As we all know, the cost of most life insurance products is based on the risk of dying: policies for males, older individuals and those having health impairments are priced higher than for younger, healthier individuals.
But it wasn’t always this way. The friendly societies and early fraternal organizations in the latter part of the 19th and early 20th centuries provided death benefits to the families of their members without considering age or health status. Unfortunately, these organizations did not appreciate the power of consumer discretion, which today we term “adverse selection” or “anti-selection”. So, the elderly and infirm enrolled in disproportionately larger numbers. This resulted in excessive death claims which they initially tried to manage by raising fees. This only aggravated the situation—the younger healthier members dropped out, leaving only the older, less healthy individuals which resulted in even higher death claims. Ultimately this led to the financial failure of many of these organizations. As they failed financially, they also failed in their fiduciary responsibility to remain solvent in order to pay the death benefits on which their members depended.
The hard lesson that history has taught us is this: Unless insurers find ways to counteract adverse selection, they will experience excessive financial losses. The most common method used today to guard against adverse selection is underwriting—where the cost of life insurance is based on the applicants’ risks of dying as reflected by their age, health status, occupations, avocations and other factors.
Underwriting has proven to be very effective in countering anti-selection and controlling mortality. It is one of the factors that has allowed the cost of life insurance to become more affordable over the years. This has occurred despite the fact that there are many more opportunities to “anti-select” today than there were in the past due to the wide availability of medical care and diagnostic testing, including direct-to-consumer blood testing, and now, even direct-to-consumer genetic testing.
But as the opportunities to anti-select have become more numerous and complex, so too has underwriting. This has led many, like underwriting consultant Hank George, to call for insurers to develop ways to underwrite better, faster, and cheaper.
Although medical record review and lab testing have traditionally been the cornerstones of underwriting, ordering and reviewing medical records and laboratory tests are expensive and time-consuming processes. One way to combat this is an enhanced tele-interview process using detailed drill down questions. This process, coupled with automated decisioning supplemented with various database queries, reduces underwriting costs and allows mortality risk to be accurately classified and priced within minutes, thereby allowing policies for favorable risks to be issued the same day without the need for medical record review or blood or urine testing.
Further advances, like leveraging electronic health records in underwriting, may be just over the horizon. The United States has been slower than other countries in adopting and implementing universal standards for electronic health records. But rapid advances are now being made and this process, when fully implemented, will allow cross platform sharing of ICD-10 codes and medical information. The ability to access data from electronic health data exchanges will revolutionize life insurance underwriting—greatly enhancing our ability to assess and accurately price risk in real-time.
The past has clearly taught us that adverse selection is a powerful force that, if not countered through prudent underwriting, may result in dire financial consequences for life insurance companies. However, the future is indeed bright for underwriting as new tools and new processes are developed to underwrite faster, better and cheaper.
MD, has over 25 years' experience in the insurance industry. He received his doctorate in medicine from the University of Minnesota. He is board certified in internal medicine, pulmonary disease, critical care medicine, sleep disorders, and insurance medicine. Before joining the insurance industry, he practiced clinical medicine for over 10 years and was the medical director of the Wisconsin Sleep Disorders Center and was on the teaching staff of the Gundersen Clinic. Dr. Engman is chief medical director at Legal & General America. He teaches the American Academy of Insurance Medicine's Mortality Methodology Course as well as their introductory course on mortality analysis. Dr. Engman has served on the Executive Council of the American Academy of Insurance Medicine (AAIM) and has been repeatedly on the faculty of AAIM's Triennial Insurance Medicine Board Review Course. Dr. Engman can be reached via email at: email@example.com.