Demystifying the life insurance underwriting process
It has been said that responsible people buy life insurance for one of two reasons; they either love someone or they owe someone. However, purchasing life insurance is not as easy as buying any other type of financial product. Just because someone wants life insurance and is willing to pay for it, does not automatically mean that an insurance company will offer to insure them. Once someone applies for life insurance coverage, the application must go through a strict underwriting process by the insurance company before an individual is eligible to even purchase the policy.
Today in the 21st century the underwriting process of a life insurance policy is still a mystery to most in the financial professionals and especially to their clients. In essence the underwriting process includes the following three steps:
- 1. Examination of the application
- 2. Decision as to whether to insure
- 3. Determination of the premium
It is as true today as it was when Albert Einstein said “make everything as simple as possible, but not simpler.” The aim of this month’s column is to demystify the underwriting process of a life insurance policy. So when you sit down at your next annual review meeting with a client and recommend that they purchase life insurance for tax or estate planning purposes you will have a basic understanding of what it will take for your client to follow through on your recommendation and own a life insurance policy.
The life insurance applicant’s responsibilities.
The Insurance Acts in each jurisdiction in Canada detail that an applicant for life insurance is obligated to report all relevant information about their health and financials that will allow an insurance company to properly evaluate a potential insured’s suitability for coverage. The applicant is required to provide 4 types of personal information on their application for insurance coverage:
- 1. Details on income and lifestyle.
- 2. Medical history of applicant.
- 3. Medical history of applicant’s family.
- 4. Hazardous occupation/activities.
A life insurance policy is referred to as a contract of “uberrima fides”. This term means “in utmost good faith”. The insurer depends on the applicant for complete disclosure. The range of negative consequences that can result from making misrepresentations on a life insurance application may range from a delay in approval or the voiding of the policy.
The insurance agents role.
Across Canada for an individual to be authorized to sell life insurance they have to be registered as an agent with the provincial licensing regulator and hold an errors and omission insurance policy. The agent’s primary role in the underwriting process is to record the client’s information on an application on the insurance form. This process is called field underwriting. The responsibilities the agent has regarding the application include collecting information accurately and completely, educating the client on consequences of incorrect information and witnessing the client’s signature on application.
The types of information that the agent will collect in the application for life insurance are the applicant’s name, age, gender, SIN#, annual “earned” income, net worth, date of birth, gender, smoking status and medical history. The agent will write down the product details which include the amount of coverage, type of policy, dividend option if relevant, duration of policy, premium payment period and riders. As well general information from the applicant will be collected in the application such as: Is there existing insurance coverage? Have previous applications been declined? Are there other pending applications? Does the applicant engage in hazardous activities? Has the applicant had their driver’s license suspended? Does the applicant have a criminal record? Who will be the named beneficiary and what is their relationship to life insured?
If the applicant qualifies they may receive a Temporary Insurance Agreement (TIA) after the application is completed. The TIA provides coverage while the underwriting process is completed. Applicants can receive the TIA provided that they qualify as a standard risk and include one month’s premium with the application. The TIA insures the applicant for 90 days after the application has been signed or when the insurance company has completed the underwriting process. The maximum amount that can be insured for under the TIA is $500,000.
The agent must inform and educate the applicant that by signing the application for insurance they are authorizing that their medical history will be released to the Medical Insurance Bureau (MIB). The MIB is somewhat like a credit bureau and exists to share medical information among insurers. There is an MIB Pre-notice form that is left with the applicant to read after the application is signed.
Lastly, after the application is signed by the applicant and before the application is delivered to the insurance company the agent is required to fill out what is referred to as an Agent Report. The Agent provides notes and comments about the applicant on the application that might assist in the underwriting process.
The insurance company’s role.
Insurance legislation across Canada states that once someone is offered a life insurance policy by an insurance company that was based on truthful information provided by the insured, the insurer most honour the contract for the duration of the policy and for as long as the premiums are paid. Therefore the insurance company must be sure that providing coverage to an insured is a good investment for the company. In essence both the insurance company and the policyholder make a bet with each other. The insured is betting that one day they will die and the insurance company is betting that the insured is not going to die today.
The policy is issued only after the insurance company underwriters have reviewed the inspection and medical report. This report is prepared by a third party interviewing the applicant to confirm the information. The objective of the inspection report is to determine whether or not the face value applied for is justifiable. Depending on the size of the face amount being insured will determine whether there is to be a medical exam, a medical exam by a paramedical service or a medical exam by a physician. The “inspection report” verifies information on the application, especially which relates to financial matters. After all this information has been collected and reviewed, only then can the coverage be approved, and the premium rates are determined based on the insured’s age, gender and health.
Delivery of the contract.
The final requirement in creating a legal contractual agreement between the policy owner and the insurance company occurs only when the policy is delivered to the applicant. The policy holder is only bound to the insurance contract after receipt, examination and their acceptance of the policy. The prompt delivery and proof of delivery are very important for insurance policies because a delayed delivery may create a danger of a change in insurability of the insured from the time the underwriting is completed and the policy is delivered. A signed delivery receipt with a health statement that certifies no change in insurability status must be signed by the insured before the permanent policy is in force. If there is a change in the health of the insured and the policy is signed and the insurer has not been notified of this change, at the time of death the insurance company can legally deny the claim and may only be required to return paid premiums. The end result is the full insured death benefit will not be paid out to the beneficiary.
The bottom line.
At your next annual review meeting with a client, you may recommend that they purchase a life insurance policy for tax or estate planning purposes. As the client’s fiduciary it is absolutely imperative that your client receive the right advice and be sold the right policy. It is wise that you work closely with a qualified agent who is experienced and has the proper recognized professional designations noting true professionalism. The Certified Financial Planners (CFP) and Chartered Life Underwriters (CLU) are technically competent in the area of life, disability, critical illness, long-term care and medical and dental insurances. These individuals who have attained either the CFP or CLU designations must continually meet education, examination, experience and ethical standards. As a public accountant, working with these types of professionals is your best personal insurance policy in making sure that your client’s best interests are protected – as well as your own.