1. INSURANCE UNDERWRITING – PRINCIPLES AND PROBLEMS
LECT 3- IRU07203
INSURANCE UNDERWRITING – PRINCIPLES AND PROBLEMS

2. INTRODUCTION
In this topic we examine the basic principles that apply to the underwriting of general insurance risks.
And look at some of the problems that underwriters face.
We begin by defining the activity of underwriting.

3. MEANING OF UNDERWRITING
The purpose of underwriting is to choose to cover, from all the risks which are proposed to the insurer, those which collectively will be profitable.
Underwriting is the process of selecting and classifying applicants for insurance.
Or is the process of classifying applicants for insurance into various risk categories so that an appropriate premium will be charged.

4. MEANING OF UNDERWRITING cont..
Good underwriting helps the insurance company in the following ways:
Make the insurer financially stronger; and
Helps secure competitive advantage.

5. MEANING OF UNDERWRITING cont..
It is the critical process where the underwriter decides whether or not to insure applicants, and at what rates and conditions following standards set by the company.
Underwriting includes all the activities necessary to select risks offered to the insurer.

6. MEANING OF UNDERWRITING cont..
This is an insurance function responsible for assessing and classifying the degree of risk, a proposed insured or group represents and making a decision concerning coverage of that risk.

7. ASPECTS OF UNDERWRITING
Underwriting covers the following aspects:
Accepting or rejecting risks offered and fixing premiums and retentions (the insurer’s retention being the amount of the risk that is willing to cover);
Classifying and rating each risk, establishing the standards of coverage to be offered to acceptable risks;
Securing a safe and profitable distribution of risks and establishing standards, rules and procedures and to preserve those standards.

8. FUNCTIONS OF INSURANCE
Insurance performs the following functions:-
Risk transfer;
Creation of a common pool; and
Equitable premiums.

9. FUNCTIONS OF INSURANCE cont..
From the second function of insurance that is “CREATION OF A COMMON POOL”
An insurer sets up to operate a pool.
Also insurers operate a number of separate pools for each class of insurance
With contributions of many people going into the pool and the losses of few being met from it.

10. FUNCTIONS OF INSURANCE cont..
Company underwriters are responsible for managing the pool.
In managing the pool(s), underwriters have to:
Assess the risk that a person brings to the pool;
Decide whether to accept the risk and if so how much;
Determine the terms, conditions and scope of cover to be offered; and
Calculate a suitable premium.

11. GENERAL INSURANCE UNDERWRITING PROCESS
In general insurance, insurers general approach to underwriting can be distinguished in respect of:
Personal insurances; and
Commercial insurances.
Underwriting personal insurances is straightforward.

12. GENERAL INSURANCE UNDERWRITING PROCESS
The proposal form is the main source of information
If needed, the underwriter can request extra information from the proposer.
Underwriting of commercial business insurances is more complicated.
Commercial insurances range from small shops and factories to large multi-national corporations.

13. GENERAL INSURANCE UNDERWRITING PROCESS
The degree of the complexity of underwriting will differ with the size of the risk.
Certain principles need to be recognised.

14. BASIC UNDERWRITING PRINCIPLES
The insurance underwriting process consists of an assessment of the following:
The major underwriting factors affecting claims experience for a particular class of business.
e.g. frequency and severity of incidents in schools and colleges is higher than that presented by hardware shops;

15. BASIC UNDERWRITING PRINCIPLES
2. The “average” claim per member of the group; and
3. The proposer’s characteristics in comparison with the “average” member
In essence, the underwriter is evaluating the hazard associated with the risk which is being proposed.

16. MEANING OF UNDERWRITING cont..
The person responsible for evaluation and acceptance/rejection of risks and computation of premium is called as the underwriter.

17. UNDERWRITING PROCESS
Underwriting process involves the following steps:
Preparing quotations requested by clients;
A quotation is the document requested by a client containing the price, terms and conditions of the cover.

18. UNDERWRITING PROCESS cont..
2. Issuing Proposal Forms:
A proposal form is a document containing questions to be competed by the prospective insured and submitted to the underwriter.
It can be obtained from the insurer or an intermediary.
It is used for most personal insurances (like motor and household insurance).

19. UNDERWRITING PROCESS cont..
QUESTIONS CONTAINED IN THE PROPOSAL FORM:
General Questions:
Proposer’s name;
Proposer’s address;
Proposer’s occupation;
Period of insurance.
Specific Questions:
Proposer’s age;
Description of the subject matter to be insured;

20. UNDERWRITING PROCESS cont..
Business details;
Past insurance history;
Has the proposer been insured before?
Have they had insurance declined?
Loss record and claims experience?
Sum Insured or limit of liability.

21. UNDERWRITING PROCESS cont..
3. Premium Calculation:
A premium is the amount paid to an insurer in consideration of the insurer agreeing to cover the risk.
One of the tasks of the underwriter is to calculate a suitable and fair premium.
A suitable premium is one that reflects the risk presented by the proposer.

22. UNDERWRITING PROCESS cont..

23. UNDERWRITING PROCESS cont..
It contains all details of the item/exposure insured, the operative perils, period of cover, exceptions, conditions, the premium and other relevant information.
The policy is effectively evidence of the contract and not the contract of insurance itself.
The contract is concluded once the insurer accepts the proposal, terms have been agreed and the premium has been paid or has been agreed to be paid.

24. 5.0 UNDERWRITING PROCESS cont..
Cover Notes:
The production of the actual policy document may take some time.
Instead a cover note is given to the client as a temporary evidence of the contract.
A cover note is a document issued as evidence that insurance has been granted, pending the issue of a policy.

25. UNDERWRITING PROCESS cont..
Certificate of Insurance:
For compulsory insurances, it is a legal requirement that a certificate is issued to prove a policy is in force.
It is evidence that a contract of insurance exists.
It is issued by the insurer in the name of the insured.

26. 5.0 UNDERWRITING PROCESS cont..
5. Contract Certainty:
The insured must be assured of the acceptance of his/her risk by the insurance company.
The insurer must acknowledge to the insured that the risk has been accepted.

27. 5.0 UNDERWRITING PROCESS cont..
6. Premium Payment:
The insurance contract comes into force once the insurer accepts the proposal and the premium has been paid.
Payment will usually be:
A single upfront payment;
By credit; and
In monthly instalments.

28. METHODS OF UNDERWRITING
Pricing of insurance products is a very complicated task to most people.
It differs from pricing tangible products where one can figure out the cost of inputs.
Insurance is the business of buying risk.

29. PREMIUM COMPONENTS Two types of premiums:
Risk (pure) premium: is the amount which the underwriter must collect in order to cover the cost of claims only.
Office premium: is the amount finally charged to the insured
- This amount will be greater because it includes loadings for expenses.

30. The risk premium is determined by:
PREMIUM COMPONENTS
The risk premium is determined by:
Claim frequency;
Claim size
Claims-handling expenses
Modifying factors:
Effect of a deductible
Loading for contingencies
Adjustments for inflation

31. PREMIUM COMPONENTS Adjustments for investment income Expenses:
Commission
Expenses per policy (e.g. renewal costs)
General overheads
Profit loading
Market forces

32. THEORY OF RATING
For the generally acceptable risks the underwriter must decide what cover is to be offered and fix a premium for it.
‘Pricing’ aspect of underwriting is often described as rating.
Rating is the process whereby the insurer arrives at a premium to be charged for a given risk.

33. THEORY OF RATING cont.. Judgement rating:
There are three basic approaches to rating:
Judgement rating:
Means the fixing of a premium by means of personal intuition alone, without the use of statistical data.
risks are rated basing on the experience of the underwriter, when new of unusual risks are to be insured.

34. Group (or ‘Class’) rating:
THEORY OF RATING cont..
Group (or ‘Class’) rating:
Used for the vast majority of general insurance risks.
Insurance premium is often the product of two factors:
A measure (or unit) of exposure: the extent to which the insured subject matter is exposed to the risk of loss.
- In property insurance: value of the property
A premium rate

35. METHODS OF UNDERWRITING cont..
Experience rating:
Is the pricing of a risk on the basis of the proposer’s own past claims experience or rating the risk on its own merits.
It can be used for motor fleet risks, employer’s liability business.
Used to modify a premium that is initially set by the group (class) method.

36. Assessing the proposer in terms of Moral Hazards.
RISK ASSESSMENT
Is an overall process of risk identification, risk analysis and risk evaluation.
Involves an:
Assessing the risk proposed for insurance in terms of Physical Hazards; and
Assessing the proposer in terms of Moral Hazards.

37. RISK ASSESSMENT cont..
Physical Hazards: relates to the physical nature of the risk.
Examples include:
Motor insurance: age of driver; Condition of vehicle etc.
Security protection at a shop: better security systems.

38. RISK ASSESSMENT cont..
Personal accident and sickness: proposer’s occupation.
Property construction: materials used during construction.

39. carelessness: a driver’s lack of care; Dishonesty; Social attitudes.
RISK ASSESSMENT cont..
Moral Hazard: arises from attitude and conduct of people.
Example:
carelessness: a driver’s lack of care;
Dishonesty;
Social attitudes.

40. RISK ASSESSMENT cont..
Obtaining Material Facts: Through:-
Proposal forms;
Brokers;
Risk Surveys;
Questionnaires: e.g. in money insurance, fire risks, public liability risks;
Meeting with clients;
Call centres; and
Internet.

41. UNDERWRITING CYCLES Insurers enter the market
Increased Supply lower prices
Soft Market (lower prices)
Insurers exit the market due to losses
Decreased Supply causes prices to go up
Hard Market (higher prices)

42. PROBLEMS FOR THE INSURANCE UNDERWRITER
Moral hazard
Adverse selection
New risks and new covers
Long-tail claims: a problem associated with some forms of liability insurance.