Chapter 8

Selection of Risks

Slide prepared by: Abdullah Al Yousuf KhanAssistant Professor - IUBAT8

ChapterMcGraw-Hill/IrwinCopyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.Selection of RiskThe selection of a risk is a process whereby the inferior lives are weeded out. The function of the process is to either accept or reject the applicant.The degree of risk presented by the applicant must be proportionate with the established premium for same category.Or additional premium should be charged.Purpose of SelectionsTo accept or reject the application.To determine the rate of premium to be charged for the insurance. The premium depends upon the degree of risk.The higher the risk the more will be premium.It is also known as selection of risk.Since it is impossible to charge various premiums for each and every individual (each applicant has different degree of risk) Risks are classified into standard or sub-standard on the basis of selection. So it is possible to determine what risks are to be accepted at normal rate and what risks will be at extra rate or not accepted at all. To avoid discrimination of the lives assured. Different premiums should be charged for different groups. Essential to avoid adverse selection. Factors Affecting RiskAgeBuildPhysical conditionPersonal historyFamily historyOccupationResidence Present habits Morals Race and nationalityGenderEconomic statusDefense servicesPlan of insurance

Age Age is important to determine the premium.Age is rounded to nearer to the birthday. Person bellow six months and above six months of the age will be treated of the same age.E.g. a person of 22 years 7 months and another person of 23 years 5 months will be treated as 23.Maximum and Minimum Age Limit;To avoid adverse selection, maximum age limit is fixed. At advance age the chances of moral hazard is higher.Most applicant will fail in the medical examination at old age.Mortality is certainly higher.The minimum age limit is meant to avoid risk of infant mortality. Build Build refers to physique of the proposed life and includes;Height,Weight, The distribution of weight, andChest expansionThere are standard of weight according to maximum weight reveal the indication of certain hidden diseases. The relationship between height, weight, and girth, and expansion of chest are the basic determinants of mortality expectations.Overweight is dangerous in advanced age and underweight is similarly not desirable at younger age. There is a standard for maximum and minimum weight according to the height for easy reference. If any applicant falls outside of the standard than the premium is adjusted . Physical ConditionThe physical condition of the life proposed has a direct bearing on the mortality of the life assured.Conditions like applicants;Sight,Hearing,Heart,Arteries,Lungs,Tonsils,Teeth,Kidneys,Nervous system, etc.The information is confirmed and supplemented by a medical examination which is to detect any malfunction of the vital organs of the body.

Personal HistoryThe history may be connected with the Health record; e.g. previous surgical operation or certain serious disease. Past habit; e.g. addiction to drugs and alcohol which may be repeated.Previous occupation; the past hazardous occupation generally affects health slowly. Insurance history; the previous amount of insurance may disclose the degree of risk.

Family history Family history of other family members like parents, brothers and sisters. Even the childrens history is also required. E.g. diseases like tuberculosis and insanity, diabetics, high blood pressure. Occupation Occupation is important because;If the nature is hazardous, than accident may happen any time. The morale may go low as a result they may be tempted to indulge themselves in drinking or taking drugs.The chemical effect may be poisonous while workers may contact chemicals at work.Unhealthy working condition (or poor construction without ventilation) may deteriorate the health of the of the workers. Residence The risk is generally less in a good climate area and more in a bad climate.The Geographical location, Atmosphere, Political stability, Climate, Construction of house, Travel, etc. are important factors which may affect the risk. Present habitsDrunkards and non-temperate people cause increase in mortalityExcessive and careless smoking tends to shorten the life due to development of nicotine poisoning Temperate habits tend to increase longevity of a person. Physical exercise is considered to increase the longevity.Morals Unethical conduct is considered to be another form of moral hazard. Infidelity and departure from the code of sex behavior are seriously regarded to be a health hazard.Insurance is not generally given to bankrupt and reputed dishonest person. e.g. moral hazard is present when someone takes an insurance at an old age where the person is suffering from serious disease.Race and nationality The mortality rate differs from race to race and nation to nation. In India, person of high race or cast are expected to live longer than the scheduled castes or tribes. Countries nearer to equator have more mortality.The climate and way of life of a country affect the health conditions or the people. Sex Mortality among female sex is, generally higher than that of male sex because the physical hazard or maternity is present in the female. Moreover, the ladies are physically more handicapped. The lesser education, conservatism, and non-employment of the ladies also affect the mortality.The chances of moral hazard are also present in the female insurance.Economic statusThe high insurance (sum assured) for persons with high income is justified.The circumstances need to be investigated to justify the need for the insurance for the amount applied.The chances of death is also lower in higher strata of the society.Defense serviceCertain restrictive clauses are imposed for insuring persons engaged in defense service.E.g. flying, and gliding, etc.Extra premiums may be requiredBut for commercial flying, no extra premium is required since this profession is regarded not hazardous.Plan of insuranceCertain plans involve more responsibility to the insurer at death and not these plans are restricted to only first class lives. Some plans have lesser risk and, therefore, can be issued without any extra investigation.E.g. the multi-purpose policy is issued only to first class lives and the pure endowment policy can be issued to any one irrespective of health. Sources of Risk InformationThe Proposal Form;The application form;Home address, term of insurance, sum to be assured, mode of premium payment, date of birth, object of insurance, name of the nominee, previous insurance history, acceptance or rejection of the proposal, engagement in navy, air force, and military serviceThe personal statement;Either the life to be assuredThe agent or the development officer, writing at the dictation of the life to be assured. The statement mentions name of the life to be insured, family history of father, mother, brothers and sisters in connection with their health and illness and cause of death. Questions about the bodily impairments, serious disease, habits, operation, accident or injury. Sources of Risk InformationMedical Examiners Report;The information is given by medical examiner is deemed to be correct and it is expected that the medical examiners would give true and fair picture; but certain cases in India have revealed that the reports are not hundred percent reliable. Opinions of the medical examiner for the longevity, suspected health, first class lives, etc., are required.He has to declare that the findings are true and correct.

Sources of Risk InformationAgents ReportThe agent is required to state whether the life of the assured, is insurable or not. He has to furnish information of sum assured, name, acquaintances with the proposer, time and place of first introduction, identity of the life, medical examiners name and address, occupation and monthly income of the proposer, general state of health, relationship with the agent etc.The agent has also to disclose the financial and social position of the proposer. The agent is required to disclose all the unfavorable information of the life proposed.

Sources of Risk InformationThe Inspection ReportThe insurers generally verify the information obtained by an independent agency. Sometimes this investigation is conducted without the knowledge of the applicant. Insurance companies employ their own inspection staff who are generally known as inspectors or field officers or development officers.For a large amount of insurance, a deep and thorough inquiry of habits, character, social condition, occupation, and health is required. Inspectors interview the applicants neighbors, employers, bankers, business associates, and other who have special information pertaining to business, ethics, temperate habit, social behavior, health.

Sources of Risk InformationPrivate Friends Report;For some checking purposes, confidential reports of the friends of the proposer are considered.Since friends are fully aware of the personal and private life of the proposer, they can give better information than the agents.But naturally the real friends do not want to harm their friend.So friends report may not always be correct.

Sources of Risk InformationAttending Physicians;The attending or family physicians can give better records of health, history of the proposed life and his family.It has been revealed that the family physicians have given true and fair reports of the required information.

Sources of Risk InformationMedical Information Bureau (MIB);

Sources of Risk InformationNeighbors and Business Associates;Confidential reports about the applicant can be easily obtained from the neighbors and business associates although it may be prejudice to the extent friendship or enmity with the proposer. The obtained information can be matched with other collected information.

Sources of Risk InformationCommercial Credit Investigation Bureau;

Classes of RiskAll risks cant be treated individually, so they are put under a few broad categories based on the degree of each risk;Un-Insurable RisksInsurable Risks;Standard RiskSub-Standard RiskSuper-Standard RiskUninsurable RisksPractically, there are number of reasons why some persons are not insurable. If the insurance can be purchased with higher premium, there should not be any uninsurable risk.So people in death bed would buy the insurance knowing that after few premiums they will die which will be a case of speculation. Then it would be unfair to other healthy policyholders.

Insurable RisksThe insurable risks are those which after the selection process can be carried out by an insurer although there can be different terms and conditions for different policy-holders.There are; Standard risk; related with normal lifeSub-standard risk; where risks are higher than the standardSuper-standard risk; risk is less than the standard risk. Methods of Risk ClassificationThe Judgment MethodNumerical rating System