1.4 Underwriting, Premiums & Policy Issue
Key Takeaways
- Underwriting selects and classifies risk to charge an adequate, equitable premium and avoid adverse selection.
- The application, MIB, attending physician statement, and inspection reports are core sources of underwriting data.
- Under the FCRA, an insurer must notify the applicant before ordering a consumer/investigative report.
- Net premiums are based on mortality and interest; the expense (loading) factor produces the gross premium.
- When a policy is issued as applied for, coverage begins on policy delivery only after the first premium is paid.
Purpose & Process of Underwriting
Underwriting is the process of reviewing, selecting, classifying, and rating risks. Its purpose is to protect the insurer against adverse selection and to ensure premiums are adequate (enough to pay claims and expenses) and equitable (each insured pays a fair rate for the risk presented). The underwriter must avoid unfair discrimination — applicants with the same actuarial risk must be charged the same rate; classification by race or other prohibited factors is illegal.
The application is the primary and most important source of underwriting information. It has two parts: Part I (General) — personal data, beneficiary, plan applied for — and Part II (Medical) — health history. The producer, as field underwriter, must ensure both parts are complete, accurate, and signed.
Sources of Underwriting Information
| Source | What it provides |
|---|---|
| Application | Applicant's own statements (Parts I and II) |
| MIB (Medical Information Bureau) | Coded prior impairment flags from member insurers; signals to investigate, never used alone to decline |
| Attending Physician Statement (APS) | A report from the applicant's own doctor; ordered for specific medical history |
| Paramedical / medical exam | Physical, blood, and urine specimens for larger face amounts |
| Inspection report | A general background/lifestyle report from an outside agency |
| Investigative consumer report | Interviews with associates about character, reputation, and habits |
MIB rule: An insurer may not decline coverage solely because of an MIB code; the code only prompts further investigation. The applicant must give written consent before the insurer queries the MIB.
Fair Credit Reporting Act (FCRA)
The federal Fair Credit Reporting Act (FCRA) governs the use of consumer reports in underwriting. Its tested points:
- The insurer must notify the applicant in writing that a consumer or investigative consumer report may be obtained.
- The applicant has the right to know the nature and scope of the investigation and to request a copy of the report.
- If coverage is declined or rated up because of information in the report, the insurer must give the applicant the reason for the adverse action and the name and address of the reporting agency so the applicant can dispute inaccuracies.
Risk Classification
Underwriters sort applicants into rate classes:
- Preferred — better-than-average health/lifestyle; lowest premium.
- Standard — average risk; standard premium.
- Substandard (rated) — higher-than-average risk; charged an extra premium via a table rating or a flat extra, or issued with a benefit reduction.
- Declined — risk too great to insure at any price.
Premium Factors & Modes
The net premium rests on two factors; adding the third produces the gross premium:
- Mortality — the expected number of deaths in an age/gender group, drawn from a mortality table. Higher expected mortality raises the premium.
- Interest — the rate the insurer assumes it will earn investing premiums. Higher assumed interest lowers the premium (the money does more work).
- Expense (loading) — the cost of doing business (commissions, taxes, overhead) added to the net premium to reach the gross premium actually charged.
Premium modes: premiums can be paid annual, semiannual, quarterly, or monthly. Because more-frequent modes add billing cost and lost interest, the more frequently a premium is paid, the higher the total annual outlay — annual is the cheapest mode.
Policy Delivery, Effective Date & Backdating
Consideration from the applicant is the initial premium plus the statements in the application. Two delivery scenarios:
- Premium paid with application → the producer issues a conditional receipt; coverage can begin as of the application/exam date if the applicant proves insurable.
- No premium with application → the policy takes effect only when it is delivered and the first premium is collected, and (per the statement of good health) the insured is still in good health at delivery.
Backdating lets a policy be dated earlier than the application — in most states up to 6 months — to secure a lower premium based on a younger insurance age. The applicant must pay the back premiums for the predated period.
Conditional, Binding, and Premium Receipts
The type of receipt the producer gives when collecting premium with the application determines when coverage starts:
| Receipt | When coverage begins |
|---|---|
| Conditional receipt | As of the application or medical-exam date (whichever is later), but only if the applicant proves insurable for the amount/plan applied for — the most common life receipt |
| Binding (temporary) receipt | Immediately, for a stated period, regardless of insurability — more common in property/casualty |
Under a conditional receipt, if the applicant dies during underwriting and would have been issued a standard policy, the insurer pays the claim; if the applicant was actually a substandard or uninsurable risk for the plan applied for, the condition is not met and coverage never attached.
Field Underwriting at Delivery
When the producer delivers the policy, several duties arise: collect any premium still due, obtain a statement of continued good health if the first premium was not paid earlier, explain the policy's provisions, ratings, and any exclusions, and deliver any required outline of coverage or buyer's guide. Prompt delivery also starts the policyowner's free-look period, during which the contract may be returned for a full refund. Careful delivery closes the loop on field underwriting and reduces the chance of later disputes.
Putting Premium Math in Context
A quick recap of cause and effect, since the exam loves "which raises/lowers the premium" items: higher mortality → higher premium; higher assumed interest → lower premium; higher expenses → higher premium; more frequent premium mode → higher total annual cost. Net premium reflects only mortality and interest; gross premium adds the expense loading.
An applicant's MIB report contains a coded entry suggesting a past impairment. How may the underwriter use it?
Which premium assumption, if increased, will LOWER the premium an insurer charges?
An applicant submits a life application but pays NO premium. When does coverage become effective?
Why would an applicant choose to backdate a life insurance policy?