For personal coverage, there are two main ways that an amount of insurance can be justified: Income replacement and estate preservation.
- For income replacement, the underwriter assumes that the purpose of the insurance is to replace the client’s future lost wages. The underwriter will review the client’s annual income from salary or wages and multiply it by a factor that is based on the person’s age. As a person’s age increases, the factor used will decrease. For example, at age 30, the factor may be 25 times earned income, but at age 70, the factor may be seven or less times earned income. Underwriters reduce the factor because as a person ages, the number of future years that the client can expect to continue to work decreases.
- For estate preservation, the underwriter assumes that the purpose of the insurance is to provide payment of estate taxes, so the underwriter uses a formula that approximates the amount of estate taxes that would be due. The formula is approximately 50% of net worth, increased by a factor that takes into account potential future growth in the estate. Underwriters typically assume that the estate will grow at a rate of around 6% annually, continuing for half of the person’s future life expectancy, up to a maximum of 15 years. The underwriter will then divide this figure in half (50%) to equal the estate preservation need. Before submitting an estate preservation case to a carrier, the staff underwriter will help you establish the net worth of the client, advise what assets to count and what growth factor to use, and provide a justification of the amount of coverage needed.
For business coverage, there are three main ways that an amount of insurance can be justified: Key person, buy-sell and loan replacement.
- For key person, the underwriter assumes that the purpose of the insurance is to provide the employer with the amount necessary to compensate the business for the loss of a critically important employee. The underwriter will use a formula of the employee’s annual income times a factor ranging from five to 10. The staff underwriter will help you to justify to the carrier that the insured has unique skills that bring significant irreplaceable value to the employer.
- For buy-sell, the insured must own a portion of the business, and the underwriter assumes that the purpose of the insurance is to provide funds for the other owners to buy out the insured’s ownership share at death. The staff underwriter will help you to establish and document a market value that is reasonable for the business, considering such things as the balance sheet, profit and growth expectations of the business. Additionally, the underwriter will expect that each owner will apply for coverage based upon their proportionate share of ownership. If that is not the case, then an explanation is needed.
In some cases, a person is both a part-owner of the business and a key, irreplaceable employee. In that case, the staff underwriter may be able to convince the carrier to increase the face amount to a higher coverage than they would get if there was just key person or buy-sell value alone.
- For loan replacement, the underwriter assumes that the purpose of the insurance is to pay off an existing loan at death. Most carriers will not consider insurance of more than 80% of the loan balance, and some companies only consider 50% coverage for outstanding debt. Carriers assume that the loan balance will decrease over time as payments are made, and that the business will have something of value that would be available to pay the remainder of the debt.
So, when you consider the variety of ways that an amount of insurance can be justified and the differing documentation that carriers will require, you can see that the financial question is one area where a staff underwriter can be of enormous assistance to you and your client.
Next month, we discuss question number nine: Are there any sensitive histories such as alcohol, drug or motor vehicle problems?
Bob Pedigo, CLU, FALU, FLMI, heads the underwriting division at Davis Life Brokerage. Mr. Pedigo is the former Vice President and Chief Underwriter with Indianapolis Life. As the Vice President of Underwriting for Davis Life, he assists producers in navigating their cases through the sometimes rocky sea of underwriting. In addition to being available for consultation with agents on tough cases, he is an advocate in working with home office underwriting departments. In addition to his 30 years of underwriting experience, Bob also sold life insurance early in his career.