Life Insurance Underwriting Classifications

In my last entry, Underwriting Life Insurance….What Every Trustee Should Know, I wrote about the steps that should be taken to ensure the best pricing when purchasing a life insurance policy. The difference in underwriting offers can play a large role in the success of the ILIT you are managing.   After all, keeping a policy in force over the lifetime of the Insured is much harder if the policy pricing is dramatically higher. In a new policy placement case I reviewed, the offers from the 3 carriers deemed to have the best chance of providing economical coverage were dramatically different, causing a wide gap in pricing. A male, age 52, who was large in build, but with no outstanding health issues, was applying for $5,000,000 of 10 year Level Term coverage. As you can see below, he received offers that varied in cost by almost 100%.

  • Carrier #1: Rated Table C, annual premium of $18,586
  • Carrier #2: Standard, annual premium of $13,535
  • Carrier #3: Standard Plus, annual premium of $9,500

After I wrote that last Blog entry, I hosted a webinar designed to acquaint Trustees with the nuances of underwriting life insurance. One of the questions I got afterwards was about the differences in underwriting classifications and "rated" policies. A great question.

In general, there are three main underwriting classifications with some carriers providing sub-classifications (as in example above, Standard and Standard Plus).

Preferred underwriting is reserved for only the healthiest individuals, with no adverse medical history. Usually, they are not on medication for any condition and have no family history of early onset diseases. They are at an ideal weight for their height, with an acceptable body mass index. They have never smoked tobacco, or if they have, they have quit for extended period of time. In addition, they do not participate in high-risk behaviors. By the way, a person who smokes can get Preferred Smoker rates, if all else (except the smoking habit) is as above.

A person who obtains Standard underwriting has an average health and normal life expectancy with lab results in the normal to slightly abnormal range and can have some negative family health issues, but does not participate in dangerous sporting activities or have a hazardous occupation.

Those considered “Rated” or Sub-Standard are those deemed to have a below average life expectancy.  They typically have a height to weight ratio considered undesirable. They may have been treated in the past with an illness, or have a chronic illness or other major health issue. They almost always have bad or questionable lab results. Note: It is rare for a carrier to provide an underwriting offer if the applicant is currently going through a health issue. It is not that insurance cannot be obtained at some point in the future; it is just that the carrier needs to be able to assess their risk. If the applicant is in the midst of a current health issue, that is impossible to do.

Carriers have different ways of dealing with rated policy pricing. They can increase the premium by “rating up in age”, where they simply raise the age of the Insured from their actual age to a higher age based on the health of the Insured. This results in a higher cost of insurance in the policy to account for the health issue. Another method is to use a Flat Extra, an extra cost per thousand of insurance coverage that is added to the base premium. A Flat Extra can be put on for a short period of time. For example, a Flat Extra could be put on for 5 years only after a successful treatment for cancer. Or the Flat Extra could be more or less permanent. A Flat Extra could be added for a recreational pilot and be a part of the policy pricing as long as the Insured was participating in that type of aviation.

The most common method of pricing a sub standard case is with a Table Rating where a number or letter grade is assigned to the sub standard rating with an increasing cost of insurance as the rating goes up. The table below shows the increased cost of insurance within a policy as the table rating goes up. A Table 2 rating would mean that the policy would have a cost of insurance that was 150% of the Standard rated cost. Remember, that in a Permanent policy, the cost of insurance is not the only cost in the policy but it is by far the greatest cost. Other charges, including administration fees, costs of riders, etc., are added to the pure mortality cost of the policy, but the cost of insurance, over the life of the policy will be the most significant expense. Hence, the importance of the underwriting obtained at policy issue.

Table

COI

Standard

100%
2

150%

3

175%

4

200%

5

225%

6

250%

8

300%

10

350%

12

400%
14

450%

16

500%

So, how can the difference in underwriting offers vary so much between carriers? Each carrier has an underwriting handbook that spells out the general parameters of their underwriting classifications, but underwriting is as much an art as a science. A good Underwriter will know which carrier is “best” for each type of health issue. Some carriers have had better “luck” underwriting certain ailments and price accordingly and a good Underwriter will know this. Some carriers pay more attention to "Lifestyle Credits". Does your client exercise regularly, is he or she married, active in the community, adhere to any special diets? Any of these things may put them in a better light at certain carriers. And some carriers just view the same health information differently.  Also, remember that this is a business and in business, business decisions are made. A good Underwriter who is part Quarterback, part Advocate for your client will be able to drive a favorable business decision.

As a Trustee you may not be part of the underwriting process, but you should be aware of the importance of underwriting and be aware of the underwriting skill of the life insurance advisor and firm you are working with. It may save your client some money.