Underwriting: insurable interest, medical information, and risk classification

What underwriting is for

Underwriting is the insurer's process of risk selection and classification: deciding whether to accept an applicant at all and, if so, at what price. Its purpose is to keep the pool of insured lives close to the mortality the insurer assumed when it priced the product, and to guard against adverse selection -- the tendency of people who know they are poor risks to seek insurance more eagerly, and in larger amounts, than people who are healthy. The producer is the field underwriter: the first person to see the applicant, the one who completes the application accurately, and the insurer's main defense against a policy being issued on a life that should never have been insured.

Three questions organize the underwriter's work, and this lesson takes them in order: does the applicant have an insurable interest, what does the medical and personal information show, and into which risk class does the applicant fall?

Gate one: insurable interest

A life insurance contract is only valid if the person buying it has an insurable interest in the insured. Anyone of legal capacity may insure his or her own life for the benefit of anyone at all; but no one may procure insurance on another person's life unless the benefits are payable to the insured or the insured's personal representative, or to a person who had an insurable interest at the time the contract was made (Fla. Stat. 627.404(1)).

Florida lists the interests that count for life, health, and disability insurance (Fla. Stat. 627.404(2)(b)):

• Yourself -- every individual has an insurable interest in his or her own life, body,

and health.

• Close relatives -- a person closely related by blood or by law, in whom you have a

substantial interest engendered by love and affection.

• Economic dependence -- anyone whose continued life gives you an expectation of a

substantial pecuniary advantage and whose death would cause you a substantial pecuniary loss. This is the basis for creditor and key-person coverage.

• Business relationships -- a party to a buy-sell contract has an insurable interest in

each other party, for the purpose of that contract only; a business entity has one in its owners, officers, partners, managers, and key employees, but only with the key person's written consent before the insurance is purchased, and it may not retaliate against a key person who refuses.

• Fiduciaries and organizations -- a trust or trustee in the grantor and the grantor's

close relatives; a guardian or other fiduciary in the person whose property it holds; a 501(c)(3) charity in anyone who consents in writing; and a retirement-plan trustee or sponsor in a plan participant who consents in writing.

The timing rule matters on the exam: insurable interest must exist at the inception of the contract, and need not exist afterward (Fla. Stat. 627.404(1)). A divorced spouse or a former business partner who owns a policy keeps it. The insurer, for its part, is entitled to rely on the applicant's statements about insurable interest and incurs no liability beyond the policy for representations it relied on in good faith (Fla. Stat. 627.404(3)) -- which is exactly why the producer must ask the question and record the answer honestly.

Florida adds a rule aimed at the producer personally. A life agent may not place or modify coverage on the life of anyone who is not a family member when the agent, or a member of the agent's family, is the named beneficiary, unless the agent or family member has an insurable interest in that life (Fla. Stat. 626.798(1)). Insurable interest for this purpose means an actual, lawful, and substantial economic interest in the continued life of the insured, or a reasonable expectation of benefit from it (Fla. Stat. 626.798(3)(b)).

Gate two: medical and personal information

The underwriter draws on several sources, roughly in order of cost:

• The application itself, whose Part II (the medical section) asks about the

applicant's health history, medications, family history, tobacco and alcohol use, and hazardous occupations or hobbies. The producer's report, sometimes called the agent's statement, adds what the producer observed.

• The MIB (Medical Information Bureau) report -- a coded database shared by member

insurers that flags conditions reported on prior applications. MIB is used to detect omissions and misstatements; it is never the sole basis for a decline.

• An attending physician's statement (APS) -- the applicant's own doctor's records,

requested with the applicant's signed authorization.

• A paramedical or medical exam -- height, weight, blood pressure, blood and urine

specimens, sometimes an ECG -- ordered when the age and face amount cross the insurer's thresholds.

• A consumer or investigative consumer report -- financial, occupational, and lifestyle

information from a reporting agency.

Federal law wraps this information in notices. Under the Fair Credit Reporting Act the applicant must be told in writing that a consumer report may be obtained, and if coverage is declined or rated because of one, told the name and address of the agency so the information can be disputed. A HIPAA authorization, signed by the applicant, permits providers to release protected health information to the insurer. Medical and financial information gathered in underwriting is confidential and may be used only for the purpose collected.

Gate three: risk classification

With the file assembled, the underwriter assigns the applicant to a risk class:

• Preferred -- better-than-average expected mortality; lowest premium.
• Standard -- average mortality; the rate the policy was priced for.
• Substandard (rated) -- higher-than-average mortality because of health, occupation,

or avocation. The insurer accepts the risk at an increased premium, expressed either as a table rating (a percentage multiple of the standard rate, often in steps such as Table B or Table 2) or a flat extra per thousand of face amount, which is common for hazardous occupations or a temporary condition and may be removed later. A substandard applicant may also be offered a modified policy -- a lower face amount, an exclusion rider, or a graded death benefit.

• Declined -- the risk is uninsurable at any price because the likelihood of loss is

far above the class or too uncertain to price.

Classification must rest on factors that actually predict mortality -- age, sex, build, health history, tobacco use, occupation, avocations, driving record, and finances -- and never on race, creed, color, or national origin. A risk that is placed in a class different from the one its facts support is either overcharged or, more dangerously for the pool, undercharged.

The producer's role

Field underwriting comes down to accuracy and candor: confirm insurable interest before taking the application, record health answers exactly as given, note anything observed that the applicant did not volunteer, and collect the required authorizations and notices at the time of application. Get those right and the underwriter's decision will stand; get them wrong and the policy may be contested when it is needed most.