No matter how long you have made a living in the financial services industry, you are at the very least somewhat aware of the amount of time and usual care that goes into the underwriting of insurance policies by carriers. Insurance companies employ learned, specialized professionals to analyze risk and weigh the financial gain of making a profit by collecting premiums versus providing financial protection products to consumers. Underwriting is defined as accepting liability under the form of an insurance policy, guaranteeing payment of benefits in case of loss or damage. In the eyes of the insurer, there is a delicate balance of indemnifying risk and paying out monetary claims while still making money.
Underwriting methodology is, dependent upon the type of insurance, often broken down into two categories—medical underwriting and financial underwriting. As medical underwriting is a complicated subject unto its own, it quite rightly deserves a separate discussion at a later time. Here we will focus on the other imperative aspect of insurance risk analysis—financial underwriting.
Financial underwriting involves the evaluation of insurance policy applicants and classifying them so appropriate rates may be charged and appropriate benefit levels may be provided. It further involves assessing whether a proposed sum insured and product limitations are reasonable when considering the potential financial loss to a client.
Many of you sell life insurance and are probably very familiar with the underwriting standards and financial guidelines set forth by your usual life carriers. Benefit limitations are generally based upon calculations of multiples of income, varying proportions of net worth or even estate tax liability snapshots of your prospective clientele. In general, the equations measuring the financial underwriting of life insurance tend to remain straightforward and less complex than other insurances. Disability insurance financial underwriting, on the other hand, tends to be less elementary, requiring extra diligence by both insurance company underwriters and the consumer’s representative insurance agent.
Disability financial underwriters are commonly certified public accountants or at the very least have strong backgrounds in accounting on top of professional financial degrees. Expertise in the position doesn’t happen overnight and it can take years to develop the craft as they analyze risk after risk, case after case, while heading toward a common goal of reasonable financial protection of the carrier while providing marketable and affordable income-protection benefit programs to consumers.
Financial underwriting methodologies can differ among disability product lines. Regarding personal disability insurance, underwriters tend to maintain the insured person as their focus in terms of fiduciary needs and over-insurance concerns. Requested benefit amounts are commonly reduced to save the client from overpaying for benefit levels that wouldn’t come to fruition during a claim because of the client’s relatively lower annual income. However, reconsideration of benefits are available once an applicant’s financial situation has improved. Over-insurance is a main concern of dutiful financial underwriters while underinsurance should remain a rightful concern of insurance advisors.
The first step in consideration of the financial insurability of an applicant is the thorough review of the application itself and the financial summary provided by the applicant. In some cases additional information and proof of insurability is needed—like two consecutive years of recent individual federal and state income tax returns. Benefit eligibility is measured upon a percentage of net earned non-passive income set by the insurance company. Domestic DI carriers often penalize applicants for having passive “unearned” income such as rental property or investment proceeds. Specialty-market carriers like Lloyd’s of London and other Surplus Lines insurers often times ignore passive income without reduction of available benefits. If the applicant’s current work year is showing more positive signs in terms of higher income levels compared to previous tax years, financial underwriters will review employment pay stubs, fully-executed employment agreements, K-1 earnings and sometimes corporate financial statements in the sincere attempt to prove financial insurability among clients whose taxable earned incomes aren’t measuring up to their requested benefit amounts.
There are differing ideologies when it comes to domestic carrier underwriters and specialty-market underwriters regarding their respective maximum benefit limitations and participation caps. Domestic carriers stick to strict benefit participation levels of 50 to 60 percent of income with usual monthly benefit caps anywhere from $10,000 to $25,000, dependent upon on the applicant’s age, occupation class and income level. Specialty-market carriers lean more liberally and flexibly in their offerings, allowing participation of benefit levels up to 65 to 75 percent of income without monthly benefit caps often regardless of age, occupation or income level.
Underwriters are regularly presented with unique cases and situations which raise concern and require a more investigative approach. An applicant’s earnings history can show significant income fluctuations and volatility in employment confidence which will require underwriters to analyze the occupation, industry, and economic trends that may have impacted past earnings and contribute to future income streams. Business owners showing unwavering earnings in industries ripe with historical earnings fluctuations will often require additional financial documentation to support the earnings stated on the application. Spousal business partnerships may require additional detail since income splits can be convoluted and unclear as to how the earnings are truly being generated. Newly self-employed individuals with no previous earnings history often require a more cautious approach since earnings trends are not established and accounting records may not be readily available. Seasonal employment opportunities can be challenging, as well as the income variations and earnings advancements seen with occupations stemming from the entertainment, arts and literature industries.
Circumstances may arise in the underwriting process that commonly call for a reduction of available benefit or even the ultimate declination of coverage. Applicants who report gross revenues instead of net income are problematic as well as those that include passive real estate income in their earnings when they are not considered real estate professionals. Another “red flag” is the inclusion of distributions from an S-Corp or draws from a partnership in personal income instead of appropriate non-passive taxable earnings as reported on a K-1 schedule for a given tax year. Also, applicants commonly leave out details of in-force disability insurance policies through other carriers as well as failing to indicate whether said coverage is employer-paid and/or taxable to the insured person. On the contrary, underwriters will seek to advise applicants if their eligibility for higher benefits exceeds the benefit level for which they applied.
The disability financial underwriting of business cases is similar to that of personal DI, but the fiduciary analysis becomes more focused on the corporate entity rather than proposed insured person’s personal finances. And again, over-insurance remains a primary concern, but underwriters assume a business owner knows his or her business needs better than the insurance company. Underwriters employ supplemental questionnaires to evaluate risk for the underwriting of key person, business overhead and buy/sell insurance policies. The financial underwriting is fairly straightforward as opposed to underwriting personal benefits, yet all business disability cases still require substantial in-depth review.
Key person DI underwriting uses a simple multiple of personal annual income of the proposed insured key person as a beginning measurement for financial justification of the benefit. Underwriters will take other factors into consideration in their analysis such as potential fiduciary loss to the company, potential loss of current and future accounts, corporate ownership value of the insured person as well as perceived value of the key person to the company.
Business overhead expense underwriting requires the applicant to provide a detailed listing of average monthly tax-deductible expenses including mortgage interest payments, utility bills, insurance premiums, accounting services, maintenance costs and certain employee salary expenses.
Buy/sell DI underwriting requires an accurate outline of corporate structure as well as an executed buy/sell agreement and corporate or partnership tax returns.
As an insurance professional, your role is absolutely important in the support of attaining disability insurance for your clientele. You can read between the lines and address certain criteria as to what attributes disability underwriters will favor and fault in a prospective risk. You can also help streamline and accelerate the financial review processing of your client’s file by providing missing information that was mistakenly not disclosed on the application. Be proactive in assisting your clients by providing tax returns, year-to-date pay stubs and any details pertaining to changes in employment or income fluctuations. Providing these items can simply help provide a sense of goodwill with underwriters, demonstrating the client is forthcoming with their overall financial situation, and will most likely help in the ultimate approval of the risk and the issuance of the insurance policy in a timely manner.
The financial underwriting of personal and business disability insurance policies isn’t always black and white and is much more than just numbers, dollars and cents. Underwriters will look at all the provided figures and data, but additionally take the inherent value of the prospective client into consideration, in hopes of providing appropriate insurance levels to paying consumers while still maintaining a profitable bottom line for the insurance company.