One of the problems faced by young people just starting their careers is a combination of limited income and a growing future need for life and health insurance protection as their life cycle evolves. The guaranteed insurability option, also known as the additional or guaranteed purchase option, permits an insured to purchase additional insurance without providing evidence of insurability. It was developed to permit young individuals to be certain that they would be able to purchase additional insurance as they grew older, regardless of their insurability. The usual rider gives the ir1ured the option (in finance terms, a call option) of purchasing additional insurance at periodic, set intervals (e.g., three years), provided the insured has not attained a specified age, such as age 40. Special option dates may be allowed for such life events as birth or adoption of a child and marriage. In most cases, the amount of the additional insurance is limited to a multiple of the basic policy face amount or an amount stipulated in the policy for the additional purchase option, whichever is the smaller. Insurers offer up to $100,000 or more per option date. The option requires an extra premium that is based on the company’s estimate of the extra mortality that will be experienced on policies issued without evidence of insurability. The premium is payable to the last option date. The premium can be considered as the cost of insuring one’s insurability.
We would reasonably expect insured’s in poor health to be more likely to exercise their options than insured’s who are in good health and otherwise insurable. In economic terms, the option can be viewed as an invitation to adverse selection; buyers use their superior knowledge about their insurability status to secure good deals for themselves. Stated in finance terms, the option holder is more likely to exercise the call option because the option’s exercise price (the premium for additional life insurance at standard rates) is less than the market price (the premium for additional life insurance at higher than standard rates). Of course, the insurer is aware that option holders, as a group, will behave in this way. The premium for the option is supposed to be calculated to cover the expected extra mortality incurred. Also, by designing the benefit to limit the age to which and times at which the options may be exercised, the insurer is minimizing opportunities for insured’s to select against the company.
Assume that the owner/insured purchases a $25,000 ordinary life policy at age 21 and that the guaranteed insurability option is included. Under this option, the company agrees to issue, on the owner/insured’s request, an additional policy on his or her life at each option date. No evidence of insurability is required. To minimize adverse selection, option dates customarily occur at set ages, such as 25, 28, 31, 34, 37, and 40. Thus, if the insured desires, he or she could add as much as $150,000 additional coverage. Separate policies need not be issued when the option is included within a universal life or other flexible policy.
Although potentially beneficial, the GlO is not as flexible as one might prefer. It permits the exercise of the option at specified dates only, provides additional protection of relatively low amounts (for most companies), and requires the purchase of an additional insurance policy, with attendant policy fees and front-end loads (although many companies now permit internal policy increases in face amounts via the GlO, such as with universal life policies). Although it would admittedly be complex to devise, price, and administer, insurers could provide a useful service by devising a pure guaranteed insurability rider and policy with greater flexibility. Even so, the rider can prove to be of value, especially to those whose family health history suggests that potentially significant medical problems may develop.