Life insurers pool the risk of you lodging a claim against your policy with that of all the other policyholders with the same policy.
Premiums are collected from all policyholders based on the cost of paying out claims to those who do claim.
But some policyholders are higher risk than others and identifying the higher risk ones through underwriting allows insurers to charge those who are a higher risk more and the rest of the group less.
Life, disability, severe illness and funeral insurance policies can be fully underwritten or have limited underwriting.
Underwriting is the process a life insurance company uses to determine how much risk it will taking on by insuring you. Without underwriting standard premiums for everyone would increase to provide for the increased risk of certain lives.
Based on the outcome of the underwriting process, a life insurer will decide whether to accept or decline your application for cover, and under what conditions. The conditions are set out in the terms of your policy and include your premiums and any exclusions from cover.
Underwriting identifies those who have a higher chance of claiming, so that they can be charged more than low- or average-risk policyholders. They will pay what is referred to as a premium loading.
It also reduces the possibility of those who know they will claim soon – such as the terminally ill - applying for cover. Long-term insurers guard against this kind of behaviour – known as anti-selection – because if allowed it would lead to higher claim rates and higher premiums for all policyholders.
Questions asked
You can determine the extent to which the policy is underwritten by the questions you are asked about your health and the medical tests you are asked to undergo.
A policy with limited underwriting may require answers to a few questions about your age and health, but few or no medical tests. The underwriter then has to decide on the risk of offering you cover without an accurate assessment of the risks which could result in you paying more for your cover.
A policy that is fully underwritten may require your answers to extensive questions about your medical history and that of your family members. The life company may ask for medical tests such as blood samples or an electrocardiogram (ECG) to check your heart rate and rhythm.
Funeral cover that is sold without life or disability cover is typically sold with limited underwriting. Group life policies rely on group underwriting – the risk of the group is assessed instead of that of each individual.
If you are in good health and not too old, an underwritten policy will generally be cheaper than one that is not underwritten. But remember there are many factors that influence the cost of cover. Read What does it cost to insure my life against death, disability or dread disease?
This is because when a life insurer has established through tests and questions that you are in good health, it will be prepared to offer you a cheaper premium.
You should be aware that just because you can take out a policy after answering only a few questions about your health, it does not mean your state of health is not important to the life insurance company.
Many policies that have limited underwriting rely on clauses that exclude cover for conditions you had when you took out the policy – these conditions are referred to as pre-existing conditions.
You will be asked if you have any pre-existing conditions and it doesn’t pay not to disclose these because if you claim, the life insurer will check on your medical history and may reject a claim arising from a condition you had, but did not disclose, when you took out the policy.
These policies may also exclude cover for deaths from natural causes for a period, such as six months after you take out cover. This is referred to as a waiting period during which full cover does not apply.
The reason why life insurance companies apply waiting periods, especially on policies with little underwriting, is to prevent you from taking out cover when you have already contracted an illness that may result in a claim soon after the policy starts.
