When you buy a life insurance policy, you’re essentially entering into a bet with your insurer. The bet is that you’ll live long enough to make the premiums you pay for the policy and the investment income generated from those payments less than the amount the insurance company will pay out to your survivors.
To spread out the risk to the insurance company, your insurer does business with a wide pool of people. This creates a large enough pool of money to pay out benefits to survivors of those insureds who win the bet — by dying.
Insurers also reduce their risk by engaging in a practice known as underwriting. Underwriting is essentially assessing the risk each insured or groups of insureds pose the company by means of probability and statistics and then deciding whether to award coverage and setting premium amounts based on this information.
The name underwriting actually derives from Lloyd’s of London, perhaps the world’s best known insurer. In the past, the financial backers of sea voyages would, in exchange for a premium, write their names on the risk information spelled out on a Lloyd’s slip.
An underwriter’s essential job is to find clients who pose an acceptable risk to the insurance company and issue them policies based upon their evaluation of these risks. In life insurance underwriting, the underwriter’s task is clear, to deny or award coverage and set a premium based on your chance of dying.
Each life insurance company has its own guidelines regarding underwriting, but some basic tenants apply across the board.
For starters, a life insurer will consider your sex when you apply for a life insurance policy. Women tend to live longer than men, so it’s likely that a woman’s policy will cost less than a policy with a man with a similar age and health history.
Life insurance companies also consider family medical history when underwriting a life insurance policy. Genetics are one of the best indicators of a person’s health and future well-being, so potential insureds with family histories of cancer, heart disease and certain other illnesses pose greater risks to an insurer, and thus will likely face more obstacles to obtaining coverage and pay higher premiums.
Age is another factor considered by life insurance companies. The older you are, the more statistically likely it is that you will succumb to illness or injury, thus increasing your risk to the insurer. Older insureds can expect to pay higher premiums than younger insureds.
Tobacco use is a big factor in premium costs for a life insurance policy. Let’s face it, a smoking habit is essentially a death sentence. Therefore smokers can expect to pay much higher life insurance premiums than non-smokers. Folks with a history of drug or alcohol abuse can also expect to pay a higher life insurance premium. Don’t try to fudge the insurance companies when they ask about these things. Even if you are able to fool them, if you die and it comes to light that you lied to your insurer, they could justifiably deny your survivors’ claim on your benefits.
Some insurers choose to look at potential insureds’ jobs when underwriting a policy. High risk occupations such as construction work or security jobs will likely carry a higher premium than those for workers involved in sedentary pursuits such as office work.
Once your insurer has evaluated all the information, they’ll make a determination as to your classification as a risk. In general, there are four risk categories:
- Preferred: This is for folks who pose a very small insurance risk. Typically these are non-smokers who are in good health and have a safe job and little or no family history of serious health problems. These folks get the lowest rates for their life insurance premiums.
- Standard: This is the average joe risk category. These are folks who likely don’t smoke are reasonably healthy and who pose only a moderate risk. Their premium is the standard premium.
- Rated: These are folks who pose an above average risk. They may be smokers, or have a health problem such as diabetes or engage in risky habits or jobs. These folks pay a higher premium.
- Denied: These folks are considered uninsurable because of the elevated risk they pose to insurance plans. An insurer will decline to offer coverage to these people.
Now that you know the basics of how underwriting works, you’ll have a better idea of what risk group you’re likely to fall into and why. If you’d like to get a better rate, you may be able to make some changes to your lifestyle that could lower the insurance risk you pose, such as quitting smoking or eating healthier.