Underwriting is the process by which a life office accepts or declines a proposal for cover under a risk product. Where the proposal is accepted, underwriting will determine the specific terms on which the policy is accepted i.e. if the proposal for insurance is accepted at ordinary rates or if loading or exclusion is required.
Perhaps the best way to appreciate the importance of the underwriting process is to consider what would happen if life companies no longer used underwriting.
If, for example, testing for cholesterol was stopped, there would probably be cases of people suffering from high cholesterol taking out contracts with life companies. Even though they run high risks of suffering heart attacks, they would be charged the same rates as people who fall into the normal risk pool.
Life companies will experience a larger number of early death (or other) claims than expected and will need to increase their rates. This increase in rates would then apply to everyone, and even healthy lives would be charged more.
One of the cornerstones of insurance is that the same rates are charged for the same risks. Underwriting is a form of stratification so that high-risk clients can be identified and charged more than low-risk clients.
Without underwriting, clients would need to pay more for reduced cover and claims would take longer to pay out.
It should also be pointed out that testing for conditions such as high cholesterol for underwriting purposes can also benefit clients as they may not have been aware that there is a problem with their cholesterol.
WHY IS UNDERWRITING USED?
The benefits of underwriting to the policyholder and to the life office are:
Identifying high-risk clients
Premium rates are normally set to be appropriate for standard lives, most applicants for risk cover. Certain applicants will, however, have a higher chance of claiming than is the norm. Underwriting allows the life office to identify those applicants with a higher chance of claiming. Most applicants are charged the appropriate standard rates.
Removing any cross-subsidisation
Underwriting assists in removing any cross-subsidy that may occur between the standard (or ordinary) risk applicants and the higher risk applicants. The removal of the cross-subsidy results in the more equitable treatment of different policyholders.
Lower standard premium rate
Without underwriting, the standard premium charged would have to increase to allow for the increased risk of certain lives. The result of underwriting is a lower premium for most applicants.
Reduce the risk of selection
Underwriting allows the life office to identify policyholders that have a higher chance of claiming and reduce the risk of a policyholder selecting against the life office. For example, without underwriting, a client who is terminally ill and not expected to live for more than a few months could purchase life cover at standard rates.
Determining the appropriate premiums
Cover high-risk lives
Once the life office has identified a life as being a high-risk client relative to that life office’s standard, underwriting assists in determining the appropriate action to be taken in order to accept the policy. This enables even lives with higher risks to obtain cover.
There are several aspects involved in the underwriting process. These aspects are used to determine the factors to assess the risk. Different factors will have more influence on the decision depending on the type of cover required. The applicant’s occupation, for example, will have more of an impact when underwriting for income disability cover than it may have for dread disease cover.
Assessing Health Risks
Health underwriting is a process that considers the applicant’s current physical condition, their medical history and family history. Health risks are assessed using the information provided by the applicant at the proposal stage. Questions related to the physical condition of the person such as height, weight, and current illnesses/treatment are indicating factors of the general health of the person. By using the proposal form together with the applicant’s family history and their own medical history, a view of the applicant’s health risk can be obtained.
Assessing Lifestyle Factor Risks
Lifestyle factors refer to the standard of living that the person is accustomed to, including factors such as the person’s leisure pursuits. In addition, lifestyle habits such as smoking and drinking that affect the health of the person are also considered. The proposal form will usually contain questions asking the life assured about their leisure activities including any sport or hobbies they participate in. Some activities expose the applicant to dangerous environments – for example, rock climbing, deep sea scuba diving, parachuting and base jumping are all considered extreme sports and place the applicant in potentially hazardous circumstances. The aim of lifestyle underwriting is to make a prudent allowance for any additional risk to the proposer arising from his/her lifestyle choices.
Assessing Occupational Risks
Occupational risks are risks that a life assured would be exposed to in performing the normal duties of their occupation. Certain types of occupations, which are more physically intensive or expose the person to hazardous work environments, are considered high-risk type occupations. For example, compare an engineer who works in an office to an engineer who is physically on a construction site. These engineers may be of the same profession, but they have very different risk exposures in their job. In these circumstances, the on-site engineer may be judged to be at worse risk than the office worker. Occupational underwriting is used to assess the risk arising from the person’s work interests.
Assessing Foreign Residential Risks
Certain countries are considered more dangerous to live in. Usually, the proposal form will simply ask the applicant where they reside for most of the year to assess this risk. If the applicant resides in a foreign country for most of the year, an extra premium may be charged or if the risk is assessed as being particularly severe (for example countries at war or with civil unrest), cover may be refused.
Assessing the Financial Risk
Financial risk assessment is essentially the assessment of the relationship between the following factors to ensure that the proposal makes sense:
The proposed sum assured
The finances of the proposer
The reasons for the cover
The beneficiaries of the insurance proceeds
The proposer and the life assured
The aim of financial underwriting is to:
Ensure there is a valid insurable interest. The beneficiary must, for example, have a legally recognisable economic relationship with the life assured and should not stand to gain more from the death of the insured than from their continued life.
Ensure that there is no intention or temptation on the part of the insured or any other person, to bring about the insured event sooner than expected. This is known as moral hazard.
Ensure that the sum assured proposed is reasonable in relation to the insured’s needs and lifestyle.
Minimum Standard Requirements
Minimum standard requirements state the number and type of medical tests required depending on:
The age of the life to be insured.
The rating category of the life.
Type of cover.
For example, for a small sum assured the applicant may need to only have an HIV test. While an older life, with a higher sum assured, may need to undergo more comprehensive testing.
These required tests can be seen as initial screening. If there are any “red flags” then further tests may be required.
SOURCES OF INFORMATION
All the underwriting processes described above occur at the proposal stage of an application for risk cover. The main source of information is, therefore, the proposal form that the applicant (or the intermediary) submits to the life office.
The sources for information required for the underwriting process are:
Medical Attendant’s Report
Generally, medical examinations and specialist reports are only requested if the proposal form indicates a potential risk.
CLAIMS UNDERWRITING PROCESSES
Underwriting may also be used at claims stage to evaluate the validity of the claim. The information required here depends on the nature of the benefit and claim. For example, a payment made on disability would require proof of the nature of the disability and could call for doctors’ and specialists’ reports.
Outcomes of underwriting at claim stage
In most cases, once proof of the condition has been supplied and the claim has been deemed to be valid, the claim will be paid. There may however be cases where pre-existing exclusions may be applied, or it may be determined that there has been non-disclosure.
Pre-existing conditions are defined as health conditions that the life insured was, or should have been, aware of at inception of the contract. If the life subsequently claims for a benefit as a result of that condition (either directly or indirectly), the benefit will not be paid, unless the client was fully underwritten for this condition at application stage.
Non-disclosure is where policyholders, when they took out the policy, failed to disclose to the life company important information about a serious medical condition like cancer or their lifestyle (for example, participation in dangerous pursuits like skydiving) that does have a direct impact on the risk.
DIFFERENCES IN THE UNDERWRITING PRACTICES
Underwriting processes differ depending on the following factors:
Life companies. Different life offices will have different underwriting practices.
Product type. A proposal for life cover benefits would be underwritten at the proposal stage, while funeral benefit may only be underwritten at the claim stage.
Sum assured of the benefit selected. Minimum underwriting standards generally apply to lower levels of cover.
Benefits selected. Risk benefits may have different underwriting criteria, for example, income disability benefits would have a special focus on occupational risk factors while life cover benefit would focus on health risks, although the two do impact on each other.
Reassurance agreement. The type of reassurance arrangement (e.g. quota share or facultative) as well as the reassurance company being used will affect the underwriting process.
The life office will always weigh up the benefits of underwriting compared to the additional cost of underwriting.