This post was written by Brian So at AAFS insurance. He provides great insight on why you may have to pay more.
Have you ever been given a quote for life insurance, applied, and was approved with a higher price? If this has happened to you, it means that your policy was rated and you were classified as a substandard risk. What is a life insurance rating? Will the rating last for the life of the policy? Should you even accept the policy? These are questions that only you could answer, but by reading this post, you should have a better understanding of life insurance ratings and your choices.
What is a life insurance rating?
Because some people are healthier than others and insurance companies don’t want to decline everybody who is of substandard health, the rating system was created. It’s a given that people with a higher risk also have a higher mortality rate, meaning that these people have a greater chance of dying at any given age than the average person. To reflect this higher risk, a higher premium is charged. The extra premium offsets the risk that the insurance company faces by offering the policy and ensures that it remains profitable. This premium is proportional to the risk, where individuals with slightly higher risks have slightly higher premiums, and individuals with extremely high risks are charged extremely high premiums.
If the applicant leads a lifestyle that is at the top end of the risk meter, the insurance company will outright decline insuring this person. Only 4% of applicants in Canada are declined, so if there’s a reasonable chance to insure somebody, the insurance company will find a way to do so.
There are many reasons why someone is considered a higher risk. The most obvious is health concerns. Someone with hypertension, elevated cholesterol and blood glucose levels is of a higher risk than someone with normal readings. Direct family members with illnesses with a hereditary background will also raise red flags. Someavocations such as scuba diving or mountain climbing are also considered high risk, and depending on how often the applicant performs these activities, a rating may be applied.
How is the rating determined?
There are two ways life insurance ratings can be applied: percentage and flat rate. A percentage is usually implemented for health issues, such as hypertension. Using 100% as the base premium, an extra 25-400% can be tacked on to come to the final premium and this percentage depends on the severity of the health issue. For example, a monthly premium of $50 with a rating of 100% will double the premium to $100. In some cases where health is poor enough that the insurance company doesn’t want to assume the risk even if a 400% rating was applied, the applicant will be declined.
If an applicant’s health condition improves over time, the rating may be reduced or removed if he applies to have it reviewed and if the underwriting is favourable with regard to the entire medical history. This means that if underwriting uncovers a new problem while the old one goes away, the applicant may have the original rating removed and a new one applied. An application for a rating review can usually be made at least two years after the rating was applied, although minor ratings may have a shorter waiting period.
The other method, flat rate, can be applied for both health and lifestyle risks. This approach calls for a fixed extra premium per thousand dollars of coverage. For example, if the extra premium is $1/year per $1,000 of coverage and the total coverage applied for is $500,000, the extra premium charged will be $500 annually. The flat rate can be on a permanent or temporary basis. For a temporary flat rating, the rating will automatically be dropped after a designated period of time. With a permanent flat rating, the rating will stay until it is applied to be reviewed and removed.
An example of a temporary flat rating would be if an applicant is a hobby pilot and does not have enough experience according to his record. In two years, he will have enough hours to satisfy the experience requirement of the insurance company. Therefore, he will receive a temporary flat rating for two years, which will drop off automatically after two years.
We mentioned above that an application can be made to review the rating to either have it reduced or removed entirely. While there are some circumstances where health can improve, there are also conditions that are unlikely to improve over time. For example, consider type 1 diabetes. The longer someone has it, the greater the risk of complications and the higher the mortality rate. As such, ratings for type 1 diabetes are unlikely to be reduced or removed.
Generally, ratings can only be reviewed after two years from the date of issue, and new medical evidence will be required. For joint policies where multiple lives are involved, medical underwriting will have to be done on all the lives covered. To ensure a successful reduction in rating, all lives involved should have a lifestyle equal to or healthier than when the policy was issued.
Should you accept?
This comes down to several factors including your financial situation and risk management goals. First, since you did not anticipate paying more than what you were quoted for, you will have to reassess your cash flow. Does the policy fit into your budget? What will you have to sacrifice to make room for it? Retirement savings, mortgage repayment, or an extra vacation? Have you applied all the life insurance savings tips? If it’s a temporary rating, you’ll likely be able to live with paying higher premiums for the first two years.
Next, you need to determine your risk management goals. Ask yourself if the amount you applied for is necessary. Can you cut the amount of coverage and still reach your goals? Can your family survive with a lower percentage of your current income? Does the mortgage have to be paid off on your death?
Whether or not you accept the rated policy depends on you and your unique situation. For some, they should accept the policy and take the rating as a wake up call to change their lifestyle. Others will decide that that the value has decreased to the point that they should decline the policy. Before you decide, speak with your family and consult with an informed insurance advisor to make sure you are making the right decision.
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