Life Insurance Underwriting Explained

Life insurance underwriting is about risk assessment just as life insurance is about risk management. The premise for underwriting does not arise from the mere existence of risk, but from the reality that all risks are not equivalent. Since the premium level is associated with the risk level, life insurance underwriting is necessary to review each risk so that the insurer could apply a commensurate premium.

Underwriting in a general sense is concerned with the insurer’s risk selection. Insurers employ life underwriters to review life insurance applications. However, insurance agents or sales representatives often do the initial underwriting- hence, they are referred to a ‘field underwriters’. The insurer trains ‘field underwriters’ to ensure that only suitable risks are referred to the insurer’s underwriting department for consideration.

Life insurance underwriting is based on the hazards presented by an applicant. Physical hazards, moral hazards and occupational hazards are just some of the risk areas examined. Physical hazard refers to conditions of the body that increase likelihood of the insured’s death. Moral hazard refers to the likelihood that the applicant may be seeking to gain unlawfully, speculate on the life of another or otherwise act dishonestly in applying for the policy. Based on the hazards present, underwriting can be subdivided into groups.

Medical underwriting

This type of underwriting can take place with or without medical examinations. Sometimes the underwriter requires a combination of warranties and representations from the applicant and medical tests. This depends of the applicant’s age and coverage sought typically. Information such as family history and personal medical history will be sought in this phase.

Occupation/ lifestyle underwriting

The underwriter also requires basic information about activities undertaken for employment or enjoyment. Risky jobs include the armed services, pilots and construction. Activities that are considered hazards include racing and skydiving for instance. Lifestyle considerations may also include sexual orientation and drug use. Non-disclosure of such activities may constitute misrepresentation that can lead to an insurance contract being modified or cancelled.

Financial underwriting

Financial underwriting involves the policy owner and insured (if the two are different persons). It is used to detect moral hazard and also to ensure that persons don’t speculate on their own lives by taking out far more insurance than they are worth. A person, who takes out a large policy on the life on his or her spouse, while having a small amount of life insurance themselves, will raise eyebrows. Financial underwriting broadly states that no one should seek individual life cover more than 30 times their income without justifying it.

Major underwriting factors

Life insurance underwriters must use the information to assess the risk of loss (death) of a particular applicant. This is not done by a whim, but by placing the applicant in a risk group that is defined by a specified rating system. Information about age, height, weight, occupation, hobbies, medical condition, finances and medical history (personal and family) is used to classify an applicant according to risk. The questions on a life insurance application and non-medical form are designed to uncover warranties and representations necessary for the underwriting process.

Underwriting action

Once a life insurance application is reviewed, it is then assessed in terms of the risk posed by the applicant. The proposed insured is classified into one of four risk groups:

a) Standard risk- This is the ‘normal’ rating.
b) Substandard risk- Can be accepted but at a higher premium rate.
c) Declined risk- This is a risk that it too high for the insurer to accept
d) Preferred risk- One that is granted a premium lower than the standard rate.

The result of life insurance underwriting is that an application is declined, deferred or accepted. With a deferral, the underwriter temporarily refuses to accept the policy until a particular condition is addressed. The applicant is free to reapply once the condition of concern is addressed. Once a policy is accepted, it can be accepted at a higher rate, standard rate or preferred rate.

Life insurance underwriting is about safeguarding the insurer against anti-selection (the tendency of high risk groups to actively seek insurance). It also allows the insurer to select suitable risks in order to prevent guaranteed underwriting losses. Underwriting also serves to ensure that the insurer charges a premium that is related to the level of risk presented. Although some persons view the underwriting process cynically, it ensures that the risk that insurers accept is insurable. See Characteristics of insurable risks