Lecture 7

Underwriting II
Objectives
1) Sources of information by life insurers for
underwriting.
2) Methods used to classify standard and substandard of
risk.
3) Special underwriting practices.
4) Reinsurance of life insurance
 Purpose of reinsurance
 Concept of retention
 Reinsurance arrangements & agreements
 Life reinsurance plans
 Sources of Information
 Insurers obtain information about proposed insured
from several sources, including
1) Applications
 Part 1 (Basic) e.g. name, address, birth date, sex,
amount of insurance etc.
 Part 2 (Medical history) e.g. regarding any illness,
diseases, injuries and surgical operations experienced
in the last 5 or 10 years.
2) Physical examinations – current medical
examination recorded by physician or paramedic.
3) Laboratory testing – blood & urine testing –
concerns over excess claim exposure due to AIDS
and illegal drug use.
4) Agent’s report – how long he or she has known the
proposed insured & know of any adverse information.
5) Attending physicians – is used when individual application
or report reveals conditions about which more information is
desired (reveal additional health conditions or the names of
additional physicians not reported in the application).
6) Inspection companies – collects and sells information
about individual’s employment history, financial situation,
creditworthiness, mode of living etc.
7) Industry sponsored databases – assist member
companies in detecting adverse selection (primarily of
medical nature).
 Sources of Information
1) Proper assessment of risk – moral and physical hazards – is
an important prerequisite in the granting of life insurance
coverage to any applicant.
2) Information necessary for proper assessment of risk is
generally obtained from different sources, which include:
 Proposal Form – personal particulars, details of insurance,
occupation & residence pursuits, personal & family history and
declaration & authorization.
 Medical Report / Special Investigations e.g. X-Ray, ECG.
 Attending Physician’s Statement.
 Agent’s Report.
 Previous Records.
 Methods of Risk Classification
 Once underwriting information has been assembled from
various sources, it must be evaluated and a decision to be
reached –
o to be accepted as preferred / standard,
o treated as substandard but acceptable
o or rejected entirely.
 The selection and classification system used by a
company should:
1) measure accurately the effect of each factor affecting
risk;
2) asses the combined impact of interrelated factors
including the conflicting ones;
3) produce equitable results, be relatively simple and
inexpensive to operate.
Basic Systems to Accommodate these Concerns

1) The Judgment Method

 The company depends upon the combined
judgment of those in the medical, actuarial,
and other areas who are qualified for his work to
make underwriting decisions.

2) The Numerical Rating System

 Based on the principle that a large number of
factors enters into the composition of risk and that
the impact of each of these factors on longevity can
be determined by statistical study of lives.
*Objective of Selection

 The main purpose is to decide whether the risk

o within normal limits and acceptable to the office
(standard).
o below average but still acceptable to the office,
subject some form of restriction (sub-standard).
o below average and not acceptable to the
office, may allow for acceptance at later date
(deferred) below average and cannot be
accepted under any conditions (decline).
 Classifying Substandard Risks

 Classification of substandard life – provision must be made higher

than standard mortality – charging extra premium or by other
methods.
1) Life insurance on substandard risks
 Statistical information on past experience is essential – to
develop credible & equitable basis on different impairments
 other than life insurance policies would be articles in
medical journals & reinsurance companies.
2) Incidence of extra mortality–many factors may cause a
proposed Insured to be declined or rated substandard.
e.g. ¾ of all declined US applicants have serious health impairments,
such as obesity, diabetes etc.
*Modes of Accepting Substandard Lives
 Extra risks can be generally fall into 3 main
groups:
 Increasing extra mortality e.g. overweight places strain on
the heart and other organs.
 Level extra mortality – extra risk that will remain
constant from year to year e.g. liquor trade occupation.
 Decreasing extra mortality – risk present at younger ages
but will lessen in later life.

 Extra risks may be allowed for in several ways:

 Increasing premium, decreasing death benefit,
bonus adjustment or alternative policy plan or
exclusion of a particular hazard.
 Methods of Rating
 Several methods exist for rating impaired
lives.
 Objectives in establishing extra-premium
structure are that:
 Equitable between impairments and between
classes.
 Easy to administer.

 Easily understood by agents and the public.

 Methods of Rating
1) Multiple Table Extra
 Most common method used for substandard life
insurance.
 Substandard risks are divided into broad
groups according to their numerical ratings.
 Premium rates and mortality charges are based on
mortality experience correspond to the average
numerical ratings in each class.
 Refer to page 672 & 673, Chapter 26 (Skipper).
Example of substandard classification table
Gross-premium rates for ordinary life contract under
different scales of substandard mortality classification
2) Flat Extra Premium
 Used when the extra mortality, measured in
additional deaths per thousand, is expected to be
constant, either for a temporary period or
permanently, and when it is largely independent
of age.
 Regular policy with constant premium to provide
for additional expected mortality.
 The policy is treated as standard for the purpose
of dividends and non-forfeiture values.

3) Other Methods
 Provide a limited death benefit equal to a refund of
premium if death occurs in the first two years.
 With little or no underwriting, example: older age
groups (over 50).
Special Underwriting Practices

1) Non-medical life insurance

 Substantial proportion of all new ordinary insurance is
written without the benefit of a medical or paramedical
examination.
 Confusing because sometimes considered as idea that the
insurance issued without any medical information.
Medical information is still sought.
 Non medical - no physical examination ordinarily
required.
2) Guaranteed issue insurance
 Contractual arrangements under which retirement
benefits are provided to employees - individual
contract pension trust.
 Under this arrangement, benefits are provided
through retirement annuity or retirement income
contracts purchased by the employer for each of the
employee eligible to participate in the pension plan.
 Group underwriting – dispense with individual
underwriting.
3) Reinstatements and policy changes
 When a life insurance policy lapses for non-payment of
premium, the policy owner has the contractual rights to apply
for policy reinstatement.
 Must pay past-due premiums.
 Provide evidence of insurability to satisfy insurer with
minimal effort and time.
 Shortened version of the original application.

4) Highly impaired risks

 Individuals with significant impairments have opportunities to
obtain insurance at cost that they can afford even though the
original application may have been declined by one or more
companies.
 Opportunities with companies specialize in this market.
Selection of Lives to be Insured

 Financial underwriting (seek to discover the

presence of moral hazard):
 The existence of insurable interest.
 Amount to be insured commensurate with financial
standing (earning capacity).
 Whether the insured maintains multiple policies with
other insurers.
 Experience of being turned down an application for
insurance coverage by other insurer.
 Medical underwriting
 Questions concern height, weight, personal and family
medical history, lifestyle etc.
 Supplementary questions furnish medical report or go for
further medical examination.
 Other than at normal terms – substandard / impaired
life.

 Non-medical underwriting
 Medical evidence not required for some cases
based on age and sum insured.
 Reinsurance of Life Insurance Risks
 Reinsurance is the transfer of all or a portion of
an insurer’s loss exposure under an insurance
policy to another insurance company.
 It is insurance for insurer.
 The company that issues the policy is direct-
writing or ceding company.
 The company in which the risk is transferred is
the reinsurance or assuming company.
Life Reassurance
Introduction
• Life reassurance is long-term
• Cover is more common on surplus compare to quota share.
• Non-proportional and catastrophic are relatively rare.
• Smaller sum insured more common on life than in general.
• Differences between life and general reinsurance:
1) Long-term and non-cancellable
2) Level annual premium
• Build-up reserve
• Split uneven mortality risk
3) Varying proportion of protection and savings elements in the different
types of policies.
Objective of Reassurance
1. To avoid too large a risk concentration within one company.
Claim under life always a total loss claim – death claim.
2. To take advantage of the underwriting judgement of the
reinsurer
3. To transfer all or certain classes of substandard business
4. To reduce the strain on surplus caused by writing new
business
5. To stabilize the overall mortality experience of the ceding
company – to protect a life fund against adverse mortality
fluctuation
6. To obtain advise and counsel on underwriting procedures,
rates and forms.
Methods of Reinsurance
1. Facultative reinsurance
2. Treaty reinsurance

1) Facultative
• Direct office sends a proposal to the reinsurer.
• Reinsurer has an option to accept or reject the offer.
• Reinsurer can impose any special terms such as extra
premiums which are conditional to its acceptance
• Once completed, reinsurer prepare a guarantee which is
evidence of a contract between parties.
• Case by case basis
• Normally used for larger and substandard cases
 Disadvantages of reinsurance
 Causes a great deal of work and expense.
 Cannot be certain that cover is available until other reinsurer have been
approaches and have indicated willingness to asset risk on the term
offered.

2. Treaty
a) First Surplus Treaty
• Reinsurer will cover the balance of risk exceeding its own
retention.
• However, there is limitation that the balance, describes as
automatic
cover.
Example:
Retention - $60,000
Max Limit of Cover - $100,000
b) Quota Share Treaty

The ceding company and reinsurer sharing proportionately in

every cases, for the class or classes of business covered by the
arrangement.
Exam:
Retention 40%
Reinsurance - 60%

Cases ($) Retention (Ceding Co) $ Reinsurance (60%)

10,000 60,000 80,000

100,000 60,000 100,000

150,000 60,000 90,000

Reinsurance cover can be provided in 2 ways:
• Original terms or coinsurance plan.
• YRT or yearly renewable term plan (also called risk
premium).

1. Original Terms
• Premium rate charges by the ceding company including
any extra premium attaching to the contract.
• Reinsurer will be liable for the proportion of the original
policy throughout its duration.
• Pays its due share of any claim.
• Term insurance normally reinsured on original term.
2. The Yearly Renewable Term Plan (YRT) or Risk Premium

• Ceding company only reinsure the NAR (net amount at risk) in

excess of its retention limit.
• As the reserve increases yearly, both the net amount at risk in
excess of the retention limit and the amount of reinsurance
decrease (risk premium basis).
• Risk premium rates are determine by the reinsurer and based
on a suitable mortality rate with loading to cover the expenses
and profits of the reinsurer and fluctuations in the mortality
experience.
• The premium rate vary from year to year depending on the
age.
• Premium will be high in the early years and decrease during
the later years.
 Comparing the bases of reinsurance

1. YRT (yearly risk term premium) is a permanent contract which

cannot be cancelled at the option of either the ceding company
or reinsurer but under original term, either party can cancel
the contract.
2. Under YRT (risk premium), the direct office (insurance company)
retains the reserve applicable to the whole policy, miscellaneous
profits earned on life funds, surrender or lapse of the original
policy will accrue to the direct office.
3. Under YRT, the premium paid to reinsurer is relatively small, the
ceding company retained greater premium income compare to
original terms where the insurer must share the original
premium until policy matured.
4. However, under the original term, reinsurer pays
overriding commission which can reduce of expenses.
 Summary
• Sources of information used by life insurance
for underwriting.
• Methods used by life insurers to classify
standard and substandard risk.
• Special underwriting practices relate to life
insurance.
• Purpose of reassurance.
• Methods of Reassurance.
• Basis of reassurance.