Unit 4- Underwriting Basics

sources of underwriting information- the application Investigative Consumer Reports

an investigative consumer report includes information on a consumer's character, general reputation, personal habits, and mode of living that is obtained through investigation (i.e., interviews with associates and friends and neighbors of the consumer). Such reports may not be made unless the consumer is clearly and accurately told about the report in writing

sources of underwriting information- the application Agent's Statement

many companies require an agent's statement to be completed and submitted as part of the application. Generally, this includes information regarding the agent's relationship to the proposed insured and general knowledge about the proposed insured's financial status, habits, general character, and any other information that may be pertinent to the risk being assumed by the insurer

5 Classifaction of Risks standard risks

standard risks reflect average exposures and fall into a normal range. These risks can be insured for standard rates and premiums

field underwriting

an agent plays an important role in underwriting. As a field underwriter, the agent initiates the process and is responsible for many important tasks, including: ■■ making proper solicitation ■■ ensuring the suitability of the product being underwritten ■■ completing the application with the applicant ■■ obtaining all proper signatures ■■ explaining the sources of insurability ■■ disclosures at point of sale ■■ collecting the initial premium and issuing a receipt ■■ completing the agent's report ■■ delivering and explaining the policy

incomplete applications

because the application is the critical tool used by the company in the underwriting process, the agent has the responsibility to see that an applicant's answers to the questions are recorded accurately and completely

sources of underwriting information- the application Attending Physician's Statement (APS)

in addition to requiring a medical examination, an underwriter may request an Attending Physician's Statement (APS) from the proposed insured's doctor. Usually, the APS is designed to obtain more specific information about a particular medical problem revealed in the application or during the medical examination

sources of underwriting information- the application AIDS Consideration

in general, insurance applications for life or health insurance cannot ask applicants questions that are designed to elicit information for the purpose of determining sexual preferences or lifestyles. Sexual orientation cannot be used in the underwriting process or to determine insurability. However, applicants may be asked questions relating to their having or having been diagnosed as having AIDS. Insurers may require that applicants take the test, at the insurer's expense

Determining Premiums or Rating Considerations Morbidity

morbidity is the likelihood that a person will suffer an accident, contract a disease, or otherwise require medical care

5 Classifaction of Risks substandard risks

substandard risks reflect an above average risk of loss (due to health, occupation, habits, or some other factor), but are still within an acceptable range. The underwriter must use some rating technique in order to obtain a relatively higher premium for these risks (flat additional charge, rating at a higher age, or other adjustment of premium or benefits)

Determining Premiums or Rating Considerations Setting Rates

to set rates for health insurance, insurers need to consider not only how often people will become ill or injured, but also how much it will cost when they do. Insurers look at how frequently claims happen among a particular population, or the claim frequency rate, as well as the average dollar amount per claim. These two figures are multiplied to create the aggregate claim amount, which is a primary element in calculating health insurance rates

sources of underwriting information- the application Inspection Reports

to supplement the information on the application, the underwriter orders an inspection report on the applicant from an independent investigating firm or credit agency, which covers financial and moral information. If the amount of insurance applied for is average, the inspector will write a general report in regard to the applicant's finances, health, character, work, hobbies, and other habits

5 Classifaction of Risks declined risks

a declined risk is one that an insurer has decided not to insure. The insurer declines the application for insurance. Insurers rarely do this; rather, they seek to insure for a higher premium, and/or by limiting or excluding certain losses

sources of underwriting information- the application Part I

Part I of the application asks for general or personal data regarding the insured: name, address, DOB, SSN...

sources of underwriting information- the application Part II

Part II of the application is generally designed to provide information regarding the insured's medical history, current physical condition, and personal morals. If the insurance applied for qualifies as nonmedical (no physical exam required), the producer and the insured will complete Part II of the information. In some cases, the proposed insured is required to take a medical examination and Part II of the application is completed as part of the physical exam in addition, Part II requires information regarding the current health of the insured by asking for current medical treatment for any sickness or condition and types of medication taken. The name and address of the insured's physician are also required usually Part II of the application also will include questions regarding alcohol and drug use by the insured. Avocations and high-risk hobbies are also usually reported in Part II

changes in the application

any changes made to an insurance application after it is completed must be initialed by the applicant

adverse selection

exists when the group of risks insured is more likely than the average group to experience loss the potential for adverse selection exists because people who perceive that they have a higher risk of loss have a greater tendency to apply for insurance, and to apply for higher limits of coverage, than those who perceive that they have very little chance of loss for example, if there were no underwriting controls, a disproportionate number of people with serious health problems or diseases would apply for life, health, and disability insurance, and the insurance companies would lose money

third-party ownership

in a business situation, a corporation may apply for insurance on the life of a key employee. In this case, the corporation is the applicant and the policyowner, and the key employee is the insured. The corporation would also be the beneficiary

underwriter's job

the process of underwriting life and health insurance policies includes reviewing the background information and medical history of the applicant this information permits an insurance company to determine whether to accept or reject an applicant for coverage. In addition, this information also determines whether the insurer will charge standard or modified premium rates

sources of underwriting information

the underwriter has various sources of information to provide the necessary information for the risk selection process. These sources include: **the insurance application **medical exams and history **the attending physician's statement **consumer reports (general or investigative) **Medical Information Bureau (MIB) **a federal credit report **an agent report

sources of underwriting information- the application HIPAA Disclosures

(HIPAA) imposes specific requirements on health care providers with respect to the disclosure of insureds' health and medical informationor protected health information insurers and producers are under similar requirements when dealing with the protected health information of applicants and insureds when examining an applicant for underwriting purposes, all medical information is to remain confidential and the insurer must protect the applicant's privacy

once the prospect has agreed to purchase the insurance contract, three important functions take place

**the underwriting process begins **the application will be submitted, and the policy will be issued (or declined) **the producer will deliver the policy to the policyowner

sources of underwriting information- the application National Do Not Call Registry

Calls are permitted to consumers with whom the company has established a business relationship, as follows: ■■ a consumer can establish a business relationship with an insurer by requesting information from it or submitting an application to it. In this case, the business can call for three months from the date of inquiry or application ■■ a company with which a consumer has an established business relationship may call for up to 18 months after the consumer's last purchase or last delivery, or last payment, unless the consumer asks the company not to call again

Determining Premiums or Rating Considerations expense ratios

an expense ratio is determined by dividing an insurer's operating expenses by total premiums. When the combined loss and expense ratio is 100%, the insurer breaks even. If the combined ratio exceeds 100%, an underwriting loss has occurred. If the combined ratio is less than 100%, an underwriting profit, or gain, has been realized Expense ration= operating expenses/premiums

underwriter's job

an underwriter's job is to select risks that can be assumed by the insurance company at a reasonable price and to reject other risks. Part of an underwriter's job is to protect the insurance company against something known as adverse selection the goal is to achieve a profitable distribution of exposures—a broad base of risks where average losses fall within a normal range an underwriter's job is also to identify the risks that have a higher probability of loss, and to either obtain a higher premium for the risk (if it is within an acceptable range) or to reject the risk (if it cannot be assumed at any price)

reserves

by law, a portion of every premium must be set aside as a reserve against the future claim under the policy as well as other contractual obligations, such as cash surrender and nonforfeiture values reserves are accounting measurements of an insurer's liabilities to its policyholders theoretically, the reserve is the amount, together with the interest to be earned and future premiums to be paid, that will exactly equal all of the company's contractual obligations the extent to which an insurer's assets exceed its liabilities is known as surplus policy dividends are paid out of an insurer's surplus

Determining Premiums or Rating Considerations Expenses

expense loading- if the cost of mortality is calculated (discounting for interest), there is enough money to pay claims, but the insurance company has no money with which to pay operating expenses. The premium without expense loading is a net premium an expense loading is added to the net premium to: ■■ cover all expenses and contingencies ■■ have funds for expenses when needed ■■ spread cost equitably among insureds

Determining Premiums or Rating Considerations Expenses- loading

loading consists of four main items: acquisition costs—all costs in connection with putting the policy on the books are charged as incurred in the insurance accounting. One of the highest acquisition costs is the producer's first-year commission general overhead loading—clerical salaries, furniture, fixtures, rent, management salaries, and so forth must be considered when determining expenses loading for contingency funds—once a level premium policy has been issued, the premium can never be increased. However, unforeseen contingencies could make the rate inadequate immediate payment of claims—in rate making, it is assumed that all claims are paid at the end of the year relying on the law of large numbers, it is safe to assume that claims will be spread throughout the year. Allowance must be made for this loss in the expense loading

Determining Premiums or Rating Considerations Loss Ratios

loss and expense ratios are basic guidelines as to the quality of company underwriting a loss ratio is determined by dividing losses by total premiums received. Loss ratios are often calculated by account, by line of insurance, by book of business (all accounts placed by each producer or agency), and for all business written by an insurer loss ratio information may be used to make decisions about whether to renew accounts, whether to continue agency contracts, and whether to tighten underwriting standards on a given line of insurance loss ratio= losses/premiums

Determining Premiums or Rating Considerations Mortality

mortality table- insurance companies have kept the kind of records required to produce precise predictions. The table is based on statistics kept by insurance companies over the years on mortality by age, sex, and other characteristics mortality rate- is defined as the number of deaths per 1,000 people, and is taken from the mortality table and converted into a dollar and cents rate the mortality portion of a rate is simply the charge for the expected number of deaths per 1,000 insureds based on the insured's attained age Premium Components Mortality - Interest + Expense Acquisition costs General overhead Contingency fund Immediate payment of death claims

5 Classifaction of Risks preferred risks

preferred risks reflect a below average risk of loss. These risks may be insured at preferred or discounted premium rates due to favorable risk factors (such as healthy lifestyle, favorable medical history, or low-risk occupation).

Determining Premiums or Rating Considerations premium mode

premium mode- the frequency with which a policy premium will be paid. The most common premium modes for life insurance are annual, semi-annual, quarterly, and monthly. The more payments the insured wishes to break the premium into, the higher the total premium will be

sources of underwriting information- the application Medical Information Bureau (MIB)

reports issued by the Medical Information Bureau are another source of information which may aid the underwriter in determining whether or not to accept a risk. This is a non-profit trade association that maintains medical information on applicants for life and health insurance

5 Classifaction of Risks

risks that are acceptable to an underwriter are classified for rating purposes. Generally, acceptable risks fall into one of three classifications: **standard- average risk **substandard- higher risk of loss rated up age flat additional premium tabular ratings graded death benefit ** preferred- lower risk of loss

required signatures

several signatures are required to complete a life insurance application. Required signatures include the applicant, the proposed insured (if different from the applicant), and the agent soliciting the insurance. The agent's report must be completed and signed by the agent only

sources of underwriting information- the application

the application is divided into sections or parts: **Part I—General Information **Part II—Medical Information **the agent's statement or report **proper signatures of all parties to the contract

Determining Premiums or Rating Considerations

the final step in the underwriting process is the rating of the risk for the determination of the premium. There are three factors used in determining insurance rates: ■■ mortality (life insurance rates) or morbidity (health insurance rates) ■■ interest ■■ expenses

Determining Premiums or Rating Considerations gross annual premium

the gross annual premium, or the amount the policyowner actually pays for the policy, equals the mortality risk discounted for interest, plus expenses by definition, the net premium is the mortality risk discounted for interest, without any expense adjustment by formula: gross premium = mortality − interest + expenses net premium = mortality − interest

beneficiary

the individual or individuals who the policyowner has named to receive the benefits of the policy

applicant

the individual who fills out the application and applies for the insurance

policyowner

the individual who pays the premium, accepts the policy when it is delivered by the agent, and has the special owner's rights, such as designating beneficiaries

insured

the individual whose life is covered by the policy

Determining Premiums or Rating Considerations level premium

the level premium concept was devised to solve the problem of increasing premiums. Mathematically, the level premiums paid by the policyowner are equal to the increasing sum of the premiums caused by the increased risk of mortality. Accordingly, in the early years of the policy, the level premiums paid are actually more than the amount necessary to cover the cost of mortality. Conversely, in the later years of the policy, the premiums paid are less than the amount necessary to cover the increased cost of mortality

underwriting

the process of selection, classification, and rating of risks

sources of underwriting information- the application Medical Examinations and Testing

when modest amounts of insurance are involved, the applicant and agent are usually permitted to complete the medical portion of the application. This is referred to as underwriting on a non-medical basis, or simplified issue if the amount of insurance applied for is relatively high, the proposed insured is usually required to take a medical examination, in which case the medical portion of the examination will be completed by the doctor as part of the medical exam. Medical examinations, when required by the insurance company, are conducted at the company's expense

selection criteria and unfair discrimination

while insurers must use actuarially sound principles to determine whether to insure a risk and at what premium, they cannot impose underwriting criteria that unfairly discriminate among members of the same or similar actuarial class