Treating Sub-Standard Risks In Life Insurance

We have discussed how some of the accepted risks are considered as ‘standard’ and others as ‘sub-standard’.┬áThe standard risks are accepted at standard or normal premium rates.

In this tutorial, we shall discuss what treatment may be given to the sub-standard risks so that equity is maintained as between standard risks and sub-standard risks.

Equity can be maintained only when the extra-risk in sub-standard risk is given special treatment or additional premium is charged.

Types of Sub-standard Risks

The sub-standard risks are divided into three categories according to the incidence and intensity of extra-risk.

(a) Increasing Extra-Risk

In this category, the extra mortality increases as the life assured grows older. For example, patients of diabetes, occupational diseases, overweight, etc.

The effect of extra-risk in these cases tend to rise with the passage of time and on the lies assured becoming order.

(b) Decreasing Extra-Risk

In this category, the extra hazard decreases with increasing in age. The extra mortality, consequently, would be experienced more in the early years and would be going down as time passes. In some cases, the extra-mortality tends to decrease until the extra risk might, have disappeared.

For example, persons of defective past history.

(c) Constant Extra-Risk

Here, the extra hazard remains at the same level throughout the life-time of the assured. There cannot be any risk which are strictly constant.

They may decrease or increase to some extent. However, there are certain cases when risks are approximately constant. For example, blindness, or loss of limb, deafness, etc.

Such a classification permits the company to assess premiums according to the incidence of the extra deaths, that is, assuming the company expects the same number of extra-deaths to occur in two more groups will have to be collected for extra-risk in a group where the deaths occur early (decreasing risk) than where the death occur later (increasing risk), because the effect of reserves have to be estimated.

In level premium plan the reserve increases year after year and so, the amount at risk decreases along with the increase in reserve. The rate at which reserves are accumulated is also very important.

For meeting decreasing risk, higher reserve should be made in the beginning and for increasing risk, the rate of reserve should constantly increase as the time passes.

The rate of reserve in constant risk may remain at par.

Methods of Treating Sub-Standard Risks

The Sub-standard risks may be treated in five ways:

  1. Increase in premium
  2. decrease in death benefits
  3. change in class and period of assurance,
  4. any combination of the above-mentioned methods, and
  5. postponement of risk

1. Increase in Premium

The premium can be increased in any of the following manners:

(a) Rating up of Age

Under this method, the life assured is assumed to be a number of years older than his real age. The premium rate is calculated according to the assumed higher rate.

So, the cash value, loan, paid up and surrender values are also increasing according to the increased premium. The extra number of years to be added is determined according to the extra risk involved with the life assured.

The policies issued under this plan will be similar to those issued at standard premium. The only difference is that the premium is increased according to the assumed higher risk.

The rated up plan is best adopted to the increasing type of extra-risk although it does not deal equitably with all risks of this type.

The plan has certain advantages.

It is easy for insured to understand; it appeals him because of the increased surrender values and loans. It is simple for insurer to handle. There are certain disadvantages, too.

The insured may take advantage of higher surrender values and get back a substantial part of the premium paid by surrendering the policy.

(b) Flat Extra Premium

Under this method a flat annual extra premium of so many rupees per thousand sum assured per year is charged.

Thus, a Constant additional premium is added to standard premium; but unlike the rated up age, the extra premium is not taken into accounting for surrender and paid up values.

The extra premium is constantly charged up to the life of policy or up to the existence of the extra-risk.

In practice, however, it is usual to charge a level extra premium when the extra risk is constant or decreasing one (as in the case of hazardous occupations or even in the case of decreasing extra risk such as a young under-weight).

Extra premium is also charged for certain defects and deformity like imputed arms and legs, partial or total blindness, deafness, etc. or in the case of standard impairments.

Under numerical rating system, the extra-hazard risk is treated by charging that extra according to the degree of extra-hazards.

The extra premium should not be flat or constant when there is heavy and immediate risk in the inception.

Otherwise as soon as the period of heavy extra passed, there will be a tendency to drop the policy.

In such cases, therefore, if extra is to be charged, a heavier extra should be charged for initial period so many years when the risk is considered to be very heavy and the extra is removed thereafter.

The Life Insurance Corporation of India charges flat extra premium for a Scheduled Occupation. This extra rating mostly vary from Rs.2/- to Rs.6/- per thousand of sum assured per annum. Heavy extra flat is also charged from commissioned officers in submarines.

(c) Extra Percentage Plan

There are certain classes of sub-standard risks which are determined by numerical rating system.

For each class of extra risk, a certain percentage of the standard premium is charged. This extra percentage is added to the standard premium and is charged along with the standard premium.

The classes of sub-standard risks are divided on the basis of incidence of extra risk on the mortality. Once the extra premium is determined on the standard premium, it would not vary later on and will be charged according to that extra premium.

The difference has in the fact that the amount of extra percentage premium will vary according to the standard premium. Thus, it will be higher when standard premiums are higher.

But, in case of flat extra, the same premium is charged irrespective of the age or standard premium. Thus, the rate of extra premium as compared to standard premium is higher in the early age and lower in the advanced age.

The extra percentage may be used in increasing risks also while the flat extra premium will not be suitable to increasing risks.

2. Decrease in Death Benefits

The death benefits may be reduced in two ways:

(a) Line Method
(b) Restrictive Clause

(a) Line Method

The amount payable under this method would be the sum assured less the outstanding lien at the particular time of the policy.

The line is for a fixed number of years. If the life assured dies within this period, the amount of lien is deducted from the policy amount and rest is paid to the beneficiary but if the life assured survives the period of lien, the whole of the policy amount is paid at the claim.

The amount of lien goes on decreasing in most of the cases, as time passes until whole of the lien is finished. Thus, the amount of claim will go on increasing as time expires because lesser amount of lien is to be deducted at later age.

The premium charges is the standard one but only policy amount is reduced. Thus, the effective premium per thousand of the sum payable will be higher in the beginning and lower at the later stage and consequently, in the end, when the lien is terminated, it will be equal to the standard premium.

For example, a reducing lien of Rs.500 per Rs.1,000 assured for 10 years would mean that the sum payable would be reduced by Rs.500 if death occurs in the first year, by Rs.450 if in the second year, and Rs.400 if in the third year and so on, so that the full sum assured will be paid if death occurs only after the expiry of 10 years.

The lien may be constant, and decreasing for the first few years. The type, amount and term of lien would always depend on the nature and extent of extra-risk.

This method is most appropriate when the extra-risk is of decreasing type. As the risk decreases, the amount of lien decreases.

For example, an underweight young man with family history of tuberculosis is subject to an extra risk of death during the early years but as age advances, the effect of this extra risk reduces.

In this case the lien would be most suitable because other treatments may not provide sufficient fund at the early death. The insured may also be willing to purchase the policy at standard premium only.

Thus, the insurer is not at loss if death occurs during the first few years of the policy because he can deduct a certain sum before payment. The insured is also assured of getting the policy amount after the lien period without payment of extra-premium.

The plan is simple in operation and is readily understood.

The method is not useful for increasing extra-risk. A small degree of extra mortality may ripe out a substantial amount of claim at the early death.

The method appears to be arbitrary in its working as the extra-risk operates fully on one day and then suddenly on the next day, the assured becomes a first class life.

The next disadvantage is that a lien reduces the protection substantially during the early years when the need for it is the greatest.

The corporation, therefore, uses this method in special cases. For example, lien is allowed when the life assured is underweight and the life is aged below 33 and there is specific request from the proposer.

The lien is used to factory workers, low income people, persons from mofussil centres with inadequate or no income, no arrangements for medical examination, personal or family history of tuberculosis or suspicion of moral hazard.

(b) Restrictive Clause

Under this clause, the extra hazard is accepted with a restrictive clause which limits death benefit under certain circumstances.

Such a clause states that the amount payable under this policy will be on a reduced basis which may be surrender value or return of premiums paid, in case death occurs due to the specified extra hazard.

For example, the first pregnant clause which excludes the risk of death arising from causes connected with first pregnancy is often applied to lives of ladies who have not undergone a normal full-time confinement and who do not wish to pay extra premium to cover the extra-hazard.

Similarly, in aviation clause, the amount of claim is restricted to surrender value or premium paid if death occurred while the life assured was engaged in fight.

This method can be used satisfactorily where the cause of death can be distinctly known.

3. Change in the Class and Period of Assurance

The life assured is not given all types of insurance and for a longer period.

The policy is given at standard premium but all types of policies are not issued. The types of policies to which the choice is restricted are those which carry a higher rate of premium such as ordinary endowment policy.

Whole life, multipurpose or triple benefit policies are not given because in these cases the degree of risk is higher as compared to accumulation of reserves.

This plan is useful where the extra-risk is expected to occur later in life, such as the case of an over-weight, unfavourable family history.

Special dividend plans may be issued to those who are expected to give share of dividend or bonus with higher mortality.

By declaring lower bonus rates the insurer is in a position to charge an extra amount for the extra risk assumed. This plan can be used only for the participating policies.

The period of assurance in all types of insurance is limited. The age at the inception or maximum maturity ages for policies are fixed in various types of policies.

4. Any Combination of the above-mentioned Methods

For certain proponents, any of the above methods can be used, which depends on the practical experience of the insurer. For example, a proposal for a multipurpose plan may be accepted under an endowment Assurance Plan with a lien, if the proponent is young and underweight.

5. Postponement

Consideration of proposal is postponed for a period, when the initial risk is so heavy that there is little hope of offering insurance immediately and the proposal is postponed.

In future, when health will improve, the proposal can be accepted. Postponement in different type of risks are different. It has been observed that the postponement vary from 3 months to 3 years.

The extra premium or line etc. may be removed later on when the extra-risk is improved and the extra-mortality was nominal discreet and no chance of recurrence. In practice the extra are removed in special cases when there are agreement for this.