Insurability of specific risks
Insurance is sold on a case-by-case basis. Insurance companies consider a number of factors in order to determine whether a proposed risk is an insurable risk.
The people who are involved in the creation and operation of an insurance policy:
Applicant – The person or business that applies for an insurance policy
Policyowner – The person or business that owns an insurance policy
Insured – The person whose life is insured under an insurance policy
Policyowner-insured – The person who is both the policyowner and the insured
Third-party policy – An insurance policy that one person or business purchases on the life of another person
Beneficiary – The person or party the owner of an insurance policy names to receive the policy benefit if the event insured against occurs
Insurable interest requirement
Only pure risks are insurable.
Insurance is intended to compensate an individual or a business for a financial loss, not to provide an opportunity for gain.
To prevent people from using insurance policies as means of making wagers (gambling by purchasing policies on lives of people who were completely unrelated to them and created a possibility of financial gain if the insured died), the government passed law that when an insurance policy is issued, the policyowner must have an insurable interest in the risk that is insured. The policyowner must be likely to suffer a genuine loss or detriment should the event insured against occur.
An insurable interest exists when the policyowner is likely to benefit if the insured continues to live and is likely to suffer some loss or detriment if the insured dies.
If the insurer determines that the proposed policyowner does not meet the insurable interest requirement, then the insurer will not issue the policy.
All persons are considered to have an insurable interest in their own lives.
Insurable interest laws do not require that the named beneficiary have an insurable interest in the policyowner-insured’s life. A policyowner-insured can name anyone as beneficiary.
Most insurance company underwriting guidelines require that the beneficiary also must have an insurable interest in the life of the insured when the policy is issued.
In a third party policy, both policyowner and beneficiary must have insurable interest in the insured’s life when the policy is issued.
Certain family relationships are deemed by law to create an insurable interest between an insured and a policyowner or beneficiary – natural bonds of love and affection and financial dependence
Spouse, mother, father, child, grandparent, grandchild, brother and sister
Assessing the degree of risk
Not all individuals of the same sex and age have an equal likelihood of suffering a loss
Antiselection, adverse selection or selection against the insurer – the tendency of individuals who believe they have a greater-than-average likelihood of loss to seek insurance protection to a greater extent than do those who believe they have an average or less-than-average likelihood of loss
Underwriting or selection of risks – the process of identifying or classifying the degree of risk represented by a proposed insured.
Two primary stages of underwriting:
Identifying the risks that a proposed insured presents
Factors that can increase or decrease the likelihood that an individual will suffer a loss
Physical hazard – a physical characteristic that may increase the likelihood of loss
Moral hazard – the likelihood that a person involved in an insurance transaction may act dishonestly in that transaction
Classifying the degree of risks that a proposed insured presents
To enable the insurer to determine the equitable premium rate to charge for the requested coverage
Standard risks - the risk category that is composed of proposed insureds who have a likelihood of loss that is not significantly greater than average and are charged standard premium rates
substandard risks - the risk category that is composed of proposed insureds who have a significantly greater than average likelihood of loss and are charged substandard premium rates or special class rates
declined risks - the risk category that is composed of proposed insureds who are considered to present a risk that is too great for the insurer to cover.
preferred risks - the risk category that is composed of proposed insureds who present a significantly less than average likelihood of loss and are charged lower than standard premium rate
Underwriters – the insurance company employees who are responsible for evaluating proposed risks.