Several methods have been devised to provide insurance protection to people with impaired health. With the exception of the lien, most United States life insurance companies utilize all the available methods. In general, companies make an effort to adapt the method to the type of hazard represented by the impaired risk, but departures from theoretically correct risk treatment are frequently made for practical reasons.

One method of treatment, widely used in the past and still favored by many companies for joint-and-survivor products, is to "rate up" the age of the applicant. Under this method, the applicant is assumed to be a number of years older than his or her real age, and the policy is written accordingly. The number of years older is usually determined by adding the amount estimated as necessary to provide for the extra mortality to the net premium for the applicant�s actual age, and then finding the premium in the standard table that most closely matches that total, and deriving the rate-up from the standard age in the table. For example, assume the net level premium for an ordinary life contract issued at age 25 is $12.55 per $1,000. If a male applicant for such a contract, aged 25, should be placed in a substandard classification that is expected to produce an extra mortality equivalent to $3.67, the correct net premium for the applicant would be $16.22 per $1,000. The net level premium in the standard table closest to this amount is $16.43, which is the premium for age 33. Therefore the applicant is rated up 8 years and is thereafter treated in all respects as if he were 33 years of age. His policy would contain the same surrender and loan values and would be entitled to the same dividends, if any, as any other ordinary life contract issued at age 33.

This method of dealing with substandard risks is suitable only when the extra risk is a decidedly increasing one and will continue to increase indefinitely at a greater rate. Although few impairments give rise to such a consistent and rapid increase in the rate of mortality as provided in the rated-up age method, the method is considered to be appropriate for all types of substandard risks where the extra mortality, in general, increases with age.

The chief appeal of the method for the insurance company is its simplicity. Policies can be dealt with for all purposes as standard policies issued at the assumed age. No separate set of records is required; no special calculations of premium rates, cash and other surrender values, reserves, and dividends are involved. For the applicant, the method is attractive because the higher premium is accompanied by correspondingly higher surrender values and dividends (if participating). Thus a portion of each extra premium is refunded as a dividend, and another portion is applied to the accumulation of larger surrender values than would be available under a policy issued at the applicant�s true age. If the policy is surrendered for cash, the additional cash value is equivalent to a refund of a portion of the extra premium paid. To protect themselves against the use of the surrender privilege for this purpose, some companies add a slight loading to the original extra premium.

The most common method of dealing with risks that present an increasing hazard is to classify them into groups based on the expected percentage of standard mortality and to charge premiums that reflect the appropriate increase in mortality. The number of substandard classifications may vary from three to 12, depending to some extent on the degree of extra mortality the company is willing to underwrite. Some companies are unwilling to underwrite substandard groups whose average mortality is expected to exceed 200 percent of standard, and they usually establish three substandard classifications with expected average mortalities of 150, 175, and 200 percent, respectively. Table 23-1 shows a scale of substandard classifications widely used by companies offering coverage up to 500 percent of standard mortality.

The extra mortality under the extra percentage method is relatively small at the early ages, unless the percentage of extra mortality is high, since the normal (or base rate) mortality at such ages is small. As the base death rate increases, however, the margin for extra mortality increases very greatly. This explains why the method is appropriate for substandard risks whose impairments are expected to produce an increasing rate of extra mortality. Like the increase-in-age method, extra percentage substandard tables should, in theory, be used only when the hazard is expected to increase at a greater rate. In practice, however, they are used for all types of impairments that are expected to worsen as the years go by.

The reserves under policies issued in accordance with extra percentage tables must be calculated on the basis of the mortality assumptions underlying the premiums, which requires separate classification records and tabulations. Depending on company practice and state law, surrender values may be based on the special mortality table or may be the same as surrender values under policies issued to standard risks. Many companies do not make the extended term insurance nonforfeiture option (which is discussed in chapter 25) available under extra-percentage-table policies, especially at the higher percentages, and those that do compute the period on the basis of the higher mortality rate even when only the normal surrender value is allowed.

Extra percentage tables are sometimes used as a basis for determining the extra premiums needed under other methods of underwriting substandard risks. Thus the risk may first be assigned to an extra percentage table, after which the rating is translated into the equivalent age markup. This is a convenient way to determine the necessary step-up in age when statistics on the additional mortality expected from a particular impairment are available.

A third method of underwriting substandard risks is by assessing a flat extra premium. Under this method, the standard premium for the policy in question is increased by a specified number of dollars per $1,000 of insurance. Assessed as a measure of the extra mortality involved, the flat extra premium does not vary with the age of the applicant. It may be paid throughout the premium-paying period of the policy, or it may be terminated after a period of years when the extra hazard has presumably disappeared.

The flat extra premium method is normally used when the hazard is thought to be constant (deafness or partial blindness, for example) or decreasing (as with a family history of tuberculosis or the aftermath of a serious illness or surgical operation, in which case the flat extra is usually temporary in duration). The flat extra premium is widely used to cover the extra risk associated with certain occupations and avocations. When used for this purpose, the extra premium usually ranges from $2.50 to $10 per $1,000 of insurance. Unless a permanent impairment is involved, the extra premium is generally removed if the insured leaves the hazardous occupation or avocation.

At first glance, a flat extra premium for an extra hazard that adds an approximately constant amount to the rate of mortality at each age appears to be a fair arrangement. In practice, however, it works out equitably only if an allowance is made for the fact that the amount at risk is not a level sum under most policies. Except for term policies, the net amount at risk decreases with each year that elapses. Thus a flat extra premium becomes an increasing percentage of the amount at risk and, in effect, provides for an increasing extra risk.

When the extra risk is constant, the extra premium for a cash value contract should diminish each year in the proportion that the amount at risk decreases. To avoid the labor and expense that would be involved in such an annual adjustment, and in recognition of the fact that the flat extra premium is an approximation, most companies compute the flat extra addition on the basis of the average amount at risk. Some companies vary the extra premium with the plan of insurance, charging less for high cash value policies than for policies with lower reserve elements.

The flat extra premium is not reflected in policy values and dividends. It is assumed that the entire amount of the extra premium is needed each year to pay additional claims and expenses. The dividends and guaranteed values are identical to those of a comparable policy without the flat extra premium. Thus the policyowner must regard the flat extra premium as an irrecoverable outlay, a costly way to get even except through premature death.

When the extra mortality to be expected from an impairment is of a distinctly decreasing and temporary nature, such as that associated with convalescence from a serious illness, neither an increase in age, a percentage addition to the rate of mortality, nor a flat extra premium is an appropriate method of dealing with the risk. A more suitable method�from a theoretical standpoint, at least�is to create a lien against the policy for a number of years, the amount and term of the lien depending on the extent of the impairment. If adequate statistics are available, it is possible to calculate the term and amount of the lien that are equivalent to the extra risk undertaken. If such a method is utilized, the policy is issued at standard rates and is standard in all respects except that, should death occur before the end of the period specified, the amount of the lien is deducted from the proceeds otherwise payable. The method is frequently refined to provide for a yearly reduction in the amount of the lien on the theory that the hazard is decreasing.

The lien method has a psychological appeal, in that few persons who are refused insurance at standard rates believe themselves to be substandard risks and tend to resent the company�s action in classifying them as such. If the only penalty involved is a temporary reduction in the amount of protection, most applicants are willing to go along with the company�s decision, confident that they will survive the period of the lien and thus "prove" the company to have been wrong. The plan appeals to the applicant�s sporting instinct.

A practical and serious disadvantage of the method is that a comparatively large lien is necessary to offset a relatively small degree of extra mortality. Furthermore the reduction occurs in the early years of the policy, when the need for protection is presumably the greatest. Frequently the beneficiary has no knowledge of the lien, and the company�s failure to pay the face amount of the policy may be the source of great disappointment and resentment, to the detriment of the company�s reputation in the community. There is also a possibility that the lien is in conflict with laws in certain states that prohibit any provision that permits the company to settle a death claim with a payment smaller than the face amount. These laws are known as "no-lesser-amounts" statutes.

A method of dealing with substandard risks when the degree of extra mortality is small or when its nature is not well known is to make no extra charge but to place all of the members of the group in a special class for dividend purposes, adjusting the dividends in accordance with the actual experience. This method can accommodate only those impairments that produce an extra mortality that does not exceed the normal dividend payments. Moreover a sufficiently large number of such risks must be underwritten to yield an average experience.

Some impairments can be dealt with by merely limiting the plan of insurance. The extra mortality associated with certain impairments is largely postponed to advanced middle age or old age. These impairments can be underwritten at no extra charge by issuing single premium or modified endowment contracts that have minimal amount at risk before the impact of the extra mortality. Being moderately overweight is a typical impairment that is adaptable to the endowment plan at standard rates.