Have you ever wondered how a death benefit is determined in a life insurance contract? Whether or not you choose a term life, whole life, or universal life insurance contract, every contract comes equipped with a tax free death benefit, otherwise known as a face amount. But how does the insurance company come up with the magic number for a death benefit? It's all based on mortality tables using the health and age of the proposed insured. Let's take a closer look at how insurance companies rate each policy and how underwriting determines the outcome.
We have all heard of the term underwriting. However, underwriting can be used to analyze either the health of a person or the justification of a financial transaction, like a home mortgage loan. For our purposes we will be focusing on the underwriting of an individual for a life insurance policy. Once a person has done the adequate research to determine what type of policy would be the best fit, the underwriting process of gathering information follows the signed application. After the application, the insurance company will set up an appointment with the proposed inured (the person applying for insurance) with a para med (usually a mobile nurse or health care equivalent). The para med will take down vital statistics of the proposed insured, including a blood test and urine analysis. This information is then sent to a laboratory to be analyzed for the insurance company.
Outside of the initial physical of the para med, other information is also collected to determine the face amount of the policy. The age and sex of the insured is considered. Additionally, past medical records will be summoned from the acting physician to be reviewed by the insurance company. The lifestyle of the proposed insured is also reviewed, as a motocross racer has a much higher chance of being killed on the job than a receptionist. Lastly, the insurance company must consider the financial state, or suitability, of the client to determine if the recommended policy will meet the client's needs.
Once all of this information is collected for the insurance company, the underwriter will then analyze this information and come up with a tax free death benefit. The underwriter basically calculates all of the risk (chance of death) of the provided documentation against set mortality tables before an offer can be considered. Generally speaking, the mortality tables provide a societal average of what a reasonably healthy person will live to be. For example, females tend to live longer; therefore, on average the death benefit for a female is slightly higher than a male. Mortality tables provide the insurance company with a time line of profitability to make sure the death benefits they offer do not put them in the red over the long term. Because of this life insurance payouts are much higher today then they were 50 years ago, as people are living much longer; translating to higher profits for the insurance company.
Only when all of this information is analyzed can an offer from the insurance company be made. This is why it is important to speak to a reputable agent discussing the financial needs of your life insurance policy. If the wrong policy is recommended based on absent facts, the long term financial consequences could be severe. For example, a person who wants a higher death benefit would be better off with a whole life policy as opposed to a universal life policy which concentrates on cash value accumulation. Pertinent questions must be addressed upfront at the time of the application to adequately determine the right policy. Bottom line, underwriting is a proven method that can help the proposed insured come up with the appropriate face amount for their family's needs if properly addressed.