Underwriting and Risk Selection
Underwriting and Risk Selection tests how an insurer decides which risks to accept, on what terms, and at what price. You must classify risk, detect moral hazard and adverse selection, and choose standard, substandard, exclusion or decline terms.
Core rules
- Risk classification groups similar risks so premiums reflect expected loss; factors must be actuarially justified and not unfairly discriminatory.
- Sources include the proposal form, medical examination, attending physician reports, financial evidence, claims history and inspection reports.
- Moral hazard is behaviour that increases loss after cover; adverse selection is the tendency of poorer risks to buy or retain cover.
- Financial underwriting checks whether the sum insured is proportionate to income and need, reducing anti-selection and fraud.
- Decisions include standard acceptance, extra premium, exclusion, reduced sum insured, postponement or decline.
- Reinsurance capacity and underwriting guidelines constrain what the direct insurer can accept.
Worked example
An applicant with BMI 34, treated hypertension and a 20-a-day smoking habit applies for 10,000,000 of life cover. The underwriter notes controlled blood pressure but a family history of early cardiac death. Decision: substandard, with a 50% extra mortality charge, a hypertension-related exclusion for the first two years, and a reduced sum insured to align with income. Reasoning: the risk is insurable, but not at standard rates; the exclusion addresses a specific hazard while the loading prices the remaining uncertainty.
Traps
- Assuming an agent can bind cover before underwriting approval.
- Treating non-disclosure as irrelevant if the applicant forgot.
- Using a declined risk as a reason to discriminate unlawfully.
- Confusing moral hazard with poor health.
- Ignoring financial underwriting on large policies.