results in the marketing of products with relatively high administration costs and extended distribution chains.

Some insurers, such as Hollard, sell funeral policies via direct marketing - in other words, over the phone.

The large insurers - Momentum, Sanlam and Old Mutual - are licensed for assistance, life and other policy categories and offer a wide range of insurance and investment products. There is no regulatory limit on the value of cover that can be provided by these insurers. The funeral benefits typically offered vary between R1 000 and R20 000 per life covered, although life assurers offer higher value policies through their individual life assurance policies. The benefits allocated to children, parents and extended family vary between R1 000 and R20 000, but the most basic funeral policy does not exceed R10 000. A basic policy refers to cover for the immediate family - in other words, spouse and children only.

Some short-term insurers, such as Mutual & Federal and Santam, offer add-on products on some of their short-term policies.

When these add-ons provide funeral benefits they are called death benefit plans or bereavement benefits, and resemble assistance funeral policies.

Administrators.

An administrator is a company or organisation that profits by administering a portfolio of policyholders. An administrator is not registered as an insurer under the Long-Term Insurance Act, but the policies that it administers must be underwritten by an insurer that is registered in terms of the Act.

An administrator's chief role is to provide efficient and cost-effective administration of policies. It can provide administration services for formal insurers, funeral parlours, burial societies, employers or other groups, such as church groups. There are an estimated 50 funeral administrators operating in South Africa.

The benefits offered by administrators are similar to those offered by formal insurers as they mostly offer insurance products but add their profits on to the policy premium charged by the insurers.

Burial societies.

Burial societies are voluntary not-for-profit organisations that are generally formed by people who know each other, such as family or friends.

When a member of the society dies, the family of the dead member receives cash assistance, not formal insurance benefits. Some societies enter into agreements with funeral parlours to save for the funerals of their members. Others buy insurance from either funeral parlours or insurers.

Burial societies have to register under the Friendly Societies Act and may not provide benefits of more than R5 000. Alternatively, they may operate under the Long-Term Insurance Act if they wish to provide benefits of more than R5 000. However, some burial societies do not register under either Act and are therefore unregulated.

Friendly societies that do not offer insurance to their members - that is, which do not contractually guarantee benefits - are not conducting insurance business and thus do not have to comply with the Friendly Societies Act or the Long-Term Insurance Act.

When there is a death, members are offered emotional and physical support, as well as a cash benefit, often referred to as "bereavement money". The cash benefit, which is typically less than R3 000, may be paid in two instalments - one before the funeral and one after.

Funeral parlours.

There are an estimated 3 500 to 5 000 funeral parlours in South Africa. They range from one-man businesses to public companies, some of which are listed on the stock market. Some funeral parlours are owned by large insurance companies.

The main aim of funeral parlours is to provide funeral services. But in an attempt to secure a market for their services, most of them have added several funeral-related financial services to their offerings, including assurance, loans and funeral savings plans. Funeral parlours are supposed to register under the Friendly Societies Act and are limited to providing benefits of less than R5 000.

This article was first published in Personal Finance magazine, 2nd Quarter 2006. See what's in our latest issue

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