INSURANCE CORNER

PART I

BASICALLY, underwriting consists of two components; risk assessment and pricing. Successful underwriting requires a system of risk selection to obtain a group in which loss results will be reasonably predictable by means of the law of averages or the law of large numbers, which states that given enough trials the frequencies of events with the same likelihood of occurrence even out. To accomplish this goal there must be a balance between obtaining volume and obtaining homogeneous or similar risks.

If an insurance company issuing individual life policies, for instance, adopted such strict standards that it would only accept individuals who were practically perfect physically, ideal from a moral stand point, and in risk free occupations, there would be only a very small group from which to choose. Such a group would be very homogeneous, with all the risk units, in this case the individual lives would present or pose the same chance of loss.

But the mass or volume of risk units would be very small, and thus the predictability of loss might be negatively affected. Another element that makes selection of such a group impractical would be the selection procedures that are necessary to obtain this near perfect set of individuals.

The expense involved would outweigh the savings from the mortality rate of the group. In underwriting, selection expense is a factor to be considered. There has to be a balance between the strictness of selection standards and the necessity of having a large volume of risk units to be insured.

As an example, group life insurance selection standards are set up to achieve this balance. Usually group insurance companies adopt selection standards broad

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.