PRINT - Chapter 4
Disability Income Underwriting


The important points addressed in this lesson are:

Disability insurance underwriting generally focuses on three important factors: occupation, health history and overinsurance

The classification of occupations according to the disability hazards they represent results in occupation classes

A proposed insured's occupation class has a significant effect on the amount of disability income coverage available, the availability of favorable provisions and the premium charged

Although occupation classification may differ from insurer to insurer, occupations are generally divided into five or six categories that differ principally in their manual work content

Financial underwriting for disability insurance is concerned primarily with ensuring that the disability income insured has sufficient financial motivation to seek to return to work following a period of disability

Medical underwriting focuses on the proposed insured's health history and the likelihood that it will increase morbidity

Underwriting the impaired risk is generally accomplished through three approaches: rejection, increased premiums and/or exclusions and limitations



Occupational Classification

When we examined the disability income policy's renewability provisions, we noted that in the case of Guaranteed Renewable policies, the insurer had a limited right to raise premiums.  The limitation imposed on the insurer's right to raise premiums on these policies limits its right only to raise premiums on a class basis.  Insurers are not permitted to limit an increase in premiums only to your client's Guaranteed Renewable policy because of his bad claims history.

When we think of "classes" in disability income insurance policies, we mean that classification that is based on the applicant's occupation.  This classification system results in occupation classes.  

The primary role of occupation classes is to provide a sound and equitable basis for providing disability income insurance protection that takes into account two important considerations:

The likelihood of the insured's becoming disabled because of the risks imposed by his or her occupation, and
The probability of the insured's returning to his or her own occupation following a period of disability

Unlike the risk of death, which is principally a function of age, an applicant's occupation is an extremely important factor in the likelihood of his or her becoming disabled.  A significant reason for the difference is that the determination of the applicant's continued disability often rests on whether he or she is able to perform the duties of that job.   

Principally for that reason, it made good sense to place the many occupations in which people are employed into classifications that reflect both the job hazard and its likelihood of resumption.

Once the various occupations are assigned to their appropriate classification, these classifications play an important role in determining the:

Maximum monthly disability benefit amount available
Maximum benefit period available
Premium rate category

The insurer's Occupation Guide lists the occupation classes into which an applicant might fall based on the principal duties of his or her occupation.  The information in the guide is usually presented in two ways:  

An alphabetical listing of the most common occupations, followed by a designation of the class to which that occupation belongs  

A broad definition of each occupation class providing general guidelines as to class placement, based on typical duties of an occupation

Occupation Guide -- General Guidelines

General Description of Occupation Class
Occupation Class
 Select professionals and managers with most favorable underwriting and claims experience
 5A
 Most professionals and managers  --  office duties only; no extensive traveling
 4A
 Same as occupation class 4A, but with travel
 3A
 Persons engaged in social service, medical support, clerical, selected commission sales or office or retail setting; light manual duties
 2A
 Certain skilled trades & supervision (foreman) and some medical support personnel.  Work is often performed in a shop, medical facility, retail establishment or outdoors using light machinery; direct supervision of personnel performing manual duties; chiropractors
 A
 Personnel engaged in heavy manual duties; skilled and unskilled occupations (laborer)
 B


By looking at the general occupation class guidelines, you can see how occupation classes are characterized in this second method.  In addition, however, these guidelines generally describe the limits of manual involvement permitted within each class.  You will notice as the occupation classes move from 5A to 4A and eventually to B that the description of duties includes increasing amounts of manual work.

Although any individual insurer may change the language of the occupation classification chart, it is a composite of the way a number of companies approach the general classification of occupations.  Not unexpectedly, perhaps, there are consequences to an applicant of being placed in a particular occupation class.  

There are certain benefit limitations normally imposed by insurers on the basis of the insured's occupation class.  Often, applicants considered to present the least risk -- those that fall into occupation class 5A, 4A or 3A -- may purchase a lifetime benefit period while those applicants in the more hazardous occupations cannot.  Typically, those applicants that fall into classes A or B may be limited to 5 year or 2 year maximum benefit periods.

The limitations that insurers impose based on occupation class don't apply only to the maximum benefit periods available.  The amount of maximum monthly benefit available may also be based on occupation classes.  While an applicant that is a 5A risk may be able to obtain $15,000 of monthly income benefit, a bricklayer -- a B risk -- may be limited to $2,000 of maximum monthly disability income benefit.


BENEFIT LIMITATIONS BASED ON OCCUPATION CLASS

 Occupation  Class
Maximum  Benefit  Period
Maximum Monthly Benefit
 Disability  Definition
  5A
  Lifetime
  $15,000
 Own occupation for entire benefit period
 4A
 Lifetime
 $10,000
 Own occupation to age 65
3A
Lifetime
$10,000
 Own occupation to age 65
2A
Age 65
$5,000
Own occupation (not engaged in any other occupation)
A
5 Years
$3,000
Limited own occupation (2 years)
B
2 Years
$2,000
Any occupation


As we can see, it isn't only the available amounts and benefit periods that are limited based on occupation class, occupation class also affects the actual definition of disability.  It is undeniably more difficult for an insured in a lower occupation class to meet the definition of disability than for an insured in a higher occupation class because the definition is often considerably more stringent at the lower occupation classes that present the higher risk.  

Notice that an insured in the B occupation class often must be unable to engage in any occupation in order to be considered disabled.

Although the differences that we have discussed based on the insured's occupation class are certainly important ones, the difference in the treatment of occupation classes that is usually most visible to the applicant is the difference in premium. The premium for the insured B risk, per $1 of benefit, may easily be double that charged the 5A risk.

It is the difference in the probability and severity of the disabilities to which people in different occupations are exposed that constitute the justification for the difference in the available benefits and their cost.  It is clear that a bricklayer may suffer a disability and be unable to return to work as easily as would someone engaged in the accounting profession, simply because of the physical requirements of the job.

The nature of the industry, as well as the specific duties of a particular occupation, often impacts on the severity of the disability.  Consider, for example, an industry in which employment tends to be cyclical or sporadic.  It shouldn't be a surprise that these industries also incur the greatest number of disability claims during periods of unemployment.  This phenomenon isn't necessarily the result of malingering, either.  If disabled workers have no job to which to return, their drive to recover may be adversely affected.

Along the same lines, a job that involves irregular hours or earnings, such as a bartender, may constitute a higher disability risk.

There are also occupations that are usually uninsurable in most companies and which are characterized by:

extreme hazard
employment instability, and
significant claims administration problems

It doesn't take much imagination to conjure up a mental picture of someone in an occupation involving significant hazard.   Consider those individuals working with explosives or firearms.  In addition, occupations involving work at extreme heights would also qualify -- jobs like those of individuals building skyscrapers.

Employment instability is generally a hallmark of those individuals employed in the performing arts.  It is that employment instability that usually causes them to be uninsurable for disability income insurance in most companies.  Included in this occupation classification are actors, singers and dancers.

Those occupations in which the insured works at home may involve significant claims administration problems.  The reason for those problems is simple: it is extremely difficult to objectively determine if the insured is unable to engage in his or her occupation.  As a result of that claims administration difficulty, many insurers choose not to make their disability income insurance products available to individuals that work at home.  

An exception is often made for those occupations in which the insured maintains an office in his or her home but must leave the office to see clients.  A salesman might fall into this category.  Applicants in such a situation are not usually be uninsurable because of their home office status.


Financial Underwriting

An important disability insurance underwriting issue -- in fact, one of the key issues -- is financial underwriting.  The principal underwriting concern in the area of financial underwriting is whether the insured will be financially motivated to return to gainful employment after a period of disability.  A central reason why a disabled individual might not be motivated to return to work is if doing so would result in his or her losing income -- sometimes referred to as malingering.  That situation would result if the insured were over-insured.

To avoid the problem of overinsurance, insurers developed charts that indicate the amount of monthly disability insurance they will consider for an applicant.  These charts generally state the insurer's Issue and Participation limits.  

Issue and Participation limits charts usually contain four columns:

Annual
Income
Monthly
Income
Individual-Pay Monthly Benefit Available
Employer-Pay All Monthly Benefit Available
 40% - 65%
 50% - 75%

The benefits that are available to an insured on an individually-purchased disability income insurance policy are not usually a rigid percentage of earned income.  Instead, they range from approximately 65% of earned income at the lower income levels to about 40% of income at income levels above $200,000.  

In the same fashion, the benefits available to an insured on an employer-pay-all disability income policy usually range from about 75% of earned income at the lower income levels to about 50% of income at income levels above $200,000.

Limiting the amount of monthly benefits that are available to no more than a fraction of current earned income gives the insured some financial incentive to return to work.  In most cases, however, the benefit provided is still a meaningful one that will enable insureds to meet basic financial obligations.  

The different income tax treatment afforded the disability income benefits depending on who pays for them is the reason for the difference in percentage of earned income available.  Although we will examine the income tax treatment of benefits and premiums later, it's important to know that disability income benefits are usually income tax free when paid for by the insured.  However, the benefits received by an insured from an employer-paid policy are usually income taxable.  

Since employer-pay-all benefits are subject to income taxation, insurers typically permit such benefits to constitute a greater percentage of earned income -- sometimes up to 75% at more modest earned income levels.

There still exists the possibility that a disability income insured may be overinsured at the time that he or she becomes disabled, despite the care with which issue and participation limits are drawn.  That overinsurance possibility exists because benefits may be paid by Social Security.  

The use of the social insurance benefit riders -- a subject that we discussed earlier -- generally resolves that concern.  These riders are so effective in helping to avoid overinsurance that some insurers require applicants to purchase a certain amount of social insurance benefit rider in order to obtain the maximum monthly disability income benefits for the insured's earned income.  

Regardless of their concern about overinsurance, insurers must deal with the marketing issues of the real world.  For that reason, some insurers that generally impose such social insurance benefit requirements allow applicants in their top occupation class -- often physicians -- the option to purchase the maximum allowable benefit as all base benefit rather than as a combination of base benefit and social insurance benefit rider.

In the process of underwriting a disability income application, existing disability income coverage on the proposed insured needs to be considered.  If a proposed insured has existing disability income insurance that will not be replaced, the amount of that coverage is subtracted from the available maximum to determine the amount that may be purchased.  

In addition to existing disability income coverage, another overinsurance concern is caused by the existence of a large unearned income.  For the purposes of current disability income insurance underwriting, more than $12,000 per year of unearned income will usually reduce the amount of disability income insurance available. The amount of monthly disability income coverage available is usually reduced by $.50 for each $1.00 of monthly unearned income in excess of $1,000 per month.

Suppose that a proposed insured had annual earned income of $120,000 and received an additional $30,000 per year in unearned income.  If the proposed insured could purchase $5,000 of monthly income benefit based on earned income, the amount actually available would be $4,250.
__________________________________________________________________________

Effect of Unearned Income-Calculation

The effect of unearned income on the financial underwriting of a disability income policy is generally a reduction of the amounts otherwise available.  A proposed insured whose earned income would qualify for $5,000 of monthly benefit but who had $30,000 of annual unearned income would be eligible for $4,250 of monthly benefit.  The monthly unearned income would reduce the monthly disability benefit available by 50¢ for every $1 of unearned income over $1,000 per month ($12,000 per year), as shown below:

Available disability income coverage from Issue & Participation limit chart
 $5,000

Annual unearned income
 $30,000
Allowable annual unearned income
-12,000
Excess annual unearned income
$18,000

Excess monthly unearned income ($18,000 ÷ 12)
 $1,500
Reduction in available monthly benefit ($1,500 x .50)
$750

Reduced monthly benefit available ($5,000 - 750)
 $4,250

_________________________________________________________________________


Medical Underwriting-The Impaired Risk

Insureds die only once, but they can be disabled over and over.  Not unexpectedly -- and as a result of that difference -- disability income insurance underwriting and life insurance underwriting are substantially different from one another.  

The difference in life insurance and disability insurance underwriting is immediately evident in their respective results.  Although industry averages tell us that more than 90% of life insurance policies are issued as applied for, disability income underwriting statistics are much lower. In many companies, only 75% of disability income policies are issued as applied for.  

But, what happens to those applicants whose policies are not issued as applied for? Generally, a company has 3 approaches to dealing with substandard risks:

Reject the risk
Charge an increased premium, or
Exclude or limit coverage for specific conditions or activities

The option that all parties generally seek to avoid is rejection of the risk.  In such a case, everybody loses.  The agent loses compensation, the insurer loses potential profit and the applicant loses important coverage.  Not surprisingly, most insurers will try to choose another alternative except in the most obviously uninsurable situations.

The alternative of charging an additional premium to account for the increased risk is the one that is generally the most favorable for the proposed insured.  By paying an increased premium -- which may be surprisingly modest -- the insured receives full coverage.

The third alternative is to exclude the additional risk that concerns the underwriters or limit the coverage for it.  The additional risk factor may be the proposed insured's new cliff-scaling hobby, or it may be a recurrent medical condition.  

Suppose, for example, that the proposed insured qualifies for disability income insurance at standard rates except for his hobby.  His hobby of climbing sheer cliff faces creates an uninsurable situation.  In this case, there is an obvious alternative: exclude any disability resulting from injury sustained while cliff climbing.  The rider excludes the proposed insured's hobby, and the insured would be asked to accept the exclusion at the time the policy was delivered.

Chronic medical conditions can be resolved through a somewhat similar approach. One of the most common situations that disability income insurance underwriters face is the proposed insured with chronic back problems.  One method of handling the additional risk caused by this chronic condition is to specifically exclude it by rider.  

Insurers may exclude a chronic back condition through a broad back rider or a narrow back rider.  Both agents and applicants need to be aware of the significant coverage differences that result.  A too common underwriting method of dealing with an applicant with a lower back problem is to exclude any and all disabilities resulting from injury to the insured's back.  This type of exclusion rider is known as a broad back rider since injuries to the entire back are excluded from coverage.  

A different approach would exclude only those injuries to the specific area of the insured's back that presents the problem for the underwriter.  For example, the rider might exclude any and all disabilities resulting from pain in the lumbar-sacral area.  By employing this approach -- generally known as a narrow back rider -- the policy would cover any disabilities caused by an injury to any other part of the insured's back.

When we looked at elimination periods, earlier in this course, we noted that split elimination periods are sometimes used to resolve underwriting concerns.  A split elimination period is simply an elimination period that is longer for disabilities resulting from a specific cause -- the cause that is a concern for the underwriter. Let's consider how a split elimination period might work for the applicant with a chronic lower back problem we just looked at.

Suppose that the applicant applied for a disability income policy with a 30-day elimination period.  Since he has a history of lower back pain, the underwriter may be willing to issue a policy only with a narrow back rider that would eliminate coverage entirely for the lower back condition.  The applicant certainly knows that his back problem may disable him and could find the exclusion unacceptable.

An approach that may resolve both the underwriter's concerns and those of the applicant is to make the coverage for any disability caused by injury to the lower back subject to a 180 day elimination period, rather than the 30 day period that applies to all other disabilities.  As a result, the disability income policy would be issued with a split elimination period: a 180 day elimination period for the condition causing the underwriting concern and a 30 day elimination period for everything else.  

Frequently, a split elimination period approach can make everyone happy.  Unfortunately, it is usually the agent that must act as the catalyst to make it happen.


Summary

Underwriting the disability insurance risk involves a consideration of the proposed insured's occupation, medical history and the financial aspects of the proposed risk.  Occupations are generally classified by their manual content and the hazard that they present.  Financial underwriting is concerned primarily with ensuring that claimants are financially motivated to return to their occupation, if possible, following a period of disability.  The foremost concern with respect to financial underwriting is the possibility of overinsurance.

Underwriters generally take one of three approaches to underwriting the impaired disability risk: rejecting the risk, charging an increased premium and excluding or limiting coverage for certain conditions.