16.1 Health Underwriting and Risk Selection
Key Takeaways
- Underwriting controls adverse selection by classifying applicants as preferred, standard, substandard (rated), or declined.
- Distinguish physical hazard (bodily condition), moral hazard (dishonesty), and morale hazard (carelessness because coverage exists).
- Table ratings step in 25% increments; a substandard policy is still issued, only a declined application produces no coverage.
- Fair discrimination uses actuarially sound factors; charging equal-expectation insureds different rates is unfair discrimination.
- Health underwriting weighs morbidity (sickness/disability likelihood), not just mortality.
What Underwriting Actually Does
Underwriting is the process of classifying applicants by the risk they bring to the insurer's pool and assigning a premium that matches that risk. The goal is adverse selection control: people who expect to need coverage tend to apply more aggressively, so the underwriter must screen and price accurately or the pool becomes unprofitable.
The underwriter is the company's risk gatekeeper. The producer is a field underwriter who gathers honest information and avoids submitting business the company would reject. Selection must be based on sound actuarial data, never on unfair discrimination prohibited by law.
Risk Classifications
Life and health applicants are sorted into standard categories. Each class carries a different rate per $1,000 of coverage.
| Classification | Meaning | Premium Effect |
|---|---|---|
| Preferred | Better-than-average health/lifestyle | Lowest rate |
| Standard | Average expected mortality/morbidity | Base (table) rate |
| Substandard (rated) | Higher-than-average risk | Surcharged (e.g., Table 2 = +50%) |
| Declined | Risk too high to insure | No policy issued |
A rated policy can be expressed as a flat extra premium, a table rating, or a rate-up in age. Example: a standard annual premium is $640; a Table 4 rating adds 25% per table-step times 4 = +100%, so the insured pays $640 x 2.00 = $1,280.
Hazards the Underwriter Weighs
- Physical hazard - a condition of the body or health (diabetes, prior heart attack) that increases the chance of loss.
- Moral hazard - a tendency to act dishonestly (prior fraud, arson history) that increases loss likelihood.
- Morale hazard - indifference or carelessness because insurance exists ("the insurer will pay anyway").
For health insurance the underwriter also evaluates morbidity (likelihood of sickness/disability) rather than mortality. Build (height/weight), tobacco use, occupation, avocations such as scuba diving or aviation, and driving record (MVR) all feed the decision.
Worked Example: Substandard Pricing Trap
A candidate applies for $250,000 of coverage. The standard rate is $3.20 per $1,000 annually. Because of a controlled but chronic condition, the underwriter assigns a 75% flat extra.
- Standard premium = 250 units x $3.20 = $800/yr
- Flat extra of 75% = $800 x 0.75 = $600
- Total annual premium = $800 + $600 = $1,400/yr
A common exam trap: a substandard (rated) policy is still issued - it is not the same as a declined application. Candidates also confuse a rate-up (assigning a higher age) with an outright decline; a rate-up issues the policy at the premium for an older insured.
Underwriting Sources and the Medical Information Bureau
The underwriter draws on layered sources to verify an applicant's risk: the application (the primary source), the agent's report (field-underwriter observations), an Attending Physician's Statement (APS) for clarification of medical history, paramedical or medical exams for larger amounts, and the Medical Information Bureau (MIB) -- a nonprofit databank of coded medical impairments member insurers report and query to catch nondisclosure. An MIB code is only a caution flag; an insurer may not decline coverage solely on an MIB report without further investigation.
Substandard Risk Handling and Rating Methods
When an applicant is substandard, the insurer rarely declines outright; it rates the policy. Two methods appear on the exam: the flat extra premium (a fixed dollar charge per $1,000 for a temporary or fixed hazard) and the table rating (a percentage surcharge in tables 1 through 16, each adding roughly 25% mortality). A substandard risk may also be issued with a rider excluding a specific condition.
| Risk class | Pricing effect |
|---|---|
| Preferred | Lowest rate |
| Standard | Average rate |
| Substandard | Rated up (flat extra or table) |
| Declined | No coverage offered |
Worked Table-Rating Calculation
A standard annual premium is $1,000. The applicant is placed at Table 4, adding 4 x 25% = 100% to the standard mortality cost. Because only the mortality portion is loaded (not the full premium), the rated premium is less than double; a simplified exam treatment, however, often shows the rated premium roughly $1,000 plus the mortality surcharge. The key tested point is that higher table = higher percentage load.
Fair Underwriting Limits
Underwriting must rely on sound actuarial data and may not unfairly discriminate by race, national origin, or other protected categories; the exam frames this against the unfair-discrimination prohibition in trade-practices law.
Additional Exam Traps
- The MIB flags possible impairments but is never the sole basis for declining.
- A flat extra is a fixed dollar charge; a table rating is a percentage surcharge.
- The application is the primary underwriting source; the agent's report supplements it.
An applicant who continues smoking after the insurer offered a nonsmoker discount, knowing the carrier will pay claims regardless, demonstrates which type of hazard?
Fair Discrimination vs. Unfair Discrimination
Insurers may distinguish among applicants on actuarially justified grounds - age, health, occupation, tobacco use. They may not charge different rates to individuals of the same class and equal expectation of life, nor discriminate on prohibited bases such as race, national origin, or (in many states) genetic test results. Charging two identically situated standard risks different premiums is unfair discrimination, a violation of the unfair trade practices act.
Two applicants are the same age, same health, same class, and same expectation of life, yet the producer quotes them different premiums for an identical policy. This is BEST described as:
Key Numbers to Memorize
- Table ratings typically step in 25% increments (Table 1 = +25%, Table 2 = +50%, and so on).
- A flat extra is a fixed dollar amount per $1,000 added for a temporary or permanent hazard (e.g., $5 per $1,000 for a dangerous avocation).
- Substandard does not mean uninsurable - only declined means no coverage is issued.
Mortality vs. Morbidity
Life underwriting is built on mortality tables that predict death rates by age and gender. Health underwriting is built on morbidity tables that predict the frequency and duration of sickness and disability. The two often diverge: a person at low risk of dying soon can still be a high morbidity risk (e.g., a chronic but non-fatal condition that drives frequent claims). Underwriters price each product against the table that matches its primary risk.
The Field Underwriter's Role
The producer is the company's first underwriter in the field. Strong field underwriting means asking every question fully, recording answers verbatim, and never "helping" the applicant minimize a condition. A producer who steers a clearly substandard applicant into a standard application creates a clean sheeting problem - the policy may be issued at a price the risk cannot support, exposing the insurer to losses and the producer to E&O liability. Honest field underwriting protects the pool and the agent.