Ch 31: Underwriting

Question 1

Explain what is meant by underwriting (6)

Answer 1

Underwriting is

1. The process of consideration of an insurance risk
2. Includes assessing
   
   • whether a risk is acceptable, and if so
   • setting the appropriate premium, together with the
   • terms and conditions of cover
3. May also include assessing risk in the context of the other risks in portfolio

Question 2

What is the main purpose of underwriting? (1)

How does underwriting help insurer to achieve this main purpose? (13)

Answer 2

Main purpose of underwriting is to help insurer manage risk

Underwriting helps insurer to achieve this main purpose (managing risk) as follows:

1. Protects life insurer from anti-selection.
   
   • Insurer is exposed to 2 key premium rate risks
     
     • premiums not appropriate for lives insured
     • premiums permit anti-selection against insurer, particularly anti-selection from unhealthy PHs
   • Being slightly different from market standards may lead to increased anti-selection
   • But also needs to ensure this doesn’t discourage new buss or cost more than what is saved
2. Enables company to indentify lives with substandard health risk, for whom special terms would need too be quoted
3. For substandard risks, it identifies most suitable approach and level for special terms to be offered
4. Adequate risk classification within underwriting process will help to ensure all risks are rated fairly ie better categorisation and grouping similar lives together=> more effectively prevent anti-selection
5. Helps ensure that actual mortality experience does not depart too far from that assumed in pricing
6. Financial underwriting will help reduce risk from over-insurance

Question 3

How does underwriting compare for health and care contracts vs other contracts? (3)

Answer 3

Underwriting for health and care contracts is

• more complex than for other contracts
• this presents actuary with opportunity to become involved in multi-disciplinary teams with non-actuaries
• allowing actuary to be aware of standard approaches in industry without requiring detailed knowledge

Question 4

There is no such thing as a bad risk, only an insufficiently priced risk.

Discuss (7)

Answer 4

• Statement is true for most unhealthy lives
  
  • life insurer will want their business, albeit subject to their paying an appropriate premium
• However, statement not true for seriously impaired lives
  
  • much more difficult to rate them accurately
  • risk of death may be so high that little hope of recouping initial expenses
  • appropriate premium may be unaffordably high to realstically sell policy
• So in case of seriously impaired lives, rather just decline application for insurance

Question 5

What are the main types of undewriting (4)? Give brief outlines of each (4).

What other types of underwriting might we find in practice? (2)

Answer 5

Main types of underwriting:

• medical underwriting
  
  • medical assessment of potential PH’s health
• financial underwriting
• lifestyle underwriting
  
  • assessing influence of sporting/hazardous leisure pursuits on the risk and the extent to which lifestyle might increase possibility of contracting dangerous diseases
• claims underwriting
  
  • eg checking validity of claims, checking claim info vs proporsal stage info
  • rejecting claims may => bad publicity. need to consider this

Other potential types of underwriting

• occupational underwriting
• territorial underwriting

Question 6

Give a broad overview of the underwriting process (1)

What are the steps in the underwriting process? (7)

• consider proposal stage
• consider claims stage

Answer 6

Underwriting process involves

• requesting adequate information prior to acceptance of business/claim, such that the risk can be properly estimated

Steps in the underwriting process

• At proposal
  
  • Decide on which type of underwriting to use
  • Decide on level of underwriting
  • Collect adequate evidence
  • Specify the terms to be offered
• At claims
  
  • Consider claims underwriting

Question 7

Why might an insurer make use of medical underwriting? (7)

What are the aims of medical underwriting? (3)

Answer 7

A life insurer may have

• mortality (or health and care) risks
  
  • obtain evidence about applicant health
  • assess whether they attain required standard of health…
  • …if not, what state of health is relative to standard
• longevity risk
  
  • could also obtain evidence of health
  • if insurer intends to offer different terms according to applicant health

Medical underwriting comes with a cost - therefore its use depends on the extent of the loss that the life insurance company will make if it mis-estimates the state of health of the applicant (usually for higher levels of benefit)

The main aimes of medical underwriting are to:

• improve marketability of product
• increase fairness
• control risk

Question 8

What are the 4 main sources of medical evidence for an insurer?

Describe some features and given examples

(18)

Answer 8

• Proposal form questions completed by applicant
  
  1. heigh/weight, smoking/drinking habits, occupational/dangrous pastimes
  2. current health eg details of current treatment being received
  3. personal medical history eg any major illnesses or operations
  4. family medical history eg hereditary ailments such as hear disease
  5. dishonesty not really a problem if
     
     1. it is not rising
     2. if insurance premiums allow for it, because they’re based on insurer’s own history of mortality experience
     3. may be picked up at claims stage
     4. sum at risk is low

However, dishonesty is a problem if:
1. it is increasing
2. the company’s rates are based on some other group of lives and underwriting procedures were stricter for these lives.

• Medical doctors reports from that applicant has consulted
  
  1. still carries a cost compared to proposal forms…
  2. …but if insurer can access, cost effective way to get most of medical history
  3. maybe not useful where people have multiple doctors
  4. may be difficulties with privacy, data protection, etc
• Medical examination
  
  1. carried out on applicant by doctor, nurse, paramedic, or pharmacist
  2. usually covers many points in proposal form, bu additionally, allowing doctor to check obvious problems
  3. costly option + risk of discouraging healthy applicants
  4. usually only done if
     
     • answers in proposal form unsatisfactory
     • for high sum insured
     • no reports from previously consulted doctors are available.

​​

• Specalist medical tests on applicant ​eg blood tests, electrocardiogram, chest x-ray
  
  1. ​​ most intensive+ expensive option
  2. maybe indicated as necessary by basic medical exam
  3. maybe automatically required for high sum insured on temporary assurance product

Question 9

Besides the state of health of an applicant given by medical evidence, what other factors can affect mortality risk and so need to be investigated? (4)

Answer 9

• Applicant’s occupation
• Applicant’s leisure pursuits
• Applicant’s normal country of residence (and attendant health care environment)
• Some companies also attempt to use socio-economic factors

Question 10

With regard to the process financial underwriting, list:

What are its main aims? (5)

What role do brokers play? (2)

Answer 10

Financial underwriting is imposed mostly on large sum assured cases, and it main aims are to ensure

• premiums payable by applicant are affordable (checking their income, which is used to control persistency risk)
• applicant is not trying to commit fraud
  
  • by having higher levels of sum assured than could be justified
  • can check across all assurances across the company, tricky when considering assurances across companys

Expectations of brokers re financial underwriting

• brokers should financial consider needs of customer
• when making recommendation on appropriate insurance policy regardless of size of sum assured

Question 11

With regard to the process financial underwriting, list:

What information may be gathered? (3)

Answer 11

Life company gather information on

• sums assured applied for by applicant
• sums assured on existing policies
• income of applicant

Question 12

Outline the process by which the evidence gathered by underwriting will be interpreted. (7)

Answer 12

• Evidence obtained is interpreted in terms of standard of health required by life company.
  
  • Standard cases are done by admin staff.
  • Non-standard cases are assessed by specialist underwriters using:
    
    • doctors specifically employed by insurer for this purpose
    • underwriting manuals prepared internally or by major reinsurers
• Basic vs complex cases
  
  • specialist underwriting software used to assess + rate basic medical evidence + disclosures
  • experienced professional underwriters used for moderately complex + financial underwriting cases

Question 13

What is the very first hurdle for insurance to be granted if underwriting is done? (3)

Suppose applicant gets past financial reinsurance (if applicable) what would be the next steps after underwriting? (6)

Answer 13

Very first hurdle regading underwriting is that of financial underwriting

• applicants who fail financial underwriting tests would be declined
  
  • insurer may request more info, before declining, but if fraud suspected then further info treated with caution
  • loss of goodwill (due to declining) small price compared to reduced risk of fraud and avoiding costs of further investigations

Passing the financial underwriting, where applicable, either of the following may happen

• normal terms offered: for applicants whose health state reaches required standard, else…
• …special terms may be offered
• decline
  
  • where applicant health state doesn’t meet any of insurer’s standards..
  • ..could decline cover temporarily
  • declines on health grounds may not be regulatorily permitted, but actually sound premium may then be charged

Question 14

Discuss the four main ways in which special terms can be specified for a contract after underwriting has been conducted (10)

Answer 14

• addition to standard premium, commensurate with degree of risk
  
  • preffered for protection policies as PH decides on some level of protection required, then pays premium
• deduction from standard benefit, commensurate with degree of risk
  
  • preferred for savings policies
• exclusion clause appended to contract, excludes benefit payment arising due to specific issues
  
  • least preferred, since exclusion may go against PH needs
  • not always easy to enforce at time of claim
  • common exlusion examples
    
    • alcohol and drug use
    • self inflincted injury/attempted suicide
    • war/civil commotion
    • failure to follow appropriate medical advice
    • claimant outside agreed geographical region
• offer a different policy
  
  • e.g. reduced term, but might not be acceptable to policyholder, as
    
    • might not meet the PH needs and/or
    • premiums may be not be affordable.

Question 15

For the following contracts, which of the special term approaches is the most suitable: (a) regular premium endowment assurance (b) term assurance.

Answer 15

(a) Regular premium endowment assurance: the product is a savings vehicle, where policyholders generally decide what premiums they can afford to pay, and then see what eventual benefit they get at maturity. If this is so, then an approach which involves reducing the death benefit (only) would probably be most suitable. It also means that policyholders who do, in the end, survive to the end of the term (and hence have not contributed in any way to any mortality loss), receive the same benefit for the same premium as an unimpaired life. This seems very fair, and appears to meet most policyholders’ needs from this contract. A variation would be to impose a reducing debt, where the debt reduces by level amounts over the term of the policy, reaching zero by the maturity date. On the other hand, if for any reason the policyholder needed to have some specific amount of sum assured on death, (eg to repay a house mortgage), then an increase in premiums would be more appropriate.

(b) Term assurance: the policyholder normally decides on some necessary level of cover, and then pays the required premiums. So it will be more appropriate to increase premiums, rather than to reduce the cover from what the policyholder originally wanted.

Question 16

When deciding on the level of underwriting to use, the insurer must maintain a balance between the costs and benefits of relaxed/reduced underwriting.

What is the key message regarding the balance between costs/benefits of relaxed underwriting? (1)

What are 2 main costs of relaxed/reduced underwriting? (2)

What would be the main benefit(s) of relaxed/reduced underwriting (3)?

Answer 16

The key message/balance is essentially that

• underwriting is justified to the extent that it pays for itself in improved experience

Main costs of relaxed/reduced underwriting

• increased costs of anti-selection
• increased costs of obtaining reinsurance

Main benefits of relaxed/reduced underwriting would be

• reduced underwriting expenses
• increased attractiveness of product to distribution channels/customers
• increased profits, from increased volumes of new business undertaken
  
  • assuming benefits of greater marketability and lower underwriting costs outweigh the effects of the premium increases for worsening mortality experience

Question 17

What do we mean by claims underwriting? (4)

For what contracts is claims management particularly difficult? (4)

Answer 17

Claims underwriting essentially relates to

• checking validity of a claim at claims stage eg checking
  
  • if the claim is subject to any exclusion clauses
  • for suspicion of non-disclosure (may be difficult to obtain evidence)
• potentially rejecting claims that do not meet requirements set out in terms

Claims management is particularly difficult for

• health and care contracts as it’s…
• complicated to assess
  
  • claim validity and
  • required need to assess continued validity of income protection claim to ensure policyholders who have recovered do no continue receiving benefits.

Question 18

What are the key considerations an insurer should bear in mind when deciding on the level of underwriting to use

(18 total points: 9 core points, each with subpoint expansion)

Answer 18

Key considerations when determining level of underwriting to use

1. Expenses associated with the level of underwriting proposed
   
   • underwriting includes various costs eg underwriter salary, medical reports
   • analysis must also include costs of getting further medical evidence
2. Extent and financial significance of any potential anti-selection risk
   
   • especially financial significance
   • eg same product as competitor with less underwriting may attract anti-selective risks (Sentinel effect)
3. Impact on the potential level of sales
   
   • ​​less underwriting=> quicker processing of new business proposals
   • people maybe more inclined to take contracts with less underwriting
4. The uncertainty caused by claims underwriting
   
   • uncertainty of whether claim is accepted or not may deter people from taking up the contract.
5. Effectiveness of proposed underwriting
   
   • if underwriting leads to benefit exclusions, it may be difficult to police
   • limiting medical evidence may make underwriting more difficult for staff
   • non-disclosure also makes underwriting less effective
6. Extent of homogenisation of risk that may be achieved
   
   • applicants classified together for rating purposes have are similar risk
   • more classification cells=>
     
     • more accurate rating for each individual=> good thing
     • more information required from propose, more cost=> bad thing
7. Impact of regulation
   
   • ​​might constrain level and/or type of underwriting eg use of genetic testing
8. Terms offered by company’s reinsurers
   
   • ​more stringent underwriting=> more predictable claims=>
     
     • lower margins included by insurers when assessing terms to offer
     • may require less reinsurance, so retention levels may increase
9. How to vary underwriting
   
   • ​​eg by age, sum assured, target market and other factors

Question 19

What is the general view in terms of the impact of underwriting on a product’s marketability? (3)

Answer 19

Underwriting is generally recognised as

• a barrier to sales as well as being time consuming and invasive.
• although contrary to minimising risk, less or no underwriting may be used to increase the marketability of policies…
• …making risk costs higher and other costs lower, making the overall pricing competitive.

Question 20

In what context may an insurer apply reduced underwriting? (2)

What aims would an insurer hope to achieve by using reduced/relaxed underwriting? (1)

How might the level of underwriting be viewed by certain distribution channels? (1)

What kind of products might give rise to additional risk to the insurer due to reduced/relaxed underwriting, and what might the insurer do to mitigate these risks?

Answer 20

An insurer may apply reduced underwriting in the following contexts

• the level of sum assured, or other criteria at which underwriting is automatically applied may be relaxed in certain…
• ….products, or distribution channels.

An insurer may use reduced underwriting in order to improve

• competitivenes, hence marketability

In fact, underwriting may be viewed as a

• discriminator of which products/insurers might be recommended to clients eg in the case of intermediaries

In some cases

• policy options exist, allowing PH to increase and/or extend length of cover without additional medical health
• this can increase anti-selection risk
• in face of reduced/relaxed underwriting, insurer can mitigate this by increasing overall product charges, compared to corredponding policy without option

Question 21

In what way is an insurer’s level of underwriting linked to its reinsurance agreement with its reinsurer? (2)

Broadly speaking, what do the terms of reinsurance depend on between a cedant (insurer) and reinsurer? (6)

Answer 21

Reinsurer will require

• a certain level of underwriting to be in place and
• will carry out reviews of the underwriting carried out if a reinsurance agreement is in place for certain classes of business

Terms of reinsurance usually depend on

• past claims experience of insurer
• underwriting standards in place
  
  • more underwriting, usually=> better terms
  • cedant usually required to maintain underwriting standards, leading to considerable operational risk (reinsurer may not pay claims if underwriting deviates from specified in treaty)
• any expected change in experience after changes in underwriting standard
  
  • terms and price of reinsurance will be renegotiated if underwriting level changes

Question 22

Underwriting in a group cover context

In what wasy will the design of a scheme be used to manage risk in the context of group cover/contracts/benefits? (7)

Answer 22

One of the main mechanisms to reduce risk for group contracts is through

• the design of the scheme: lower selection risk against provider for schemes
  
  • where benefit levels determined by fixed formula related to salary
  • where membership is compulsory
  • with minimum number of members
• this can lead to
  
  • more generous free cover and
  • smaller loading for risk in premium.

Question 23

Underwriting in a group cover context

What do we mean by free cover limits within a group cover context? (4)

Under what scenarios is it ideal to apply free cover limits to group cover? (2)

What benefits are introduced by using free cover limits in a group cover context? (2)

Answer 23

Free cover limits referes to

1. amount of cover automatically granted to individuals in a group scheme without underwriting
2. standard premium rate charged to any member having benefits which do not exceed the free cover limit
3. assuming compulsory membership, most companies have a formula that applies such that most lives can be accepted without underwriting
4. benefits above the free cover limit eg highly paid employees, are subjected to underwriting

It is usually ideal to apply free cover limits to certain large groups where

1. number of lives covered is sufficiently big to allow the insurer to treat it as a separate insurance unit
2. with no single insured being significant.

Free cover limits benefit in terms of

• reduced underwriting
• reduced inconvenience to client (asking too many people to be medically examined)

Question 24

Underwriting in a group cover context

Give examples of common measures to reduce anti-selection risk taken by providers of group benefits (6)

Answer 24

1. applying exclusions
2. setting free cover limits
3. ensuring member actively working when cover begins
4. setting take up rates on voluntary schemes
5. laying down take over terms eg where insurer accepts a scheme previously insured elsewhere

Question 25

What kind of special considerations exist regarding claims underwriting for IP policies? (6)

Answer 25

Specifically for IP policies

• Insurer needs appropriate info to substantiate claim, checking info consistent policy application info.
• Benefit level checked against current salary=>ensure PH retains incentive to return to work.
• Once claim has been approved, counsellor will:
  
  • provide advice for the claimant in coping with the disability
  • provide for insurer a likely duration of illness (establishing such a date of return to work in the mind of the patient).
• Thereafter insurer will put in place procedure for monitoring (focuses on rehabilitation and is performed where appropriate by specialist nurses) ongoing claim, with periodic visits and continuing medical certification.

Question 26

Explain why each of the following features of a group IP scheme enables an insurer to offer a high free cover limit:
● compulsory membership
● a minimum number of members in the scheme the ● use of an “actively at work” criterion
● a prescribed benefit formula.

Answer 26

Note that the free cover limit fixes the amount of insurance that can be offered to a member of the group scheme without any form of underwriting except, perhaps, for an “actively at work” qualification.

1. Compulsory membership
   This will ensure that the insurer gains both the good risks and the bad risks and not just a selection of the worse risks. This means that there can be some cross-subsidy between members of the scheme, with the better risks paying more than their expected claims costs and the worse risks paying less than their expected claims cost.

If membership were voluntary, it is more likely that the worse risks will join, as they will benefit more from the scheme and will not be excluded by underwriting.

2. A minimum number of members in the scheme
   The average annual claims cost per member will be the subject of random variation from year to year. The size of this variation is inversely proportional to the square root of the number of scheme members. So the rate of decrease in the standard error of the average claim size per member is more rapid for small numbers of members than it is for larger numbers of members. When a certain size is reached the rate of decrease will be very small. So if we impose a minimum membership of about this size, it will be less likely that the premium income each year will be less than the actual claims cost.
3. The use of an “actively at work” criterion
   Those who have been actively at work are less likely to claim in future than those who have been absent as a result of sickness or injury.

This is a cost-effective form of underwriting. The prospective member does not have to provide any information, and the criterion can be readily verified from the employer’s records. A criterion of actively at work for the preceding two months should reduce the likelihood of selection against the office to an acceptable level.

4. A prescribed benefit formula
   The benefit will usually be related to the employee’s salary by means of a simple formula. This will prevent worse risks over-insuring and good risks choosing to under insure with a consequent adverse impact on the actual claims cost.

Question 27

Describe the policy conditions that are designed to help the insured back to work.

Answer 27

An early notification of sickness will enable the insurer to offer rehabilitation services.

These rehabilitation services would continue after a claim was being paid.

The policy will usually include a restriction on the maximum benefit that is payable (eg 60% of the pre-disability income). This will maintain a financial incentive for the insured to return to work.

The policy will usually include a linked-claims period. So if the insured returns to work and falls sick again within this period, the two periods of sickness will be treated as one. Any deferred period before benefits become payable will be ignored for this second period of sickness. This would also apply to any subsequent periods of work. This has the effect of encouraging the insured to try to return to work, because the penalties of falling sick again have been removed.

The policy will usually include a condition so that a proportionate benefit is paid if the insured returns to work part-time. This will encourage the insured to try working again.

If the insured has been sick for a lengthy period (eg two years), then the policy may revert to a less stringent sickness definition based on being able to do any job, rather than the job they were doing immediately before the current period of sickness. At this stage the insurer might encourage the insured to retrain for a new job, perhaps offering financial support for this training.

Question 28

For what products is underwriting very important? Quite important? Irrelevant?

Consider the following products:

Term assurance

Whole life assurance

Endowment assurance (regular premium)

Endowment assurance (single premium)

Annuity

Pure endowment

Answer 28

• Term assurance - critical
• Whole life assurance - very important
• Endowment assurance (regular premium) - important
• Endowment assurance (single premium) - not very important
• Annuity - not important unless impaired lives’ annuities
• Pure endowment - irrelevant

Question 29

Give reasons why some of these sources may not be used for all applications in practice.

Answer 29

The basic principle behind obtaining and using the underwriting information, is to enable the company to control its mortality risks in the most cost-effective manner.

Reasons for not using all the information could therefore include:
● to save on expenses
● when the opportunity for anti-selection is negligible (eg for a standard annuity)
● in order to be competitive and to increase sales (people don’t like revealing medical information)
● if the amount of cover is small (so the financial effect of anti-selection is minimal and would not justify the cost of obtaining the information)
● if group cover is being applied for (as anti-selection may be lower)
● if the cover is compulsory (as anti-selection is negligible)
● if such an invasion of privacy is not culturally acceptable
● if not allowed under legislation
● if earlier sources (eg proposal forms) suggest no problems, then further investigation may not be cost-effective
● if the product specifies that underwriting will not be performed (eg on the exercise of the option under a renewable or convertible term assurance)
● if the information is simply not available (eg medical reports, either due to data protection or because there aren’t such things).