Time and Money
Underwriting is part of purchasing any type of insurance. When you buy an insurance policy, you are asking an insurance company to take a chance on you; in the case of a life insurance policy, the chance is that your life will last as long as the average life expectancy for people of your age and gender. If you live as long as expected, then the money you pay in premiums will produce enough investment income that, after your beneficiary receives the proceeds of the policy upon your death, there will still be money left over for the insurance company and its shareholders to cover the costs of administering the policy and make a profit. (This applies to whole life insurance; if you purchase a term life insurance policy, a benefit is paid only if you die within the term of the policy.)
Reserves
But what happens if your life is cut short by illness or an accident? If your life is cut short, then your premium payments probably will not have produced enough investment income to cover the amount to be paid to your beneficiary together with the insurance company's costs. To pay your beneficiary, the insurance company will have to dip into the reserves it is required by law to maintain for just these reasons.
Predicting Risk
If an insurance company has to dip into its reserves too often, that can interfere with the company's financial stability. Financial stability is important for insurance companies because so many people rely upon them. To maintain financial stability, insurance companies seek to issue policies where they can anticipate the likelihood of early death or serious, life-threatening injury. The process by which insurance companies evaluate risk is called underwriting. Obviously, accidents and unexpected illnesses do occur. But overall, actuaries and underwriters do an excellent job of predicting risk.
Underwriting Standards
When you apply for a life insurance policy, you will be asked a number of questions. The insurance company will need your age; the younger you are, the more time your premiums have to earn money. If you are a woman, that can make a difference because women usually have longer life expectancies. The insurance company will need your medical history and information about whether or not you use alcohol, drugs or tobacco. You will need to answer questions about your jobs and hobbies; jobs and activities like race car driving and skydiving clearly entail more risk than being an accountant or knitting. With this information, your policy will be underwritten, and the premium you will be asked to pay will correspond to the amount of risk you represent; each insurance company determines their own underwriting standards. Standard policies are for applicants of average risk. Preferred policies are for applicants who represent a lower than average risk; these applicants usually pay lower premiums. Rated policies are for applicants who represent a greater than average risk but are still considered insurable; rated policies cost more. If the amount of risk you represent is too great, then your policy application will be declined.
Member Comments