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Eleven golden rules for financial underwriting

Every insurance market in the world has witnessed periods when scrutiny of the financial integrity of application forms has been found wanting. Unlike medical underwriting, financial underwriting is not dependent on sound medical experience and reams of statistics. The fact that several companies in South Africa are expressing a concern about financial underwriting when there is increasing pressure to get applications converted to insurance contracts, is just one of the examples of the underwriting cycle for things like insurable interest, over-insurance and anti-selection by dubious consumers.

Have there been early deaths that spur one to talk about financial underwriting at this juncture? No, not that we have heard about, but there is a mounting concern, because if one looks outside SA’s borders there is evidence of mortality skewed by early claims, where at death the wisdom of the underwriter’s financial judgement or lack thereof is called into question. Underwriters in SA need to ensure they are seen to be more proactive and in control of change.

Poor financial underwriting has had many recurrences in the ultra- competitive North American market. The late 1960’s and early 1970’s saw a few early claims that made underwriters look rather foolish and gullible. Subsequent rounds of papers and articles emerged following poor results with what became known as ‘jumbo cases’ in the mid 1980’s and again in the late 1980’s. When all the rhetoric is stripped away, the basic message to underwriters was ‘make sure the case makes sense’.

Underwriting standards lowered

When I review old claims I see a pattern emerging of underwriting standards being lowered under pressure from producers or zealous marketing departments. Even though the financial justification, insurable interest and/or dubious nature of the business is in question, it is easier to say ‘yes’ and move on, than stick to the premise that the producer has not made it ‘make sense’, so you are going to continue to decline until justified.

The pressure then pushes underwriters to turn to those bastions of aggressive risk taking, the reinsurers. The ‘willing reinsurer’ rationale is quite often based on doing a favour to win a friend over and hopefully get some good business. I have seen so many large early claims where only one reinsurer took the case and this is a sad reflection on the professionalism of reinsurers world wide. When insureds die early the insurer takes some solace in the fact the reinsurer took all the mortality risk, and then takes action against its own underwriter for getting it publicity on the front page along the lines of ‘Company X supplies motive for murder through unjustified amount of life insurance.’ If the case is not justified in the eyes of the insurers’ own underwriting experts, why, when one of ‘x’ reinsurers’ underwriters says they will take it on the same evidence (really lack of evidence), does he or she approve issuance?

Every company has their rules of underwriting and I am the first to concede they should be challenged when justified. Let us take the magical keyman rule. That rule states that a key person can have five times income and the beneficiary is his or her employer. It was not born of mounds of research nor statistical analysis of the key people’s worth to their company. It was meant as an educated guess as to a multiple to start from. I believe there are some people running operations who are key only to perhaps a multiple of one times remuneration. At other times the multiple need climb as high as twenty times to reflect the very unique key contribution of some talent. Each has to make sense for the circumstances and thus the rule goes by the wayside.

Medical underwriting

Underwriters the world over are so extremely proficient at medical underwriting they are like machines at directing applicants into their risk classification slot. They are aware of the intricacies of the most obscure medical impairment thanks to the teachings of mentors, manuals and group meetings, and are able to assess the most complex details of the applicant’s medical past and present. If a reinsurer takes the case so rightly in need of a rating, they are the first to challenge the sanity of the reinsurer. We have medical underwriting pegged so well it is almost boring.

Financial underwriting and the ‘common sense’ approach to the subject preached in the past decades needs to resurface and become part of today’s curriculum. All the medical testing and lab works makes for a great industry. Teaching and mentoring how to ask the simple ‘does it make sense?’ question just seems to lack pizzazz. It sometimes takes, as history all over the underwriting world has shown, a few bad claims of a magnitude to raise the eyebrows of executives, to reinstate the rallying call of prudent financial underwriting once again.

The rules of financial underwriting as I see them, can be summarized in the following fashion:

1. Large and early claims will test the best of underwriters and

management regardless of how well you select risks.

2. Does it all make sense?

3. In partnership insurance who are all the partners and are they all insured equitably?

4. Never, never allow a person to be worth more dead than alive to family or business!

5. Multiples of salaries for keypersons or personal insurance are strictly guides and must reflect in summation the true financial loss in terms of the time value of money.

6. Banks make great beneficiaries but they are not necessarily without bias — they always win with or without the insurance.

7. Are you guaranteed that the in-force to be replaced will indeed be replaced? Do you follow up? Do you have legal remedial solutions?

8. Make use of your own companies accounting and investment experts to see if the finances are right on.

9. Use the Internet as your personal search engine for finding both personal and industry information.

10. You can never reinsure the notoriety from a bad claim.

11. If, with your advice and counsel, the agent cannot make it make

sense, decline.

These are not the only rules and I would encourage senior officials to support the study of financial underwriting and its offspring — underwriting for persistency. Support means they too have to ask and make the point to the pressure of distribution: ‘does it make sense?’