As may have been noticed premium refunds will only be due where a single premium has been paid by the customer. This is because under monthly premium payments, the premium payment simply stops.
If cancellation was due retroactively on a monthly premium payment, E.g the customer using the cooling off period, or the insurer finding out that the customer was not eligible in the first place, then a refund would need to be given.
This section therefore refers to single premium polices which have been terminated before the insurance has expired.
In these cases there are several areas to consider, before dicing whether or not a premium refund is due.
- Is there a ‘no-refund’ clause.
- How much premium will be returned.
- How does the mortgage protection insurance premium refund relate to the rebating of interest on the loan.
No refund clause
If there is a ‘no refund’ clause, then no refund will be made.
How much will be returned
The premium covers the cost of the insurance company taking the risk for the whole of the cover period of the mortgage protection policy which could be up to five years. The insurer can not assume that they have earned all the premium in the first month or first year, neither will they want to wait until the last day of cover before claiming they have earned the premium. The insurer will therefore spread the premium over the period and use a calculation which allows them to take a proportionate amount of the premium each period (month or year) as having been earned into the profit and loss statement.
The insurer may well pay commission to an introducer out of the premium received. This may or may not be recoverable by the insurer, and therefore may or may not form part of the refund calculation.
Now the premium may not be earned evenly over the whole period of the cover. When the policy first starts up there will be administrative costs which the insurer must bear. These will include checking any insurance proposal/application and registering the risk in the insurer’s books.
If the cover includes Life or critical illness and the cover is based on the outstanding amount of the loan, then the benefit insured e.g. the loan amount, will be reducing over the period of the loan and hence the period of the mortgage protection policy.
If any earned calculation takes into account the risks involved, then the risk under a life policy increases with the customer’s age.
Monthly benefits which last up to 24 months will terminate once the loan is repaid. So an accident occurring on a date with only 12 months repayments to run, will only pay a maximum of 12 benefits. This exposure therefore starts to reduce as the policy nears its close date.
With these many variables the Insurer will use a figure that is acceptable to their portfolio of business and is also acceptable to the regulating authorities and the tax authorities.
A common method of applying an earned rate to premium is known as rule 78, which shows a way of earning 75% of the premium before half the policy period has expired.
Once an insurer has settled on a method to calculate earned premium, then they will usually apply that rate to the whole portfolio within this category of insurance.
In conclusion the mortgage protection insurance customer is unlikely to receive a full proportionate premium refund.
Whilst the insurer is not restricted in the way it calculates premium refunds, under the FSA rules the policy should contain all the contract terms and if the policy shows that a refund is allowed, then is would be expected that it should also refer to the method of calculating that refund. If that calculation method could be considered a significant or unusual term, then the insurer under the FSA rules would be obliged to bring that feature to the attention of the customer at the outset of the placement.