AINS 21 – Assignment 5

Underwriting

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Objectives

 What is Underwriting?
 What is the purpose of Underwriting?
 What are the activities involved in Underwriting Process?
• Line Underwriting Activities
• Staff Underwriting Activities
 What is process of Underwriting?
 What are the factors and process involved in Premium Determination?
 What is Underwriting Management ?
 What are the Regulations of Underwriting Activities?
 What is the process of Ratemaking?

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Introduction
Underwriting: Process of selecting insureds, pricing coverage, determining insurance policy terms and conditions and
then monitoring the underwriting decisions made

Line Underwriter: Underwriter who is primarily responsible for implementing the steps in the underwriting process.

Staff Underwriter: Underwriter who is usually located in the home office and who assists underwriting management
with making and implementing underwriting policy

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 Purpose of Underwriting
pose of Underwriting
 Overarching purpose: Develop and maintain a profitable book of business for the insurer.

 Book of business : A group of policies with a common characteristic, such as territory or type of coverage, or all
policies written by a particular insurer or agency.

1. Purpose to achieve profitability:

1.1 Guard against adverse selection Underwriters are an insurer’s guard against adverse selection.

• Adverse selection :The tendency for people with the greatest probability of loss to be the ones most
likely to purchase insurance.

• Underwriters minimize the effects of adverse selection by:

 Carefully selecting the applicants

 Charging appropriate premiums

 Monitoring applications and books of business for unusual patterns of policy growth or loss

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Contd…
pose of Underwriting
1.2. Ensuring adequate Policyholders’ Surplus
• Policyholders’ Surplus – written premium minus the loss liability/expenses
• Capacity – the amount of business an insurer is able to write

Underwriters ensures the adequacy of Policyholders’ surplus by:

• Adhering to underwriting guidelines.
• Making certain that all loss exposures are correctly identified.
• Charging adequate premiums for the applications that are accepted.

1.3. Enforcing Underwriting guidelines

Underwriting guidelines – A written manual that communicates an insurer’s underwriting policy.

specifies the attributes of an account that an insurer is willing to insure
Underwriters ensure that:
• Applicants accepted adhere to underwriting guidelines
• If loss exposures, risk, or policy limits on an application exceed an underwriter’s authority, they seek
approval through supervisory and management ranks within the underwriting department

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Underwriting Activities

1. Line Underwriting Activities

1.1 Selecting Insureds:

 Carefully screening applicants to determine which ones to insure.

 Line Underwriters perform this activity.

 Insurers cannot accept all applicants since

• They should avoid adverse selection: people with the greatest possibility of loss are often
more likely to purchase insurance

• Rationing an insurer’s available capacity to obtain an optimum spread of loss exposures by

location, class, size of risk, and LOB.

• Selecting better-than-average accounts.

• Charging adequate premiums of accounts with higher than average chance of loss.

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Contd…
1.2 Classify and Price Accounts:
• Underwriting Pricing Goal – premium for each insured should be at a level to enable the total
premiums paid by a large group of similar insureds to pay the losses and expenses of that group and
also allow the insurer a reasonable profit

• Premium Determination – Premium is the total amount of money an insured pays the insurer for a
particular policy or coverage.

1.3 Recommend or Provide Coverage – Line Underwriters support producers and policy holders by
inquiring about an insured’s risk management program.

1.4 Manage a Book of Business – Book of business (Portfolio) group of policies with a common
characteristic or written by the same agency/insurer

1.5 Support Producers and Customers – Line underwriters are usually directly involved with producers
in preparing policy quotations.

1.6 Coordinate with Marketing Efforts – Line underwriter should not reject applications that meet insurer
underwriting guidelines simply because of underwriter’s bias against a particular class of business.

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Contd…
2. Staff Underwriting Activities
2.1 Research the market - Staff underwriters share these responsibilities with actuarial and marketing
departments.

2.2 Formulate the Underwriting Policy - A guide to individual and aggregate policy selection that supports an
insurer’s mission. statement.

2.3 Revise Underwriting Guidelines - they are responsible for revising underwriting guidelines so that they
accurately reflect changes in underwriting policy.

2.4 Evaluate Loss Experience – they evaluate an insurer’s loss experience to determine whether changes
should be made in underwriting guidelines. Insurance Products that have losses greater than those
anticipated are usually targeted for analysis.

2.5 Research and Develop Coverage Forms – Coverage forms are developed by both insurance advisory
organization and individual organizations. Advisory organizations is an independent organization that works
with and on behalf of insurers that purchase or subscribe to its services.

2.6 Review and Revise Pricing Plans – they review and update rates and rating plans continually, subject to
regulatory, constraints, to respond to changes in loss experience, competition, and inflation.

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Contd…
2.7. Arrange Treaty Reinsurance - they are responsible for securing and maintaining treaty reinsurance.

2.8. Assist Others with complex Accounts: Staff underwriter serve as consultants to other underwriter.
They regularly see complex and typical accounts, unlike most line underwriters.

2.9. Conduct Underwriting Audit – A review of underwriting files to ensure that individual underwriters are
adhering to underwriting guidelines.

2.10. Participate in industry Associations: Many insurers are members of national and state associations
that address insurance industry concerns.

2.11. Conduct education and training: Staff underwriters are usually responsible for determining the
education and trainings needs of the line underwriters. They often develop course and serve as
instructors in technical insurance subject.

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Underwriting Process:
 An underwriter engages in a series of steps and tasks incorporating these underlying concepts:
• The purpose of underwriting is to develop and maintain a profitable book of business
• Underwriting activities include line underwriting activities and staff underwriting activities.
• Levels of underwriting authority are based on experience and knowledge.
• Underwriting policy should support an insurer’s mission.

1. Evaluate the submission

 Evaluating the submission’s loss exposures and associated hazards.
1.1 Hazard – A condition that increases the frequency or severity of a loss.
Physical hazard:
A tangible characteristic of property, persons, or operations that tends to increase the frequency or
severity of loss.
Moral hazard:
A condition that increases the likelihood that a person will intentionally cause or exaggerate a loss.
Morale hazard (attitudinal hazard)
A condition of carelessness or indifference that increases the frequency or severity of loss.
Legal hazard
A condition of the legal environment that increases loss frequency or severity.
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Contd…
1.2 Weighing the need for information – Underwriters apply information efficiency to weigh the need
for information against the cost to obtain it.

 Information efficiency – is the balance the underwriters must maintain between the hazards presented by
the account and the information needed to underwrite it.

1.3 Gathering the necessary information – underwrites compile information from many sources to
develop a profile of a submission.
 Underwriters need adequate information to analyze the potential losses each applicant represents. There
are various sources of information an underwriter can use:

• Producers: may supply data not already included in the application such as a personal evaluation

• Consumer Investigation reports: are independent reporting services that investigate applicants for a
fee

• Government Records: Such as MVR (Motor Vehicle Reports), Court Records and Public Information
regarding property ownership

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Contd…

 Financial Rating Services: D&B (Dun & Bradstreet) provide a credit rating score and Standard & Poor’s
provide the financial stability of an applicant

 Inspection Reports: can be obtained from inspecting the premises

 Field Marketing Personnel: spend much of their time on the field and may provide additional insight

 Claim Files: provide insight on frequency and severity of past losses

 Production Records: take into account the producers track record

 Premium Audit Reports: provide final figures from insured accounting record to obtain the final premium

 Applicants/Insureds Records: Annual Reports, Financial Reports, Web Sites, etc.

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Contd…

2. Develop Underwriting Alternatives

 The underwriter must consider each alternative carefully and choose the optimal one for the
circumstances.
Underwriters may:
• Accept submission as is
• Reject the submission
• Accept the submission subject to certain modifications

 Counteroffer – A proposal an offeree makes to an offeror that varies in some material way from the original
offer, resulting in rejection of the original offer and constituting a new offer.

Four major ways that submissions can be modified:

• Require risk control measures
• Change insurance rates, rating plans, or policy limits
• Amend policy terms and conditions
• Use facultative reinsurance

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Contd…

3. Select an Underwriting Alternative

 Selecting an alternative involves weighing a submission’s positive and negative features, including loss
exposures contemplated in the insurance rate, risk control measures, and management’s commitment to
loss prevention.

Factors to be considered before selecting an underwriting alternative:

• Underwriting authority – if the underwriter lacks authority, the submission must be referred to a higher
underwriting authority.
• Supporting business – a submission that is marginal by itself might be acceptable if the other insurance
components of the applicant’s account—the supporting business—are desirable.
• Mix of business – the underwriting policy determined by management and specified in the underwriting
guidelines frequently indicates the insurer’s mix-of-business goals.
• Producer relationships – the relationship between the underwriter and the producer should be based on
mutually shared goals.
• Regulatory restrictions – an underwriter must be aware of state regulations that restrict underwriter’s
ability to accept or renew business. Additionally, federal and state privacy laws restrict the type and the
amount of information about an applicant that an underwriter can obtain.

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Contd…
4. Determine an Appropriate Premium
• An underwriter must ensure that each loss exposure is properly classified so that it is properly rated.
• Insurance low costs are typically based on an elaborate classification system in which similar loss exposures
are combined into the same rating classification.
• For most types of personal insurance, workers compensation, and some other commercial insurance, proper
classification automatically determines the premium.
• For some types of commercial insurance, such as general liability, an underwriter might have the option of
adjusting the premium based on the characteristics of the account’s loss exposures.

5. Implement the Underwriting Decision

Involves three tasks:
5.1.Communicate the decision – If the decision is to accept the submission with modifications, the reasons
must be clearly communicated to the producer and applicant, and the applicant must agree to accept or
implement any modifications made as a counteroffer. If the underwriter decides to reject the application, he
or she must communicate the rejection to the producer in a positive way to preserve their long-term
relationship.
5.2. Issue documents – In accepting a submission, an underwriter might need to issue a binder and prepare
certificates of insurance.
5.3 Record information – Information about the policy and the applicant are recorded for policy issuance,
accounting, statistical, and monitoring purposes.

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Contd…
6. Monitor the Underwriting Decision
Underwriter has two tasks to ensure satisfactory results:
6.1 Monitor individual policies – an underwriter must be alert to changes in insured’s loss exposures.
Triggering events:
• Substantive policy changes
• Significant and unique losses
• Preparation for renewal
• Risk control and safety inspections
• Premium audits

6.2 Monitor books of business – entails evaluating the quality and profitability of all the business written for
any group of policies.
• The evaluation should identify specific problems for each type of insurance, which can be
subdivided into class of business, territory, producer, and other policy subgroups.
• Underwriters use premium and loss statistics to identify aggregate problems in a deteriorating book
of business.
Special attention is given to some books of business when they are defined by these characteristics:
• Class of business
• Territories or geographic areas
• Producers

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Premium Determination
 Rating – the activity of determining the policy premium or pricing.
 Insurance premium – is a periodic payment by the insured to the insurer in exchange for insurance
coverage.
 Premium (final price) – is calculated by multiplying the insurance rate by the number of exposure
units

1. Insurance Rates
Rate :
 the price exposure unit for insurance coverage.
 Is the “unit price” for insurance.
2. Exposure Units –is the fundamental measures of the loss exposures used in insurance rating.
 Ex:
Homeowners Insurance: Exposure Unit = $1,000 of insured value
For $400,000, the number of exposure unit is 400
For $200,000, the number of exposure unit is 200

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Contd…
3. Calculation of Premiums (Rate x Exposure Units)

Analogy: Pricing Structure at a produce stand

3.1. .2 peaches are sold at the price (or rate) of $0.40 per peach
Cost:
Rate per unit x Number of units = Price
$0.40 per peach x 2 peaches = $0.80

3.2. 5 pounds of peaches at the price of $0.98 per pound

$0.98 per pound x 5 pounds = $4.90

Insurance : Based on rates contained in the insurer’s rating manuals, the final price of
insurance (the premium):

Rate per unit x Number of exposure units = Premium

Ex: If the insurance rating system show a rate of $900 per auto to provide collision coverage for
one year, and a company wants to insure five autos.
Rate per unit x Number of exposure unit = Premium
$900 per auto x 5 autos = $4,500
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Contd…
Ex: A commercial property policy has a rate of $0.50 per $100 of building insurance, and the building is being
insured for $600,000.

Insured value ÷ Unit size = Number of exposure units

$600,000 ÷ $100 = 6,000 units

Rate per unit x Number of exposure unit = Premium

$0.50 x 6,000 = $3,000

4. Other Factors Affecting Premium Determination

• Other factors can affect premium determination
• Underwriters apply experience or scheduled rating credits to “better-than-average” risks and experience
or scheduled debits to “worse-than-average” risks.
• For example, an underwriter might apply a 10 percent premium reduction to a better-than-average risk
and a 5 percent premium increase to a worse-than-average risk.
• Other factors that affects final premiums: minimum premiums, increased limit factors for liability
insurance, additional charges for certain coverage options, good-student discounts, and fire protection
systems.

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Underwriting Management

1. Participating in Insurer Management:

• The head of an insurers underwriting department participates with other members of insurers management in
making the insurers goals

2. Arranging Reinsurance: The underwriting management handles arranging of reinsurance for the insurer.

3. Delegating Underwriting Authority: Management needs to decide how much underwriting authority it will
be delegating to the various underwriters i.e. how much can the underwriter do on his own without obtaining
approval

4. Developing and Enforcing Underwriting Guidelines: Underwriting Management has to develop and
communicate the guidelines that the underwriters should use. Underwriters use these guidelines to evaluate and
decide how to handle the applications they receive

5. Monitoring Underwriting Results: Management should monitor the underwriting guidelines to see if they
have had the desired effect. This can be done by underwriting audits – sending an audit team to examine
underwriting files

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Regulation of Underwriting Activities

1. Prohibited of Unfair Discrimination

• State regulations prohibit discrimination in insurance.
• The challenge lies in distinguishing between fair discrimination and unfair discrimination.
• Underwriting entails distinguishing among properties, businesses, and people and grouping them into
categories.
• Geographic Location – Refusing to issue, cancelling or nonrenewing coverage based on geographical
location alone i.e. redlining – creating a red line on a map based on location

• Gender or Marital Status - Refusing to issue, cancelling or nonrenewing coverage solely on gender or
marital status

• Race - Refusing to issue, cancelling or nonrenewing coverage solely on insured race

2. Restrictions on Cancellation and Nonrenewal

• Most states require that insurers provide notification to the insured before a policy is to be cancelled or no
renewed

• Most states require that an insurer provide notification to the insured within a specified period, such as
thirty days, before a policy is to be cancelled or nonrenewal.
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Ratemaking
 Ratemaking – is a complex process insurers use to calculate insurance rates, which are a premium component.
 Actuary – a person who uses mathematical methods to analyze loss data and develop insurance rates.
 Insurance rating system – is the price per exposure unit determined by adjusting the prospective loss costs
for expenses, profits, and contingencies.

 Loss costs – is the portion of the rate that covers projected claim payments and loss adjusting expenses.

1. Insurance Advisory Organizations – an independent corporation that works with and on behalf of
insurers that purchase or subscribe to their services, which include developing prospective loss costs and
standard policy forms.
• Insurance Services Office, Inc. (ISO)
• National Council on Compensation Insurance (NCCI)
• American Association of Insurance Services
• Surety and Fidelity Association of America

 Insurance advisory organizations continually collect loss information from many insurers.

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Contd…
2. Insurance Rating System
• Insurance Rating Systems – combine loss data from many insurers, an approach is based on the law
of large numbers.

• Law of large numbers – a mathematical principle stating that as the number of similar but independent
exposure units increases, the relative accuracy of predictions about future outcomes (losses) also
increases

2.1. Loss Costs

 Prospective loss costs indicate the amount of money an insurer can expect to pay for future claims for
each exposure unit.

 Insurer must also cover its expenses and allow for profits and contingencies

 Once determined, rates are published in an insurer’s rating manual or stored in the insurer’s rating
system.

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Contd…
2.2. Class Rating

• A rating approach that uses rates reflecting the average probability of loss for businesses within large
groups of similar risks; the predominant method used for rating commercial properties.

• All members of a class are charged the same rate for insurance

• The basic premise of an insurance classification and rating system is that insured's with similar
characteristics have similar potential loss frequency and severity.

• The groupings or classes should be big enough to reflect the law of large numbers but small enough
that all members share characteristics related to frequency and severity of loss.

2.3. Individual Rating

• Sometimes called specific rate
• A type of insurance rate that reflects the unique characteristics of an insured or the insured’s property.
2.4. Final Rate and Premium Determination
• Final rate – is the price per exposure unit determined by adjusting the prospective loss costs for
expenses, profits, and contingencies.
• To conduct business, insurers pay not only loss costs but also other expenses, such as underwriting
and loss adjustment expenses, and plan for profits and contingencies.
• After the final rate has been calculated, it is multiplied by the number of exposure units to determine
the final insurance premium.

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 Thank you

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Apply your Knowledge?

Exercise:
ABC Company is a new business that provides Internet marketing services to commercial clients. ABC is applying for
workers compensation insurance for its seven employees who are classified as clerical employees. The manual rate is
$0.30 per $100 of payroll. ABC’s annual payroll is $500,000.
Calculate the basic premium that would be charged for ABC’s seven employees, ignoring any additional rating
factors that might apply.

a. $300
b. $3,000
c. $1,500
d. $10,500

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