550 Chapter 13 Insurance and Risk Management
those financial consequences are likely to be. A person might have a relatively small
$20,000 policy intended to provide for funeral and burial expenses, or a family’s
breadwinner might have a $500,000 policy intended to financially support the sur-
viving family. A small business may have insurance on one of its partners to protect
the business and surviving partners from the financial consequences of losing a key
person.
There are several different types of life insurance. Regardless of the type, though, when
an insurance policy is applied for, the insurance company will go through a process of
underwriting. Just as an auto insurer charges different rates for different people, depend-
ing on factors used to assess the likelihood of claims, life insurers charge different rates,
depending on factors that may indicate the likelihood of a claim. In this case, the “likeli-
hood of a claim” means the likelihood of dying in the near term. Age and sex are the
most basic factors; in general, an older person will pay more for life insurance than will
a younger one. Also, since women tend to live longer than men, life insurance premiums
for women tend to be lower. A third major characteristic taken into account by insurance
underwriters is smoking (or other tobacco use). Smokers pay significantly higher rates for
life insurance than do nonsmokers.
In their rate books, life insurers set a rate (usually expressed as a rate per $1,000 of death
benefit) for each age, sex, and smoking status. These are not the only underwriting con-
siderations, however. Life insurers may also take into account other indicators of health,
such as weight, cholesterol level, family health history, dangerous occupations or hobbies,
or diagnosed medical conditions. Each insurer has its own criteria for what is necessary to
qualify for a standard policy, issued on the basis of the book rates. The underwriting cri-
teria may be much more stringent for large policies than for small ones, since the insurer’s
risk is so much greater on a large policy.
An individual who does not meet these standards may be sold insurance at a higher rate
(sometimes called a substandard rating), or may be denied coverage altogether. Some
insurers also have a preferred underwriting category, with lower rates offered to potential
insureds who, according to their current health and family health history, appear to present
an especially low risk of a claim.
When insurance is sold as a group policy, the insurer may be less stringent in its
underwriting than for individual policies. Often, the insurer will charge rates based
only on the age/sex/smoking status of the individual insureds, excluding only those
who are in particularly poor health. An insurer may even offer a guaranteed issue
contract, agreeing to cover all members of the group without exception. In cases where
the group members have a choice of how much coverage to purchase, the insurer may
agree to offer a certain level of death benefit guaranteed issue (such as “1 year’s sal-
ary”), but more carefully underwrite members of the group who choose to purchase
larger policies.Term Insurance
The simplest form of life insurance is term insurance. Term insurance provides coverage
for a set period of time. If the insured dies within that period of time, the death benefit is
paid; if not, the policy expires. (Term policies often contain a provision that they may be
renewed without having to undergo underwriting at the end of the term.) One-year term is
by far the simplest form; as the name suggests, it provides coverage for a term of 1 year.
Term policies are also commonly issued with terms of 5, 10, or 20 years. Level term poli-
cies have a premium that does not increase during the policy’s term. As you might expect,
level term policies tend to carry higher premiums than policies whose premiums increase
with time, to compensate for the fact that the premiums do not increase with age even
though the risk of near-term death does.
Premiums for term policies can be quite economical. While a working person’s death
might be financially disastrous for her family, the likelihood of a reasonably young person,
in good enough health to pass underwriting, dying in the near term is quite low. Even after