Financial underwriting refers to the process that insurance companies use to assess an applicant's financial risk before deciding whether to offer them a life insurance policy and at what premium rate. The financial underwriting process aims to ensure the applicant can adequately pay their policy premiums and isn’t applying for more coverage than they can justify. 

What factors are considered during the financial underwriting process? 

Critical aspects of financial underwriting in life insurance include:

Financial information: Applicants must typically provide detailed financial information, such as income, assets, debts, and expenses. This helps the insurer understand the applicant's financial stability and ability to afford the policy.

Credit history: Insurers often consider an applicant's credit history, including credit score and credit report, to assess their financial responsibility and payment behavior.

Occupation and industry: The applicant's job and industry may be considered since they provide insights into job stability and income potential.

Policy face amount: The face amount, or death benefit, of the policy applied for, can impact the level of financial underwriting required. Higher coverage amounts may trigger a more extensive financial evaluation.

Existing policies: Insurers may want to know about any other life insurance policies the applicant currently holds to assess their overall insurance needs and potential financial strain.

Financial ratios: Insurers may use financial ratios to assess an applicant's financial health. Common examples include debt-to-income ratios and liquidity ratios.

Medical history: While medical underwriting focuses on health-related factors, financial underwriting may also consider certain financial aspects of the applicant's medical history. For instance, a history of serious medical conditions could affect the applicant's economic well-being.

Based on the information gathered during the financial underwriting process, the insurer will decide whether to approve the application, deny coverage, or offer a policy with modified terms (e.g., higher premiums). Applicants at higher financial risk may face increased premium rates or be ineligible for specific policies.

During the underwriting process, it's essential to provide accurate and honest financial information, as any misrepresentation can lead to the denial of a claim later on if the policy is issued based on false information.

How to prepare for the underwriting process

During the financial underwriting process for a life insurance policy, applicants must provide various documents to help the insurer assess their financial risk and eligibility. The documents requested may vary based on the insurance company's policies, the type and amount of coverage being applied for, and the applicant's circumstances. 

However, here are some standard documents that are often requested during the financial underwriting process:

Life insurance application: The application form will require personal and financial information, such as name, age, gender, address, income, assets, and debts.

Identification: A valid government-issued ID, such as a passport or driver's license, is typically required to verify the applicant's identity and age.

Income verification: Proof of income, like pay stubs, tax returns, and bank statements, is crucial for assessing the applicant's ability to pay the premiums. 

Employment verification: If the applicant isn’t retired, the insurer may request an employment verification letter or contact the applicant’s employer directly to confirm his or her employment status.

Credit report: The insurer may request access to the applicant's credit report to evaluate their creditworthiness and financial responsibility.

Existing insurance policies: Details of the applicant's other life insurance policies, including face amounts and policy numbers, are generally evaluated.

Proof of insurance interest: At the time of application, there must be proof that the applicant has a legitimate need for life insurance, such as getting married, the birth of children, starting a business, etc. 

Cover letter: While not always a requirement, having a cover letter written by the advisor can help ensure a smooth underwriting process. The advisor will need to include the following:

• The client’s information like their name, birthday, and residence
• The purpose of the coverage, such as a buy-sell agreement or income replacement
• Sources of income
• The amount of coverage they’re applying for
• Additional policies currently in force
• An explanation of any financial issues like bankruptcy or poor credit history
• Any medical issues that can impact finances, like long hospital stays. 

In addition, a cover letter can be useful when justifying additional coverage for a spouse that doesn’t work. For example, if the insured spouse provides childcare in their absence, the surviving spouse may have to pay for daycare expenses. These costs can be taken into account when calculating coverage amounts. 

A platform like Modern Life, can help make the underwriting process more efficient. For example, our client intake form helps advisors get a more accurate health rating up front by asking specific medical questions and follow-ups where appropriate. This helps ensure the client has appropriate expectations and applies for the best coverage. In addition, our case dashboard also helps advisors track requirements throughout the underwriting process, and if additional financial forms are required, advisors can more easily track what’s needed. 

Personal vs. business purposes

The underwriting process and the documents required may vary depending on why the person is applying for the policy.

For example, an individual applying for the policy for spousal income replacement will only need to provide personal financial information. On the other hand, if the applicant is a business owner and wants to purchase a policy to ensure business continuity, then a business valuation and profit and loss statements may be required. 

Insurance coverage for juveniles

It’s common for parents to take out a life insurance policy on their children. This type of insurance is often called "child life insurance" or "juvenile life insurance" and is typically for children under 18, though this can vary by carrier.

The underwriting process for a child's life insurance policy will differ from taking out a policy on an adult.

Premiums and risk assessment: Child life insurance policies usually have lower premium rates than adult policies because children are generally considered lower risk. Children are less likely to have significant health issues, and the financial underwriting process for child policies focuses more on the parents' financial stability and ability to pay premiums.

Financial information: Most children don’t generate any income, so the financial underwriting process centers on the parents' or guardians' financial information. 

Riders and convertibility options: Some child life insurance policies have optional riders or convertibility features. These riders may allow the policy to be enhanced with additional benefits, and the convertibility feature may enable the child to convert the policy to provide more extensive coverage later in life without further medical underwriting.

If a family has multiple children, some carriers may require the parents or guardians to have similar or equal coverage for all the children, not just one. 

Case study

Jim and Sandy are a young married couple that just welcomed their first child. Jim is the sole income earner and wants to purchase a life insurance policy to protect his family’s future. 

They meet with Dan, an experienced wealth management advisor, to help them navigate the complex life insurance market. Dan conducts a comprehensive needs analysis to determine the appropriate coverage amount for Jim’s life insurance policy. They consider factors such as Jim's income, living expenses, future financial goals, such as saving for the child's education, outstanding debts, including their mortgage, and raising the child until adulthood.

Dan recommends a 30-year term life policy. This option provides adequate coverage for their needs while ensuring affordable premium payments. For Sandy, Dan recommends a smaller life insurance policy. This would ensure that if something happened to her, Jim would have financial support to take care of the child.