This case looks at a dispute between a claimant and their insurer, which was resolved by the Financial Ombudsman Service in June 2014. The insurer applied an offset clause to the claimant’s income protection benefit, reducing the payments. FOS overruled the insurer, ordering them to pay compensation. The case has implications for advisers recommending key person insurance for small business owners.
At a Glance
Source: FOS Circular 18 – Determination 278412 (note: FOS does not supply the names of entities involved in disputes)
Topics covered: income protection, income offset clause, disclosure
The claimant jointly owned and operated a small business with his wife. He took out an income protection insurance policy in July 2002.
At the commencement of the policy, the insured monthly benefit was $2,500 and the waiting period was 90 days. At the request of the policy holder, the monthly benefit was increased to $6,250 with effect from 10 March 2003. When he applied for the increase to the monthly benefit in 2003, the insured provided information about the profitability of the family business, which was taken into account by the insurer in accepting the application.
The monthly benefit was subsequently increased by indexation. According to the insurer, at the time of claim, the monthly benefit was $8,045.
The insured became totally disabled on or around 19 August 2011, and lodged a claim for income protection benefits. He was no longer able to work in the business, but the business was able to continue without his input and remained profitable. The waiting period on the policy expired on 17 November 2011, however the insurer did not pay any benefits.
The insured’s wife contacted the insurance company in February 2012, questioning why her husband was not entitled to any benefit under the policy, even though he could no longer earn any income by personal exertion.
The insurer responded in March 2012, saying that:
- The provision of cover (and in particular the increase in cover in 2003) had been based on a 50% share of business profits, as had the insurer’s assessment of the claim
- The business had grown, and if the claimant’s 50% share of business profits exceeds 75% of his pre-disability monthly earnings, the policy provides that no total disability benefit is payable notwithstanding that the claimant is totally disabled, and
- The policy terms do not imply a benefit would become payable solely because of an inability to perform work by personal exertion
Under the terms of the policy:
Monthly Earnings means the Insured Person’s normal monthly income from their personal exertion from salary, fees, commissions, bonuses and other payments received in the normal course of their employment, occupation or profession. If the Insured Person owns any part of a business, Monthly Earnings are the normal monthly income of the business due to the Insured Person’s activities less that person’s share of business expenses necessarily incurred in producing that income. Income which is received on an irregular basis and income which is received at periods longer than one month will be averaged and included in Monthly Earnings. Monthly Earnings do not include interest or dividend payments or any other form of unearned income. Monthly Earnings are always taken before the deduction of income tax.
Pre-disability Monthly Earnings means the greater of the Insured Person’s average Monthly Earnings in the 12 months and their average Monthly Earnings in the 36 months immediately preceding the commencement of Total Disability increased by the lesser of 7.5% and the CPI Indexation Factor each year since that date.
Further, the policy terms state that the insurer may limit the benefits paid as follows:
Total Disability Benefit
The amount of the monthly Total Disability Benefit will be reduced, where necessary, so that the total that month of:
- The Total Disability Benefit payment; and
- The amounts of workers’ compensation and other monies received under legislation or common law relating to Injury or Sickness; and
- Amounts payable from the Insured Person’s employer or business; and
- Payments from other insurance companies, superannuation funds, and other sources in respect of Injury or Sickness;
does not exceed 75% of Pre-disability Monthly Earnings (see Section 4.2 for guaranteed minimum benefit).
Dispute lodged with FOS
The claimant’s wife then wrote to FOS and a dispute was registered on 18 June 2012.
Over the course of the dispute, the insurer obtained substantial financial information from the claimant and his wife, and also obtained a detailed report from a forensic accountant.
The insurer did not dispute the fact that the claimant was totally disabled under the terms of the policy, and entitled to claim.
In October 2013, the insurer advised that it had calculated that the claimant was entitled to monthly benefits of $1,861.39, from the date of disability until 30 June 2012. The insurer said it was arranging to pay these benefits in a lump sum to the claimant.
A further email from the insurer said that, having received a further report from the forensic accountant, the insurer had recalculated the benefits payable to the claimant. The email advised that the insurer was now willing to make a total, further ‘without prejudice’ payment of $28,024.81.
The wife of the claimant said she and her husband were not informed of the existence of the offset clause when applying for the policy, or that payments under the policy could be adjusted because of the profits of the business.
The insurer argued that the clause was contained within the Customer Information Brochure (CIB). While not specifically setting out the terms of the clause, the CIB contained a warning that ‘the Total Disability Benefit will be reduced if the Insured Monthly Disability Benefit is greater than 75% of Pre-Disability Monthly Earnings, less …any money received from your employer…’
There was no dispute that the claimant received a copy of the CIB, but the FOS panel said the document did not specify how the reduction would be calculated or that money received from the insured’s business could also be offset.
For this reason, the FOS panel found that the claimant was not clearly informed of the effect of the offset clause before the policy was entered into.
FOS convened a panel to review the dispute. It noted that the offset clause had been the subject of at least one previous dispute with the same insurer. In the previous dispute the panel determined that the only amounts that could be offset against benefits were amounts that were attributable to the claimant’s personal exertion.
Although not bound by the previous Determination, the panel in the new dispute agreed with the conclusions which were reached earlier, and considered that they should apply equally to the current dispute.
FOS said it was industry practice for insurers of income protection benefits to offer cover to a prospective insured who works in his own business on the basis that the prospective insured’s share of business profits, net of expenses, is personal exertion income and therefore insurable. It was therefore normal practice and appropriate for the insurer to accept the level of cover the claimant sought at time of application.
When he became totally disabled, the claimant ceased to earn any personal exertion income and any amounts subsequently payable to him from the business were “passive” income, in the nature of dividends on a shareholding, not amounts referable to his disability, and not able to be offset under the clause.
The Determination stated that:
- The insurer was only able to apply the policy condition to amounts which were referable to the applicant’s total disability. These did not include amounts which may have been payable to the applicant as a result of the profitability of the family business after he became incapacitated, and to which he did not contribute through personal exertion.
- There is no unfairness or inconsistency in taking into account business profits prior to disablement when the applicant was working full time but not after he became totally disabled when he took no part in the business. Ignoring pre-disability profits of the business that were due to the applicant’s activities would contravene the policy definition of pre-disability monthly earnings.
- When the applicant became totally disabled, he ceased to earn any personal exertion income. Any amounts subsequently payable to him from the business were ‘passive’ income, in the nature of dividends on a shareholding. These were not amounts referable to his disability, and were therefore not able to be offset under the policy condition.
FOS deemed that the claimant was entitled to his full monthly benefit from 18 November 2011, when the waiting period under the policy expired.
However, under the FOS Terms of Reference, the maximum amount of compensation that the Panel can award for a dispute such as this is $7,500 per month.
Accordingly, the FOS panel determined that the insurer pay the claimant not less than:
- A monthly benefit for each month from 18 November 2011 to the date of this Determination equal to the lesser of:
(i) $7,500; and
(ii) The Insured Monthly Disability Benefit for that month less any Total Disability Benefit which the FSP has previously paid for that month, and
- Interest on each of these monthly benefits at the rates specified in section 57 of the Insurance Contracts Act 1984 calculated from the date each such monthly benefit fell due until the date it is paid.
The insurer was also ordered to provide the claimant with detailed calculations of the amounts of the monthly benefits and of the interest component of the payments, and the return of any premiums that may have been paid by the insured since the date of the disability.
To view a copy of the Determination, click here.