Ch 19 INSURANCE OF SUBSTANDARD RISKS

EXAMPLE

A substandard health condition that is expected to result in an increasing rate of extra mortality with aging is an appropriate situation for either the increase-in-age approach or the extra-percentage method.

VALUE OF SUBSTANDARD INSURANCE

Approximately 6 percent to 7 percent of all new policies are issued in a substandard basis.

TREATMENT OF SUBSTANDARD RISKS

Most companies utilize all the available methods. In general, companies make an effort to adapt the method to the type of hazard represented by the impaired risk, but departures from theoretically correct risk treatment are frequently made for practical reasons.

Flat Extra Premium

The standard premium for the policy in question is increased by a specified number of dollars per $1,000 of insurance. Assessed as a measure of the extra mortality involved, the flat extra premium does not vary with the age of the applicant. May be paid throughout the premium-paying period of the policy, or it may be terminated after a period of years when the extra hazard has presumably disappeared. Is normally used when the hazard is thought to be constant (deafness or partial blindness, for example) or decreasing (as with a family history of tuberculosis or the aftermath of a serious illness or surgical operation, in which case the flat extra is usually temporary in duration) . The flat extra premium is widely used to cover the extra risk associated with certain occupations extra premium usually ranges from $2.50 to $10 per $1,000 of insurance.

Increase in Age

rate up" the age of the applicant. Applicant is assumed to be a number of years older than his or her real age, and the policy is written accordingly. Number of years older is determined by adding the amount estimated as necessary to provide for the extra mortality to the net premium for the applicant's actual age, and then finding the premium in the standard table that most closely matches that total, and deriving the rate-up from the standard age in the table.

Removal of a Substandard Rating Often Requires

• Waiting period of one or 2 years • Medical examination(s)

substandard risks

Expected to produce higher mortality rate than a group of normal lives. Group concept must be emphasized, because—as with insuring standard risks—there is no certainty about any one individual's longevity expectations. All calculations, therefore, are based on the anticipated average experience of a large number of individuals, and the experience of any one individual is merged into that of the group. Not expected that every member of the group will survive for a shorter period than the normal life expectancy. In fact, it is a certainty that this will not be the case; it is known merely that a larger proportion of people in a normal group will attain normal life expectancy.

REMOVAL OF SUBSTANDARD RATING

Frequently, a person who is classified as a substandard risk and insured on that basis by one company subsequently applies for insurance with another company—or even the same company—and is found to be a standard risk in all respects. Under these circumstances, the person's natural reaction is to request the removal of the substandard rating. The question is whether the company should remove the rating. Theoretically, the rating should not be removed unless the impairment on which it was based was known to be temporary or was due to occupation or residence. At the time the policy was originally issued, the insured was placed in a special classification of risks whose members were presumably impaired to approximately the same degree. As a practical matter, however, the company is virtually forced to remove the substandard rating of a person who can demonstrate current insurability at standard rates. If it does not do so, the policyowner will almost surely surrender the extra-rate insurance and replace it with insurance at standard rates in another company. Knowing this, most companies calculate their initial substandard premiums on the assumption that the extra premium will have to be removed for people who subsequently qualify for standard insurance. Thus, the common practice is to remove the extra premium upon proof that the insured is no longer substandard.

Other Methods

If the degree of extra mortality is small or when its nature is not well known, making no extra charge but to place all of the members of the group in a special class for dividend purposes, adjusting the dividends in accordance with the actual experience. This method can accommodate only those impairments that produce an extra mortality that does not exceed the normal dividend payments. Moreover, a sufficiently large number of such risks must be underwritten to yield an average experience

Extra Percentage Tables

Most common method Classify into groups based on expected percentage of standard mortality and charge premiums that reflect the appropriate increase in mortality number of substandard classifications may vary from three to 12, depending to some extent on the degree of extra mortality the company is willing to underwrite Most notable feature of these premiums is that they do not increase in proportion to the degree of extra mortality involved. Rates under substandard table D, for example, are not double the rates at which insurance is made available to standard risks. Neither are the rates under table B one-and-one-half times the standard rates. There is a twofold explanation of this apparent inconsistency. In the first place, the rates illustrated in Table 19-2 are gross premium rates, and the amount of loading does not increase from one rate classification to the other, except for commissions and premium taxes but remains constant (with minor exceptions). In the second place, the percentage of extra mortality is computed on the basis of actual—rather than tabular—mortality. Premiums for standard risks are calculated on the basis of the 1980 CSO Table, which contains a considerable overstatement of mortality at the young and middle ages, but additions to standard premiums to arrive at the substandard rates reflect only the excess mortality for the substandard classifications over the actual standard mortality. Hence, the rates for the substandard classifications are not proportionally greater than even the net premiums for the standard risks.the method is appropriate for substandard risks whose impairments are expected to produce an increasing rate of extra mortality. Like the increase-in-age method, extra percentage substandard tables should, in theory, be used only when the hazard is expected to increase at a greater rate. In practice, however, they are used for all types of impairments that are expected to worsen as the years go by.

Liens

When the extra mortality is decreasing and temporary i.e convalescence from a serious illness, neither an increase in age, a percentage addition to the rate of mortality, nor a flat extra premium is an appropriate method of dealing with the risk. A more suitable method is to create a lien against the policy for a number of years Amount and term depend on extent of the impairment. If adequate statistics are available, it is possible to calculate the term and amount of the lien that are equivalent to the extra risk undertaken. If such a method is utilized, the policy is issued at standard rates and is standard in all respects except that, should death occur before the end of the period specified, the amount of the lien is deducted from the proceeds otherwise payable. The method is frequently refined to provide for a yearly reduction in the amount of the lien on the theory that the hazard is decreasing.has a psychological appeal, in that few persons who are refused insurance at standard rates believe themselves to be substandard risks and tend to resent the company's action in classifying them as such

INCIDENCE OF EXTRA RISK

the degree of extra mortality represented by the group and the approximate period in life when the extra mortality is likely to occur must both be known within reasonable limits. It makes a great deal of difference financially whether the extra claims are expected to occur primarily in early life, middle age, old age, or at a level rate throughout the individuals' lifetimes. If the extra mortality occurs during the early years of the policies when the amount at risk is relatively large, the burden on the company will be greater than if it occurs later when the amount at risk is relatively small. Hence, between two substandard groups representing the same aggregate amount of extra mortality, the group whose extra mortality is concentrated later in life should pay a smaller extra premium than the group whose extra mortality occurs earlier. Majority of companies therefore proceed on the assumption that each substandard risk falls into one of three broad groups. hazard increases 1. Hazard increases with age; 2. Remains approximately constant at all ages; 3. Decreases with age. High blood pressure presents an increasing hazard. Occupational hazards represent a constant hazard, as do certain types of physical defects. (Even though most constant hazards tend to increase somewhat with age, they are treated as if they remain constant.) Impairments attributable to past illnesses and surgical operations are hazards that decrease with time, although not all illnesses and operations fall into this category.