Insurance underwriting is the process of classification, rating, and selection of risks. In simpler terms, it's a risk selection process. This selection process consists of evaluating information and resources to determine how an individual will be classified (whether a standard or substandard risk). After this classification procedure is completed, the policy is rated in terms of the premium that the applicant will be charged. The policy is then issued and subsequently delivered to the purchaser by the producer (more commonly known as the insurance agent).
The underwriter's job is to use all the information gathered from numerous sources to determine whether or not to accept a particular applicant. Individuals applying for individually-owned life and health insurance typically receive more underwriting scrutiny than members holding a group policy. As such, the concepts discussed in this article apply primarily to underwriting for individual coverage. The underwriter must employ sound judgment based on his or her years of experience to read beyond the basic facts and get a true picture of the applicant's lifestyle. For instance, the underwriter will look for any factors (such as occupation, dangerous hobbies, etc.) that could make the applicant more likely to die before his or her natural life expectancy, or reasons to anticipate that the individual may become ill or involved in an accident that will create high medical expenses. Of course, the underwriter certainly cannot - and isn't expected to - foresee all possible circumstances. The underwriter's primary function is to protect the insurance company insofar as is possible against adverse selection (very poor risks) and those parties who may have fraudulent intent.
Adverse selection can be said to exist when a risk (an individual) or group of risks that are insured is more likely than the average corresponding group to experience a loss. As a basic example, let's say that in a randomly-selected group of 1,000 25-year-old individuals, only two might be expected to die in any given year. However, human nature is generally such that many healthy 25-year-old young adults do not typically regard the need to buy life insurance, and therefore prefer to spend their money on other things. It's usually only those 25-year-olds who are ill or perhaps employed in dangerous occupations that are likely to purchase insurance. The underwriter's job is to ensure that an inordinate number of these poorer-than-average risks aren't accepted or the insurance company will lose money.
The underwriter has a number of resources that can be called upon to provide the necessary information for the risk selection process. These sources include:
- The policy application;
- Medical history and examinations;
- Inspection reports;
- The Medical Information Bureau (MIB); and
- The producer or insurance agent.
The application is an absolutely crucial document because it's usually attached to and incorporated as an integral part of the insurance contract. The producer must therefore take special care with its accuracy in the interests of both the insurance company and the insured. The application is divided into sections, with each designed to obtain specific types of information. Although the form of the application may differ from one company to another, most provide for submission of the following data: Part 1 (General Information), Part 2 (Medical Information), the Agent's Statement or Report, and the proper signatures of all contractual parties.
Part 1 of the application requests the insured's general or personal data, such as name and address, date of birth, business address and occupation, Social Security number, marital status, and other insurance that may be owned. Additionally, if the policy applicant and the insured are not the same person, the applicant's name and address would also be required in this section.
Part 2 of the application is designed to provide information regarding the insured's past medical history, current physical condition, and personal morals. If the proposed insured is required to take a medical examination, Part 2 is usually completed as part of the physical exam. After reviewing the medical information contained in the application and the medical exam, the underwriter may also request an Attending Physician's Statement, or APS, from the proposed insured's doctor. The APS is typically used to obtain more specific information about a particular medical problem or issue.
The Agent's Statement, which is part of the application, requires that the insurance agent provide certain information regarding the proposed insured. This generally includes information regarding the agent's relationship to the insured, data 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 insurance company.
The signature of the insured - and the policyowner if not the same person - must be obtained in the appropriate places on the application. The producer usually also signs the document as a witness to the applicants' signatures. Additionally, the application will also contain information regarding the policyowner's choices for the mode of the premium (monthly, semiannually, annually, etc.), the use of any dividends, and the designation of beneficiaries.
Medical exams and tests, when required by the insurance company, are conducted by physicians or paramedics at the expense of the insurer. Such exams usually aren't required for health insurance (which only emphasizes the importance of the agent accurately recording medical information on the application). The medical exam requirement is much more common for life insurance underwriting than for health insurance. (As a side note, simplified issue life insurance requires no medical examination and the application asks only very basic health-related questions. This type of coverage is usually only available in low face amounts to reduce the insurance company's subjection to the hazard of adverse selection.)
To supplement the information on the application, the underwriter may order an inspection report on the applicant from an independent investigating firm or credit agency, which provides financial and moral (or lifestyle choices) information. This data is used only to help determine the insurability of the applicant. If the amount of insurance being applied for is average, the inspector will typically write a general description about the applicant's finances, health, character, occupation, hobbies, and other habits. When larger amounts of coverage are requested, the inspector will provide a more detailed report. This information is based on interviews with the applicant's associates at home (including neighbors and friends), at work, and elsewhere. Such "investigative consumer reports" may not be made unless the applicant is clearly and accurately told beforehand about the report in writing. This consumer report notification is usually part of the application. At the time that the application is completed, the producer will separate the notification and present it to the applicant.
The Medical Information Bureau
Another source of information that may aid the underwriter in determining whether or not to underwrite a particular risk is the Medical Information Bureau, or MIB, which is located in Massachusetts. The MIB is a nonprofit trade association that maintains medical information on applicants for life and health insurance. It consists of well over six hundred member companies that write more than eighty percent of the health insurance and over ninety-eight percent of the life insurance policies in the United States and Canada.
The MIB maintains an extensive database of medical information and occupational risks on applicants for life and health insurance. For every ten insurance applicants, the MIB will have a file on one or two of them. Medical Information Bureau data is reported to member companies in code form so as to preserve the confidentiality of the file's contents. The database contains no details about the individual. The codes simply alert companies to the fact that there was information obtained and reported by a member company on a particular medical impairment or vocational risk. Furthermore, the report does not disclose any action taken by other insurers, nor does it indicate the amount of insurance that was requested.
Underwriters use the MIB by comparing its file against the information contained in the prospective insured's application. If the MIB file contains a code for a condition that should be listed on the application but is not, the underwriter would then inquire more specifically about that area. For example, an MIB file might contain a code indicating that an applicant suffers from high levels of cholesterol, while the application indicates that he or she has no ongoing medical conditions. This discrepancy would prompt the underwriter to investigate whether the applicant has misrepresented his or her health status, or perhaps alternatively has recovered completely from the condition.
In addition to tracking medical and vocational information, the MIB also reports the number of times that information has been requested on an individual in the previous two years. This report is known as the Insurance Activity Index (IAI), and it's useful for two important reasons. The first is that it allows insurance companies to identify people who replace their insurance policies frequently. Since most of the costs associated with issuing a policy occur within the first year or two of coverage, insurance companies want to identify those individuals who are likely to cancel their policies within that period of time.
Second, the IAI can also help to spot situations in which an individual is accruing insurance coverage by applying for numerous smaller policies that might fall below the radar screen for other underwriting requirements. By purchasing several small- to medium-sized policies, an individual may be attempting to avoid drawing attention to the accumulation of an extremely large death benefit. This situation has occurred in several instances as part of criminal "murder for profit" schemes.
Although useful for underwriting purposes, an insurer may not refuse to accept a risk based solely on the information contained in an MIB report. There must be additional substantiating factors that lead to the decision to deny coverage to the applicant. Furthermore, the MIB must provide explanations to applicants who are denied coverage, allowing consumers to challenge possibly inaccurate information about their medical history.
Underwriting in the field
A key element in the underwriting process is the role of the insurance producer, or agent. It may even be argued that the producer is the most important part of the risk selection process. This is due to the fact that the producer is in a position to actually see and talk to the proposed insured, to ask the questions contained on the application and gauge the responses, and to accurately and completely record the answers to those questions. Thus, one of the most important functions of the producer is to oversee the completion of the insurance application. Much of the information reported on the document becomes the basis upon which to accept or reject the proposed risk. Furthermore, as previously stated, a signed and witnessed copy of the application also becomes part of the policy, the legal contract between the insurer and the insured.
The most essential element of this process for the producer is the display of accuracy, thoroughness, and honesty when completing the application. Answers to questions must be recorded with exactness and totality, along with frankness and sincerity. The producer may not omit pertinent information or report it inaccurately in order to facilitate the policy's issuance. The ethical conduct of the producer with regard to the underwriting process must be, in all instances, above reproach. Additionally, the producer can also help to expedite the underwriting process by the prompt submission of the application, by scheduling the applicant for any necessary physical exams, and by assisting the home office underwriter with other requirements (such as obtaining an Attending Physician's Statement), as needed.
Finally, if the applicant is rated or declined for coverage, it's the producer's role as a field underwriter to explain the reasons for the underwriting action. Seldom is an individual totally declined for life insurance, but it does happen that he or she may be classified as substandard and thus receive a rated (or substandard) policy in place of the one originally applied for. When this occurs, the producer must be prepared to not only explain the reasons for the substandard rating but also to explain the rated policy that the company has countered with.