This post explains in more detail the process the industry calls ‘underwriting’, a term that describes the risk assessment for a person who applies for life insurance.
Before we explain underwriting, let’s first briefly look at the concept of life insurance in terms of it being about a two-way promise, and what the premiums are used for.
Life insurance is highly regulated to ensure that life insurers meet their obligations and promises in accordance with the contracts they enter into with customers.
A life insurance policy is a contract that sets out the responsibilities of the life insurance company and the person who is taking out the insurance. Both the life insurer and insured must also meet the various requirements of the Insurance Contracts Act 1984.
The life insured (or the policy owner) agrees to pay premiums, and the insurer agrees to pay out an agreed amount/s if a certain event/s should occur.
All premiums are paid into a ‘risk-sharing’ pool in accordance with APRA regulations called a statutory fund. This pool is then available to pay claims from.
But in addition to paying claims triggered by events occurring within the pool of insured risks, this pool is also used to cover the insurer's costs.
Maintaining the balance within the pool helps keep claims costs within expected limits and to keep premiums affordable for the benefit of customers as a whole.
In addition to paying claims, TAL also uses various return to health and work initiatives to help people get back on their feet and on with their lives.
So what is underwriting?
Underwriting is the process an insurer takes in assessing whether to accept a policy for a customer and what conditions/pricing will be applied to the policy based on medical and lifestyle information provided by the applicant. This may result in standard premiums rates being applied, higher rates, some conditions being excluded from cover, or denying the cover due to unacceptable high risk.
Underwriting determines whether an individual’s level of risk falls within a particular pool and how any extra risk (whether this is medical, occupational, financial and/or pursuits and pastimes) might be handled.
Underwriting ultimately ensures that the cost of the cover is proportionate to the risks presented by the individual concerned.
People with the same or similar risk pay the same or similar premium rates.
The process of underwriting takes place when an application is submitted to the life company. To assess a person’s risk, life insurers rely on information from a range of sources.
Many forms of ‘default’ levels of life insurance provided by superannuation and workplace schemes (and in some direct to consumer policies) do not require underwriting. But when a fund member wants more than the default level of cover, some form of underwriting, or risk assessment, is undertaken.
If the policy being applied for is to be underwritten, as a minimum an application form and a personal statement (or proposal form) will be requested. These seek information on such things as residency, occupation, financial status, any pursuits and pastimes and medical history just to name a few.
The personal statement asks for details about the customer’s personal medical history, including information about any disease or disorders that increase the probability of a claim. It also asks basic questions about family medical history as this can indicate whether an applicant may be at an increased risk of developing a hereditary disease.
The underwriter's role is to look at the best information available and to arrive at a conclusion that is fair, both to the individual and to the pool of funds to cover the risks.
There are three main factors that may affect a person's risk of dying (mortality risk), or becoming disabled (morbidity risk):
- Age - older people are generally at a higher risk than younger people. Within any age group, the probability of claiming may be greater for some applicants than for others.
- Gender - women on average tend to live longer than men.
- Personal medical history - past and current which can also indicate a level of risk.
Smoker status, occupation, family history, lifestyle and pursuits are also important factors that affect the chances that a person will make a claim.
For those people who are higher risk, insurers may request higher premium for cover or exclude certain risks from the policy offered, or may offer a different or modified form of insurance. Insurers can also decline to accept a policy application.
Insurers use underwriting to control the overall level of risk in the pool, by avoiding large cross-subsidisation between the premium paid by one group of insured lives and another.
Because life insurance is voluntary and applicants are not forced to buy cover, any degree of cross-subsidisation is unlikely to be to their advantage.
For example, if individual life insurance was available for people who were involved in extreme or hazardous sports (e.g. rock climbing, motor sport racing, base jumping etc.) and to applicants who were not involved in such activates at the same price, it would be cheap for those involved in the hazardous activities – encouraging them to take out life insurance – and expensive for those not involved, leaving them less able to afford the necessary cover for themselves and their families.
Unlike car or house insurance, once a life insurance policy is issued, there are regulations which restrict an insurer’s actions in cancelling a policy or increasing premiums because of a deterioration of the policyholder’s health or change in their circumstances.