Understanding the Underwriting Process, Part 1

One of my most popular posts was in June of 2012 when I wrote about the definitions of some commonly used but often misunderstood and confusing policy terms. This entry is kind of a sequel to that.

Many advisors and their clients come to realize that the “fun” is just beginning once the decisions on amounts and types of life insurance are made. The underwriting process can be a virtual carnival of frustration; partly because so few people seem to realize all that goes into it, what to expect and how to prepare for it.

When someone is applying for a $1,000,000 policy, the issues I am going to discuss are usually not issues at all. However, for large death benefit transactions, they are commonplace and can be a minefield if not navigated astutely.

Following, in no specific order, are some industry terms.

– Financial Underwriting
– Phone History Interview
– Inspection Report
– Reinsurance
– Retention
– Auto Bind
– Facultative Reinsurance
– Jumbo Limits

We’ll start off with Financial Underwriting. Many people don’t understand that an insured individual needs to be financially underwritten as much as medically underwritten. This can occasionally be a deal killer. First of all, the process requires the insured individual(s) to provide more data than they might want to. It doesn’t always need to be very detailed but sometimes it does. At times there is a need to provide personal and/or corporate tax returns and financial statements.

In addition to this there may need to be phone calls with accountants or other advisors and signing of form 4506 so the insurance underwriter can get federal returns directly from the IRS. Just be ready for it.

At the end of the day the underwriter is looking for justification for the coverage. In other words, someone with a net worth of $500,000 and a $75,000 income can not apply for and expect to get a $10,000,000 policy unless there is a really good story behind it. Sure, I have $3,000,000 of insurance on my wife who is designated a “homemaker” on the application and has no earned income, but I was realistic and creative enough to find a way to rationalize it.

This brings to light the importance of a good cover letter. Many agents are loathe to spend time on this but it is difficult to underestimate the value of a good cover letter to the underwriter to explain the details of the situation and why it warrants the issuance of the applied for coverage. Some insurance companies understand corporate financials very well and some don’t know as much as my young children about how a business works. Do you know how many times I’ve seen policies declined because the insured’s corporation posted a loss for accounting and tax purposes? The company may be fantastically successful and the owner might have made a million bucks personally but a given underwriter might not put two and two together and argue that they are not going to issue a buy-sell or key man policy in a company which loses money. It’s astounding and maddening but true.

Some underwriters will apply a growth rate to an estate and some will underwrite based fundamentally on today’s values. You might end up in a situation where an agent and the advisors successfully argue to convince the client to procure an amount of insurance he or she will reasonably need in the future, even under conservative assumptions, only to fight with the insurance company to get it issued.

This also underlines the need to have the insured individual(s) closely on board and well rehearsed so when the insurance company or a third party calls to ask all the same questions already asked for by the agent and the examiner, plus some, they are expecting it and give consistent answers. This is referred to as the Phone History Interview or PHI. Many a time a client not expecting this call explodes in frustration and slams the phone down. It is also important to know that an underwriter hates inconsistency. “Why did the agent say this on the app and the client say that on the phone call?” Not hard to imagine.

I will make the following statement to an individual who is about to go through the underwriting process. “Now comes the seemingly ridiculous part of the process where multiple parties all ask you the same questions repeatedly. You will be asked to explain things you have already explained and answer questions which seem to have nothing to do with what you are trying to accomplish. The process will drag on longer than can be conceivably possible and you will be asked to jump through hoops which appear to be created for no other purpose than to frustrate you. In the eleventh hour they will come up with some reason to keep the process from being completed due to a tiny piece of information that they have had for months but didn’t bother to consider. Every time I visit or call you to get additional information, I will promise you that there will be another reason to visit or call you until I am proven wrong. Ready to get started?”

The Inspection Report is a term which may encompass a number of things; the phone interview, third party interviews, digging for financial information, motor vehicle reports, etc. The bottom line is that the underwriter and supporting services are gathering all of the information they feel is necessary (yes, sometimes this seems ridiculously and overly intrusive), to evaluate risk and qualify an applicant. At higher death benefit thresholds these interviews may include friends, family, business associates and advisors to cross reference information as well as to provide character references. This is also when I tell everyone involved that they need to answer the questions they are asked and answer them honestly but never provide more information than requested unless it is going to complete the picture you are creating and you have previously discussed it with your insurance professional.

This is a good time to bring up the MIB (formerly known as the Medical Information Bureau). The MIB is a member owned non-profit organization which is basically a clearinghouse for insurance company historical activity. Whenever someone has a formal application submitted to an insurance company, there is a chance that the activity will be submitted to the MIB.

“MIB does not collect, maintain or store any medical records such as examination reports, attending physician statements, lab test results, x-rays, underwriting files or reasons for denial of insurance. Instead, MIB’s members agree to share information of underwriting significance in the form of brief medical and avocation “codes,” which are a simple form of encryption.

Members report information to MIB using these proprietary and highly confidential codes to signify different medical conditions (typically hazardous vocations and adverse driving records) affecting the insurability of the proposed insured. These are conditions that have a significant impact on an applicant’s health or longevity and are reported under broad categories of medical conditions.” See www.mib.com for more information.

Let’s say your client has applied for life insurance. She may or may not have been trying to get away with something but what if when the insurance company she has applied to sees “hits” at a half dozen other insurance carriers 12 months earlier? This may raise suspicion that something went wrong, she closed the files and is trying again. On the other hand, it could have been perfectly innocent. However, the entries also have codes which may include some indication of results. For example, if there was nicotine in the lab specimens previously and that is noted, your client’s attempt to be clever and not smoke for a few weeks before the exam this time around and answer “no” to being a smoker, she will likely be caught and the underwriter will now question everything. Likewise, if she answers “no” to the question which asks if she has ever been declined or issued other than applied for and there end up being MIB “hits”, it will gum things up.

It is important to remember that underwriters and insurance company personnel wake up every morning assuming the entire world is trying to take advantage of them on every case and they act accordingly. Understanding this and putting yourself in their shoes helps in dealing with the process though it can still be maddening.

In part 2 I will get into underwriting details regarding death benefit levels and how they are underwritten in regards to reinsurance.

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