Risk Management in Banking and Insurance · Life Insurance

Life Insurance Underwriting, Risk Selection and Actuarial Valuation

Updated 11 October 2026 · Fact-checked

Underwriting is how a life insurer decides whom to cover and at what price. It classifies risks, uses mortality tables to set premiums, and then values assets and liabilities actuarially. Only a valuation surplus can fund shareholder dividends and policyholder bonuses under Section 49 of the Insurance Act, 1938.

Understand Underwriting, Risk Selection and Actuarial Valuation

Underwriting is the process of examining a proposal and deciding whether to accept it, on what terms, and at what premium. The aim is to charge each person a price that fits the risk, so that healthy lives do not subsidise unhealthy ones without limit. This guards against adverse selection, where people who know they are at higher risk are the most eager to buy cover.

Risk selection works by classifying proposers. The insurer looks at age, sex, health, medical history, occupation, habits such as smoking, financial standing and the sum assured asked for. Based on this, a life is usually placed in one of these groups: standard (normal premium), substandard (accepted with extra premium, a lien or a reduced benefit), or declined or postponed. Because the contract rests on utmost good faith, the proposer must disclose all material facts.

Premium setting starts with a mortality table, which shows for each age the probability of dying within a year, based on past experience. The insurer uses it to estimate expected claims. Then it adds loading for expenses, a margin for adverse experience and profit, and discounts for interest earned on funds. A simple pure (net) premium for one-year term cover equals the death probability times the sum assured. Longer policies need present values using an interest rate.

Actuarial valuation is the periodic check of the life fund. The actuary values the assets and the liabilities, which include future claims and bonuses on existing policies. The excess of assets over liabilities is the surplus. Under Section 49(1), a life insurer cannot use any part of the life insurance fund to declare a dividend to shareholders, a bonus to policyholders, or to pay on debentures, except a surplus shown in the valuation balance-sheet submitted to the Authority as a result of an actuarial valuation. Section 52 bars business on the dividing principle but allows bonuses allocated as a result of a periodic actuarial valuation, either as reversionary additions to sums insured or as immediate cash bonuses.

Section 64V adds that, for solvency checks, assets are valued at a value not exceeding market or realisable value, a proper value is placed on every liability, and a statement certified by an actuary approved by the Authority (for life business) is furnished as on 31 March each year.

Key rules to remember

One-year net (pure) premium: Net premium = q(x) × Sum assured; q(x) is the probability that a life aged x dies within the year. Ignores interest and loading.
Net premium with interest (death paid at year end): Net premium = q(x) × Sum assured ÷ (1 + i); Discounts the expected claim by one year at interest rate i.
Gross premium: Gross premium = Net premium + Loading for expenses, contingencies and profit; Loading may be a percentage of premium or of the sum assured. Read the question.
Valuation surplus: Surplus = Value of assets − Value of liabilities; Only a surplus shown in the valuation balance-sheet can be used for dividends and bonuses (Section 49(1)).
Shareholders' share of surplus (participating policies): Shareholders' share ≤ 10% of surplus, and not above the sum specified by the Authority; Under the second proviso to Section 49(1). In other cases the whole surplus may go to shareholders, again within the sums the Authority specifies.
Debenture payments out of surplus: Payments ≤ 50% of surplus (including interest); interest ≤ 10% of surplus; First proviso to Section 49(1). The 10% interest limit does not apply when the interest is offset against interest credited to the funds in setting the valuation interest basis.
Probability of survival: p(x) = 1 − q(x); Used when you need the chance of living to the end of the year.

How to solve Underwriting, Risk Selection and Actuarial Valuation questions

Use this order for any question on underwriting, premium or valuation. It keeps the working clear and shows the examiner your reasoning.

1Identify what is asked: risk classification, premium, surplus or the legal limit on distribution.
2For risk selection, list the relevant factors (age, health, occupation, habits, sum assured) and state the likely class: standard, substandard or declined.
3For premium, find q(x) from the table given, multiply by the sum assured, and apply interest discounting only if the question gives a rate.
4Add loading exactly as the question states it, and say whether you are giving a net or gross premium.
5For valuation, compute assets less liabilities to get the surplus. Check that liabilities include future claims and bonuses already attached.
6Test any proposed dividend, bonus or debenture payment against Section 49(1): is it from a valuation surplus, and is it within the percentage limits?
7State the result in a line and add a short reason, for example why surplus alone permits distribution.

Quickest way: Premium and distribution check in three lines

When to use it: Use when a numerical question gives a mortality rate and asks for a premium, or gives a surplus and asks how much can be paid out.

Premium: write q × sum assured, divide by (1 + i) if interest is given, then add loading.
Distribution: write the surplus first. If there is none, nothing can be distributed.
Apply the limits: 10% for shareholders in participating cases, 50% of surplus for debenture payments including interest, and 10% of surplus for interest alone (unless offset).

Common mistakes in Underwriting, Risk Selection and Actuarial Valuation

Treating the net premium as the premium the policyholder pays.
The loading step is skipped once the mortality calculation is finished.
Fix: Always ask whether the question wants net or gross premium. If gross, add the stated loading.
Ignoring interest discounting when a rate is given.
Students rely on the simple q × sum assured pattern.
Fix: If a rate is given and the claim is paid at year end, divide by (1 + i). If no rate is given, do not discount.
Saying dividends can be paid from the life fund or profits generally.
Company law ideas about distributable profits get mixed in.
Fix: For a life insurer, Section 49(1) allows dividend and bonus only from a surplus shown in the actuarial valuation balance-sheet.
Applying the 10% shareholder limit to all policies.
The proviso is memorised without its condition.
Fix: The 10% ceiling applies to participating policies. In other cases the whole surplus may go to shareholders, subject to the sums specified by the Authority.
Confusing the debenture limits.
There are two limits, 50% and 10%, and they look alike.
Fix: Total debenture payments including interest are capped at 50% of surplus. Interest alone is capped at 10%, unless offset against interest credited to the funds in the valuation basis.
Treating underwriting as only a medical check.
Students think of medical tests alone.
Fix: Include financial underwriting (income, need for the sum assured) and moral hazard, as well as health, occupation and habits.

Worked examples

Example 1

A life insurer issues a one-year term policy of ₹10,00,000 to a person aged 40. The mortality table gives q(40) = 0.002. Interest is 5% a year and death claims are paid at the end of the year. Expenses and profit loading is 20% of the net premium. Find the gross premium.

Show the solution

Expected claim = 0.002 × ₹10,00,000 = ₹2,000.
Discount for one year: ₹2,000 ÷ 1.05 = ₹1,904.76 (approximately). This is the net premium.
Loading = 20% × ₹1,904.76 = ₹380.95 (approximately).
Gross premium = ₹1,904.76 + ₹380.95 = ₹2,285.71 (approximately).

Answer: The gross premium is about ₹2,286.

Example 2

A life insurer's actuarial valuation shows assets of ₹5,200 crore and liabilities of ₹4,800 crore. The policies are participating. Find the surplus, the maximum share that can go to shareholders under the ten per cent rule, and the maximum payments on debentures including interest. Also state the maximum interest on debentures, assuming no offset against interest credited to the funds.

Show the solution

Surplus = ₹5,200 crore − ₹4,800 crore = ₹400 crore.
Shareholders' share is capped at 10% of surplus = 10% × ₹400 crore = ₹40 crore (also within any sum the Authority specifies).
Debenture payments including interest are capped at 50% of surplus = ₹200 crore.
Interest on debentures is capped at 10% of surplus = ₹40 crore, since there is no offset.
Remember that all distributions must come from this valuation surplus, as Section 49(1) requires.

Answer: Surplus is ₹400 crore. Shareholders may receive at most ₹40 crore, debenture payments at most ₹200 crore in total, and interest at most ₹40 crore.

Exam tips

Learn the Section 49(1) limits as three numbers: 10% for shareholders in participating policies, 50% for debenture payments, and 10% for debenture interest.
In MCQs, watch for the word surplus. Any option that allows a dividend or bonus without a valuation surplus is wrong.
In descriptive answers, tie each underwriting factor to a risk it controls, for example adverse selection or moral hazard.
Show every step in a premium sum. State clearly whether the answer is net or gross and whether interest was applied.
Do not quote section numbers you are unsure of. Use 49(1), 52 and 64V where they fit, and describe other rules in plain words.

Practice questions from Life Insurance

Underwriting, Risk Selection and Actuarial Valuation in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Underwriting, Risk Selection and Actuarial Valuation: frequently asked questions

What is life insurance underwriting?

It is the process by which an insurer evaluates a proposal, classifies the risk, and decides whether to accept it and at what premium. The aim is to price risk fairly and avoid adverse selection. Outcomes include standard rates, extra premium, restricted terms or refusal.

How is a premium calculated from a mortality table?

Take the probability of death at the person's age from the table and multiply it by the sum assured to get the expected claim. Discount it at the assumed interest rate if claims are paid later, then add loading for expenses, contingencies and profit. The result is the gross premium.

When can a life insurer pay a dividend or bonus?

Under Section 49(1) of the Insurance Act, 1938, it can pay a dividend to shareholders or a bonus to policyholders only from a surplus shown in the valuation balance-sheet, which results from an actuarial valuation and is submitted to the Authority. Shareholders' share is also limited by the provisos.

Does the Act allow bonuses on life policies?

Yes. Section 52 bars the dividing principle but allows an insurer to allocate bonuses as a result of a periodic actuarial valuation, either as reversionary additions to sums insured or as immediate cash bonuses. Section 112 also lets an insurer declare interim bonuses for policies that become claims in the intervaluation period, on the actuary's recommendation.