Bullish Expectations Create Strain.

Forecasting the future value of assets is speculative at best. Yet, financial underwriters are asked to accept forecasts far beyond reasonable levels.

Unless your potential insured's financial planner is Carnac the Magnificent, there is no way to predict the future. Yet, spurred to action by what was until recently a strong economy and bullish stock market, financial planners are challenging direct life insurance underwriters to rethink the conventional approach to financial underwriting.

Increasingly, home office underwriters are being asked to accept forecasted growth estimates that far exceed historical comfort levels. But unlike Carnac, a late night television mystic who knew the contents of the envelope, underwriters are at a disadvantage when they don't have all the facts in front of them.

Life underwriters are trained to take future value into consideration. Future value is the process by which today's money grows in value over time. That amount is calculated by using an assumed rate of interest or appreciation for a given duration.

Very little published information exists to help predict how much an individual's net worth increases over time. What's more, no one gathers information about the financial condition of insureds at death. So, building an accurate model to predict the financial future of an insured is impossible.

It is possible, however, to generate empirical data from Forbes magazine's 400 wealthiest Americans listing. Beginning at the start of the bull market in 1993 and following it through 2000, the growth of the U.S. economy was unprecedented. During those eight years, 208 individuals were consistently on the list. After calculating the percentage change in net worth for the 208 individuals on the list and dividing them into quartiles, the average annual growth in net worth for those in the bottom quartile (52 of America's richest) was only 4.9%. It is difficult to conceive how these 52 individuals--who probably have access to the best financial planners and financial markets--could obtain such a meager growth rate over a period of time when the stock market was delivering record returns. Conversely, by looking at the other quartiles, one might ask why we cannot forecast at much higher levels, since 75% of those on the list achieved higher growth than the bottom quartile. This is what makes financial underwritin g so difficult.

Projecting future value is risky business. Some of these risks, which for the most part are outside the control of the proposed insured, include the following:

* inflation, which can reduce purchasing power;

* family situations, like divorce, which alter tax planning;

* financial uncertainty from a lob loss or disability;

* tax law changes that could alter exemptions;

* market risks; and

* interest rate changes, which can affect an asset's value.

While medical underwriting is traditionally considered somewhat of an art, financial underwriting is better classified as a science. We have an abundance of tools, including income multiples, capitalization formulas, and the future-value approach to help us reach an amount of coverage that appears to provide a solution to the customer's needs. Yet, all of the tools have limitations. Financial underwriting is much more complex than merely selecting an interest rate and duration.

Underwriters are trained to sniff out cases that might present some form of anti-selection, selective lapses, or increased potential for violent death. These large estate planning cases can have a huge impact on the emergence of a block of business. A single case could have a devastating effect on a company's profitability.

To help minimize the impact of financial anti-selection, underwriters employ four tests. These tests apply to all cases and assist underwriters in determining the validity of the proposed scenario.

* Vulnerability: Is insurance the best method to protect the financial objective?

* Attainability: Is the forecasted growth realistic?

* Normalcy: Is the financial objective normal or speculative?

* Desirability: How strongly motivated is the applicant to achieve the objective?

As is the case with any approach to financial underwriting, the amount of coverage in force and applied for must bear some correlation to the applicant's current income and net worth. It is important for the underwriter to understand the purpose for which the policy is intended. Through this understanding, the underwriter can determine if the beneficiary's economic loss is in line with the total line of insurance. Then, the growth rate and duration variables can be tested for soundness.

Barry A. Wilkinson, a Best's Review columnist, is vice president and chief underwriting officer at Lincoln Re, Fort Wayne, Ind.