Insurability, Underwriting & Costs

The whole concept of insurance is that insurance companies will pool money from different policy holders to form a common fund which can be drawn on if there were to be any need for by the pool of policy holders. The costs of the premiums payable by each individual who will contribute to this pool is determined by the calculation of the mortality table using actuarial sciences. Every quote that you receive for your life insurance is based on these mortality tables and acturial studies.

Before actually going into the determinants of cost and the structure of life insurance companies when it comes to developing policies we must first understand the concept of underwriting. Although underwriting can refer to many different things in the financial world, we will concentrate on insurance underwriting. It is very simply the process of determining the risk of an individual in the process of client evaluation. This vital process is used primarily to determine the risk that the potential client poses to the company and thus how much premium it should pay and even to consider if the insurer should even consider them as clients.

Underwriting is based on a set of predefined guidelines which differs for each company. The guidelines help to decide on the suitability of clients to the insurer based on their risk profiles. It should be noted that with each type of insurance, guidelines change quite drastically. For example, for life insurance a client that smokes or not makes a huge difference. If you have a bad criminal history then you are a higher risk customer and your premium costs will clearly reflect that.

Another concept that must be recognized when dealing with life insurance is the concept of indemnification. Indemnity means to replace. It may seem off especially if you are talking in the sense of life insurance as replacement cost is hardly what most people would be thinking off but the fact remains that with life insurance you must value the insured’s life in order to obtain a value for the insurance policy and thus the premiums that are payable. The concept is that if you value your life more you will have to pay more. If you take out a $1,000,000 value on your life insurance then your premium will reflect that indemnified value. If you take out a trust fund arrangement with your life insurance then your life’s contribution to wealth will be taken into consideration.

We will also cover the insurer’s business model so you can understand where your money is spent and also why premiums are charged in a certain way. The basic formula is that the revenue is obtained from earned premiums plus investments of the premiums while the main expenses are incurred losses and underwriting expenses. The most difficult method of making money for insurers is to underwrite to the right amount while still keeping the insurance quotes reasonable and acceptable to the market. If the insurers underwrite too low then it is more than likely that they will not be appropriately rewarded for their risk and default in the future. If they provide too much of a buffer then their insurance rates will go through the roof and be very hard to sell.