INSURANCE UNDERWRITING VALUES
enough to permit acceptance of the large majority of insurable risks at standard premium rates. However, certain groups employed in hazardous occupations will have mortality rates consistently higher than standard risks – miners, truck drivers, construction workers, workers at fuel refineries, service men/women as examples.
Such risks are classified as substandard risks and a policy covering them would have a higher premium rate. A risk may even be rejected entirely because the mortality rate is too great or too unpredictable for insurance to be practicable. The chance of loss is never exactly the same for all risks or groups, even within the classification of insurable risks into the standard class and several substandard classes. In each class there are good risks and bad risks relative to the rest of the class.
It is the goal of the insurance underwriter to establish rules which will result in securing an average proportion of good risks. If the underwriter can accomplish this goal, the company’s average claims cost will be lower and the company may be able to offer insurance at a lower net cost.
The practice of experience rating helps in achieving this goal. The rules adopted by various companies to secure the desired result will vary, based as they are on the individual company’s experience, research, judgment, and, at the end, intuition (sixth sense). But the aims they are trying to achieve are basically the same.
For successful operation in the insurance field, the rules established by any company need to achieve the proper balance between mass and homogeneity of risks to achieve predictability of future results. The rules should establish standards permitting acceptance of the large majority of risks at standard premium rates.
There is need to secure the largest possible proportion of the average risks within each classification. In order to achieve this proportion, a company may establish a policy of accepting border line cases which are not a gain from the underwriting stand point but would provide volume to spread out over head expense.
The objective of underwriting is to produce a pool of policy holders, by categories, whose actual loss experience will closely approximate the expected loss experience of a given hypothetical (imaginary) pool of policy holders. That is, if an underwriter is told that a pool of exposures with specified characteristics (e.g., a pool of brick buildings located no more than 4 miles from a fire station) will produce a specified loss rate of, say, 2% of the value of the insured property, then the underwriter should try to place in this pool all the exposures whose characteristics match the specifications.
If the underwriter does the job well, the loss ratio of the insureds/policy holders accepted will closely approximate the expected 2% figure. Putting applicants for insurance in the classification or pool that most closely reflects the real costs of their losses is the essence of good underwriting.
Contrary to some opinions, it is not the duty of the underwriter to reject so much business that the company experiences no losses. If the underwriter rejects all but the exceptionally safe exposures, he or she has probably turned away much desirable business and income. The insurance company expects a certain number of losses to occur, and it is just as much an underwriting error to reject profitable business as it is to accept loss prone business.
The core duty of an underwriter is to accept applicants so that the losses paid by the insurance company closely match the losses that the company expects to pay. The potential for conflict between the underwriter and the insurance agent is worth considering.
The underwriter’s performance is judged primarily on the quality, rather than the quantity of successful insurance policy holders. On the other hand, the agent is paid based on quantity of production. The conflict between the two parties is more apparent than real. The agent’s responsibilities include an initial screening of applicants.
If the agent knows a company will not accept a certain class of business, such applications should not be submitted. The underwriter knows that the greater amount of business accepted, the better the application of the law of large numbers. Moreover, the agent knows that, if the applications submitted consistently result in an above average number of claims, the insurance company might decide to terminate its relationship with the agent.
Thus, while a potential for conflict appears because of the different objectives of the underwriter and the agent, in practice they are both working toward the same goal, producing a large group of properly classified insurance policy holders.
The overall purpose of underwriting is to develop and maintain a profitable book of business for the insurance company/insurer. A book of business is all of the policies that an insurer has in force or some subgroup of those policies. For instance, a book of business can include all of an insurer’s commercial policies or all of its commercial general liability policies. Book of business may also refer to business produced in a specific geographic location or by a particular branch office or agency.
There is a trade-off between the need for information and the cost to obtain it.
a) Determining underwriting alternatives b) Selecting an underwriting alternative c) Determining the appropriate premium d) Implementing the underwriting decision. e) Monitoring the loss exposures.
Although well experienced underwriters do not always follow each of these steps in strict sequence, the order of these steps provides a sound framework for underwriters to make decisions. For example, as each piece of information is received, the underwriter considers how that information will affect the available alternatives.
Likewise, if the underwriter receives information clearly indicating that the applicant is a bad risk, he or she may immediately decide to reject the application for insurance cover. Look out for Part II.
Note: In this column I offer insurance information in general. Do not completely rely on this column to make particular insurance decisions. For specific insurance advice email me at; insuculture@gmail.com
The underwriter’s performance is judged primarily on the quality, rather than the quantity of successful insurance policy holders. On the other hand, the agent is paid based on quantity of production. The conflict between the two parties is more apparent than real. The agent’s responsibilities include an initial screening of applicants.