The problem of "fair‐labelling" and insurance

16 October 2018
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We assign labels to things all the time. When you say, “Pass me a pen”, pen is the label we place on an object with which we expect to write words on paper. We often, though, assign labels unfairly and this has been a matter of concern to jurists for decades as recently pointed out by Khomotso Moshikaro writing in the South African Law Journal. When for example, a magistrate is given a docket indicating that the accused faces a crime of assault with intent to cause grievous bodily harm (“Assault GBH”), this label creates a certain expectation in the mind of the magistrate before the case has even begun. If the facts turn out to indicate that the accused’s crime should, at best, be described as “common assault”, it may be too late as the accused may well have been unfairly prejudiced by the original label put on the case by the prosecutor. 

I suspect that labels like these have often been deliberately incorrectly assigned. An incorrectly labeled then convicted accused thereby sets a precedent to be used in all future cases with similar facts. In future, the incorrectly assigned label re‐defines crimes.

Not long ago, we had a spate of motor accidents in South Africa where the facts clearly indicated that, at best, the crime was one of culpable homicide. However, the charge was deliberately incorrectly labeled as a murder. Simply incorrectly labelling a charge in such a deliberate way can often produce the outcome that prosecutors want. By purposefully assigning a given label, quite an extension to the “law” can be achieved, and there is often great incentive to do so.

Treating Customers Fairly

The problem of inappropriate labelling is not confined to law. It is appearing in the financial services market which should take deliberate steps to resist incorrect labelling, particularly by regulators. An example is the programme labelled “Treating Customers Fairly” (TFC). I have repeatedly pointed out that there is no objective evidence that the financial services sector has been treating their customers unfairly.

This TCF label creates two problems: Firstly, it implies that, historically, as a general rule, the industry has been treating its customers unfairly. Secondly, it implies that there is an objective thing called “fairness”. By any objective standard, no support can be found for the view that historically, in general, the industry has treated its customers unfairly. For example, if one looks at the claims dealt with by the industry ombudsmen, as a percentage of all claims lodged, the number of cases where the insurer is considered to be in the wrong is so small as to be statistically negligible. Secondly, those claims where the ombudsman finds against the insurer (or to have been “unfair”) are, in terms of the industry agreement, paid anyway. So technically, since the ombudsman schemes were voluntarily introduced by the industry in the 1980s, every legitimate claim has been paid. That negligible figure is hence reduced to an absolute zero.

When National Treasury tried to justify the inscrutable “Twin Peaks” regulatory architecture, it was forced to resort to embarrassingly imaginary “Thandi” and “Sipho” stories to try and justify why the legislation was necessary. With the short-term industry alone settling over R100 billion in claims every year in South Africa, one would have imagined that there would have been literally thousands of examples of “unfair” treatment to illustrate their allegation. However, only imaginary and allegoric cases could be created. No statistical evidence of unfair treatment was produced. This, notwithstanding the on‐going and unfounded contention that the industry does not treat its customers fairly, has led to there being little or no resistance to the importation of the British TCF programme. The initial and deliberate “unfair treatment” label has thus taken on the form of a self‐ fulfilling prophecy.

The second problem with this label is that it implies that there is an objective standard called “fairness”. Fairness, like beauty, is in the eye of the beholder. The relationship between the client and the financial institution is one of contract. Fairness is too vague a concept to be a contractual requirement. The South African legal system and the law of contract automatically incorporates fairness. “Fairness” is thus not a free standing or separable element of our law. It is by its very nature a routine part of the whole.

“Junk” insurance

A more recent, deliberate and troublingly inappropriate label, which seems to be surfacing, is that of “junk’ insurance. Apparently, it has been suggested that if the loss ratio of a particular product appears to be low when compared with other general loss ratios, then that insurance product is to be labelled “junk” insurance.

The loss ratio is akin to the well-known gross mark-up. That a gross mark-up can be indicative was dismissed over a hundred years ago by one of the world’s most famous economists, Alfred Marshall. He looked at the example of money being lent at a 3,000% pa interest rate. Many would hold the view that this mark-up is excessive. He successfully demonstrated that, taken in context, it was not excessive and, might indeed be too low. The National Credit Act itself recognises that interest rates by themselves are not meaningful and need to be seen in context.

Similarly, an insurance product loss ratio by itself is quite meaningless. Proper free and open competition always ensures that products are correctly priced. Preventing open competition is almost always the sole cause of product mis‐pricing. For example, regulatory intervention preventing administrative efficiency and proper competitive pricing has done considerable harm to South Africa’s credit life market, with no demonstrable benefits for customers. This includes the fact that the previous efficient market system of financed single premium payments was outlawed, resulting in an unnecessary explosion of premium administration costs, high lapse rates and thus many desperate widows and orphans left without their transport.

Industry regulators have been talking about introducing “microinsurance” for decades but have predictably produced nothing to date. The problem with microinsurance, simply put, is that the administration costs per unit will be much greater than with traditional insurance.

If and when microinsurance finally sees the light of day, it will routinely operate in the low loss ratios range. Does this mean that when and if the regulators finally get microinsurance off the ground, they will call it “Junk” insurance?

Robert W Vivian is Professor of Finance & Insurance, School of Economic and Business Sciences, University of the Witwatersrand

 

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