Life Insurance Underwriting: Managing Risk
Imagine the following scenario—you own a
life insurance company and your job is to sell life insurance and operate
the company. You have to pay death claims in a timely manner, invest payments so
they grow in very safe investments and watch health issues in this country so that
you can foresee future death claims. Additionally, you have to calculate and make
educated guesses on the people you decide to insure. What is this applicant's life
expectancy? As the sole employee charged with operating a life insurance company,
your largest responsibility would be to determine which applicants are too risky
The reason for this is that, by nature, we want to buy life insurance only when
it is needed, and not before. Some choose to apply after they learn from the doctor
that they have a serious, possibly terminal illness. Others apply for life insurance
because they have become parents, or perhaps have purchased a new home, thus requiring
two solid incomes to cover the mortgage payments. Both parenthood and mortgage protection
are perfectly acceptable reasons for buying life insurance.
So how would you handle selection and ensure that your customers are buying for
legitimate reasons? You would hire underwriters, schedule medical exams and hire
an actuary. Each of these steps are discussed below and explain how insurance companies
manage risk .
Underwriters : A life insurance company has teams of underwriters
that look at each case. A case consists of medical records ordered and collected
from an applicant's doctor, a motor vehicle report, the life insurance application
itself, copies of the results of a medical exam, and possibly a credit report. The
underwriter may ask the agent follow-up questions concerning the applicant during
the underwriting process. A decision is made by the underwriters, and the applicant
is either approved as is, approved under another condition than originally applied,
Medical exams : A basic life insurance exam consists of a urine
specimen, a blood sample, an EKG, physical measurements such as height, weight,
blood pressure and medical questions. This assessment is paid for by the insurance
company in order to get an accurate third-party look at the applicant. Although
the applicant's doctor's records are collected and scrutinized, the insurance company
runs test on the lab samples collected during the exam. The insurance company has
the laboratory test for diabetes, kidney disorders, antibodies to hepatitis, prostate
specific antigens (PSA), immune disorders, antigens to the HIV virus, cholesterol
and related lipids, tobacco use, cocaine and other drugs. Once the insurance company
reviews the information, a copy may be sent to the applicant to share with his or
her doctor. An applicant may dispute the results of a lab test; however, the insurance
company underwriter views the lab results as a snapshot of the health of the applicant.
Retesting at the applicant's expense may occur; however, the original life insurance
exam tests continue to be a source for the decision.
An actuary : When imagining what an actuary is, think of an accountant
combined with a Las Vegas odds maker. Actuaries design rates based upon sheer numbers
which include these factors: mortality, the expense of underwriting the policy,
the expense of operating a life insurance company and the expected return of investments.
Actuaries manage risk for a life insurance companies by setting rates. The actuary
will work closely with a medical director (also employed by the insurance company)
and assign rate classifications to various medical conditions. For instance, those
applicants with diabetes would pay more for life insurance than those that have
no health ailments at all. Rating classifications are assigned premium values based
upon good health. Many insurance companies use the term “Preferred Plus” for the
very best mortality risk. Other rating terms for risk may be used, such as, “Preferred
Tobacco” rate, which means that the applicant is in great health yet uses a product
containing nicotine. Actuaries manage risk by charging more for people with health
conditions and less for those in excellent health.
The life insurance industry is more complicated then this simple article. However,
by looking at life insurance underwriting from a company's point of view, risk management
is the science of protecting the assets of these companies for future claims. Insurance
companies have set aside billions of dollars to pay death claims for those that
are currently insured. By carefully underwriting applicants and collecting the premiums
from healthy individuals, money can be set aside to pay for these future claims.
Insurance companies fulfill their obligations by underwriting applicants in the
beginning and paying the death claims quickly and efficiently.