Financial Underwriting for Life Insurance Policies

Financial underwriting determines financial need of policy

If you have ever applied for a life insurance policy, you have probably experienced medical underwriting – the process wherein a life insurance underwriter assesses the risk (of dying) you present to the insurance company.  It is a process which typically includes a medical exam, health history and, in some cases, review of your medical records.  Upon review of these items, the underwriter will assign a health class to you, which will be used to help determine the rates you will pay for your policy.

However, most people aren’t aware that financial underwriting is part of the application process.  The underwriter will take a look at the following financial considerations to see if the death benefit being applied for makes sense:

  • Is there an insurable interest?  What the underwriter wants to know is if the beneficiary will suffer a financial loss should the insured person pass away.  In most policies, the beneficiary is either the spouse or children, or both.  Or it can be   a trust, specifically established to pay the death benefit to the beneficiaries.

    Certain business life insurance policies either name the surviving partner(s) or, if it’s a key-person policy, the company will be the beneficiary if a key employee dies.  In these cases, the insurable interest is fairly obvious.  In applications where the insurable interest isn’t quite so obvious, the underwriter will often request more information to help determine whether insurable interest exists.

  • Is there a definable economic loss?   In the case of a working spouse dying, the economic loss would be obvious to the underwriter.  Or, if a key-person in company is responsible for revenue, than the  loss of this employee usually translates to loss of revenue.

  • Is there a valid need and purpose for the insurance?  For  a family, it is usually income-replacement, but could also be used to fund the children’s education, or to pay off a mortgage or to pay off other debt.  For a business, it might be continuation of the business upon the death of a partner.
  • Does the amount of insurance applied for correlate with the amount of loss?  This one is also fairly clear-cut.  For a spouse, the economic loss is usually determined by loss of income for an age-specific length of time.  For younger applicants, many insurance companies will multiply the applicant’s income by 15 – 20 years to help determine death benefit feasibility, whereas for older applicants, it might only be for 10 years.  There are also formulas to help determine economic loss for business policies.

For most policies covering a spouse, the insurance company will usually want to know the applicant’s income, assets and liabilities to help determine the appropriateness of coverage.  For a business continuation policy, the underwriter will want to know the present value of the company and percentage of company stock held by the applicant.  For a key-person policy, the underwriter will want to know the income of the applicant.   

Most applications include  questions regarding income, assets and liabilities.  We are often asked by applicants why the insurance company needs this information.  I hope I have satisfactorily answered that question.   To help determine the death benefit of your life insurance policy, see our Life Insurance Calculator.

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