What Is an Insurance Risk Class?
An insurance risk class is a group of individuals or companies that have similar characteristics, which are used to determine the risk associated with underwriting a new policy and the premium that should be charged for coverage. Determining the insurance risk class is a primary component of an insurance company’s underwriting process.
- An insurance risk class is a way for insurers to underwrite policies based on one's belonging to a particular risk group.
- People in each risk group will generally share similar characteristics that help insurers better estimate the chances that the policyholder will file a claim.
- Riskier risk groups will pay higher premiums—for example, people who are sick, older, or have a poor driving record.
Insurance Risk Classes Explained
While no two individuals are exactly the same, many people exhibit similarities that allow them to be classified. Insurance companies need to know the likelihood that underwriting a new policy for a new client or business will be a profitable endeavor.
After all, taking on a new policy for several hundred dollars a year won't be a good idea if the policyholder winds up creating thousands of dollars in claims.
In the case of auto insurance, for example, an insurer may examine the age of the vehicle, the age of the driver, the driver’s history, the amount of coverage requested, and the area in which the vehicle is operated. These factors, when taken together, create a profile of a specific type of driver, which can be used by actuaries to determine how drivers in this particular profile act.
The insurance risk class allows insurance companies to determine the amount of coverage needed, as well as how much that coverage should cost. Risk classifications are most commonly applied when underwriting life insurance policies.
Life Insurance Risk Classes
For life insurance companies, risk classes are used to determine how likely the insurance company is to have to pay out benefits on your behalf if you pass away. Insurance companies may also have to pay out benefits prematurely if you attach an accelerated death benefit rider to your policy. These riders allow you to tap into your death benefit while living to pay for costs associated with end-of-life care should you become terminally ill.
In terms of premium costs, a number of factors are used to determine which risk class you fit into. Those can include:
- Smoking status
- Family history
- Whether you engage in risky hobbies or other potentially dangerous behaviors, such as substance or alcohol abuse
When you apply for a life insurance policy, the answers you provide to health and lifestyle questions are taken into account by your agent, and an internal underwriting team will provide the most accurate risk class and quote possible. Depending on the type of policy you're purchasing, you may have to complete a paramedical exam in which blood and urine samples are collected.
Some insurance companies offer no-exam policies that allow you to qualify without a health examination. Keep in mind, however, that you may pay higher premiums.
Risk Classifications and Premium Costs
The life insurance risk class you're assigned to can directly impact what you pay for life insurance premiums. Here's an overview of how individual risk classes compare.
- Preferred Plus/Elite: the lowest-risk category. People in this risk class are in excellent health, are typically younger, and have no other immediate cause for concern. These people can expect to pay the lowest premiums for life insurance.
- Preferred: a small step down from preferred plus, preferred class policyholders enjoy lower premiums due to excellent health but may have some subtle red flags like higher cholesterol.
- Standard Plus: Above average health, but things like blood pressure or body mass index (BMI) may be outside the ideal range. Premiums are more favorable than Standard risk class but you may pay more than someone in the Preferred or Preferred Plus grouping.
- Standard: This means typical risk, and for life insurers, it means an average life expectancy. You may have some health issues in your family or in your past, which keeps you out of more preferred risk groups, resulting in higher premiums.
- Substandard/Rated: If you are classified as a higher risk than standard, you are subject to various degrees or ratings of substandard, which each insurer approaches a bit differently. This can be because of health issues or a risky past. Your premiums may be among the highest rates, typically at the Standard price plus an additional 25 percent at every step down in the ratings.
- Smoker: Smokers will pay significantly more due to increased health risks. Insurers will ask if you smoke or have in the past several years and may test for the presence of nicotine in routine blood work.
Many life insurance companies view vaping in the same light as smoking for assessing risk and setting premium costs.
Changing Insurance Risk Class
Your insurance risk class for life insurance isn't necessarily set in stone. It's possible to improve your risk and potentially reduce your premium costs, though it usually requires some work.
For example, if you've been quoted a Standard Plus rate for life insurance, it's possible that you could qualify for a Preferred rate by losing weight to improve your BMI range. Quitting smoking could also work in your favor, though you need to be smoke-free for a year or two to see a difference in risk classification. Or if your premiums are higher because you have a riskier job, you may be able to lower them by switching to a safer occupation.
Keep in mind that some things may be out of your control. If you have a chronic or inherited health condition, for example, there's likely little you can do to change how that affects your risk class and insurance rates. Obtaining life insurance quotes from multiple companies can help with comparing costs and providers and selecting the most affordable policy.
What Are the Risk Rating Classes for Insurance Companies?
Insurance companies typically utilize three risk classes: super preferred, preferred, and standard. These can vary by insurance company. Insurance companies can also have a substandard risk class.
What Is the Relationship Between Risk and Premium in Insurance?
Generally speaking, the higher the risk of a policyholder, the higher the insurance premium they will have to pay for their policy. The lower the risk, the lower the insurance premium. For example, a 65-year-old person who smokes and eats poorly will have a higher insurance premium than a 25-year-old person who is an active athlete that does not smoke. Insurance companies charge higher premiums to higher-risk individuals because there is a higher risk they may have to pay benefits on the policy.
How Many Insurance Premiums Are There?
Insurance premiums are the costs that policyholders pay insurance companies for insurance. They can be paid monthly, quarterly, semi-annually, or annually.
The Bottom Line
Insurance companies use risk classifications to bucket policyholders, which gives them an idea of the risk of the policyholder and the amount of premiums to charge them for the policy. Insurance companies use risk classifications to minimize their risk.