Smoking is bad...Lying is worse
Written by Aaron Smith of Financial Times
August 21, 2024
Protective Life filed lawsuits to rescind three policyholders' life insurance policies last month, accusing them of concealing their tobacco use to obtain coverage, which the carrier claims it would never have issued at the agreed premium if it had known the truth about their smoking. In all three cases, Protective said that after the policies were issued it obtained medical records from physicians indicating that the policyholders were smokers at the time they applied for coverage.
Although this tactic of early rescission is unusual in the industry, it raises the question of whether it is more cost-effective to the carrier to deal with dishonest policyholders up front rather than contesting claims later. But according to Peter Selvin, an insurance lawyer and partner with the firm Ervin Cohen & Jessup LLP in Beverly Hills, the point is not to analyze the cost savings to the carrier but to make an example and create a deterrent against other smokers who might be tempted to lie during the application process. "These carriers must feel that as a matter of principle they don't want to get ripped off," he said. "What they're trying to do is to educate the marketplace to not lie on your applications," said Selvin.
Smoking is prevalent among life insurance policy holders. Milliman's IntelliScript division reviewed 42 million applicants over two decades and found that about 16% were using tobacco or had used it within the last few years. Lying about smoking is also prevalent, and it's been getting worse. According to a paper by underwriting researcher Doug Ingle, the percentage of applicants who "forgot to declare their nicotine use" climbed to 3.5% in 2022 up from 2% in 2015.
Deceit in the application can affect other parties besides the carrier and the applicant. Non-smokers will also bear the cost of lying smokers because the carrier will likely have to raise premiums. The process of "accelerated underwriting", which allows for almost instant approvals, relies on self-reporting, so, these products must be priced higher than fully underwritten products in order to "price in" in the falsifications.
Other carriers solve the problem in a different way. Once there is evidence of smoking, they send rate adjustment notifications to policyholders. If this becomes a trend, this strategy would lead to a two-stage system of underwriting, where the carriers issue policies based on self-reporting, then revoke or adjust them if they catch falsehoods after applicants have become policyholders. All of this means extra time, additional costs, and uncertainty for everyone involved. As technology advances, there may be additional opportunities for the carrier to increase their use of instant information such as third-party resources and electronic health records, which would catch more applicant lies before policies are issued.
