10.1 - Underwriting Property Insurance

Question 1

Underwriting Property Insurance - The Role of Brokers and Agents

Answer 1

-increasingly insurers are giving Brokers underwriting authority within specified limits
-even when Brokers do not have UW authority, brokers must do a form of underwriting, to anticipate the questions that underwriters will ask and to present them with risks and terms they are willing to accept
-brokers and agents and underwriters all underwrite the risk, but they do so from different perspectives. Broker or agent underwrites for the insured and the insurer; the underwriter underwrites for the insurer
-broker or agent has personal contact with the insured, and may even know them personally, the UW only has the information provided by the broker or agent and generally does not know the insured
-conversely, the underwriter know the types of risk the insurer needs to insure to generate a profit, and the UW may also see why certain risks may not be appropriate for the insurer. This difference in perspective may cause conflict between the broker or agent and the underwriter
-broker or agent will use the same UW process as the insurer’s UW, with the added benefit of having direct contact with the prospective insured
-brokers or agents negotiate terms and conditions for new policies, endorsements, and renewal with the insurers, so they compare the client’s needs with the insurer’s requirements
-part of the negotiation is to pre-qualify the client for the insurer in accordance with the insurer’s UW rules and guidelines and the authority granted to the broker or agent by its contract with the insurer

Question 2

“underwriter”

Answer 2

(1) the insurance company or group that underwrites or insures a particular risk
(2) the individual within an insurance company whose responsibility it is to accept or reject business in the particular line in which she specializes and, in this way, choose the risk her principals are prepared to underwrite

Question 3

Underwriting Property Insurance - The Role of Underwriters

Answer 3

-to survive and make profit, insurers must offer coverage to insureds that, as a group, are likely to incur less in losses than they pay in premiums for their coverage, therefore, insurers must seek insureds that pose acceptable risks of loss, but avoid insureds that pose unacceptable risks of loss
-in accepting or rejecting risks on behalf of an insurer, UWs are in effect investing the insurer’s capital in those risks they accept and decline to invest capital in those risk they reject
-insurer needs an underwriting strategy, such as, identifying the types of risk the insurer wants to pursue; the lines of insurance it wants to UW; the reinsurance it can arrange; the amounts of insurance it will offer for the risks of different types and sizes; and the approach it will take to pricing, among other considerations
-underwriters are trained professionals that execute the insurer’s underwriting strategy

Question 4

The Underwriting Process

Answer 4

-both Broker and agent, and the underwriter have important roles in the underwriting process, in general there are three parts to that process:

1. Evaluating the risk
2. Making the underwriting decision
3. Pricing the risk

Question 5

The Underwriting Process:
1. Evaluating the Risk

Answer 5

-brokers or agents and underwriters needs to distinguish between the information that they would like to have and the information they need to have - need to know vs want to know

Among the considerations in evaluating a property risk are the following:
>acceptable and unacceptable risks
>claims history
>Financial factors
>physical factors (COPE - construction, occupancy, protection, and exposure)
-COPE and a single family dwelling
-heritage and historic dwellings

Question 6

The Underwriting Process:
1. Evaluating the Risk
- Acceptable and unacceptable risks

Answer 6

-insurer’s target market, high valued homes, condominiums, rental properties, commercial risks?
-guided by criteria determined by the insurer, which are part of the insurer’s strategic plan
-often specified in an Underwriting guide issued by the insurer’s head office underwriting department
-underwriting guide describes the types of risks the insurer is prepared to consider
-there is also the “line guide”, which describes the maximum amounts of exposure an insurance company is prepared to accept on various classes of risk

Question 7

“line guide”

Answer 7

a listing of the maximum amounts of exposure an insurance company is prepared to accept on various classes of risk

Question 8

The Underwriting Process:
1. Evaluating the Risk
- Claims History

Answer 8

-the losses a risk has incurred in the past are a critical tool for assessing the exposure to future loss that the risk represents
-record of pass losses describes the types of loss and the amount paid for each loss, and the UW process should determine what preventative measures, if any, have been taken to help prevent similar loss in the future, which is helpful in assessing how reasonable the coverage and other requested items are, as well as the price to charge
-when applicant indicates no claims history, UW should investigate further:
>did the applicant have insurance in the past? If not, no claims history to base an assessment on
>what deductibles do existing policies included - high deductible may mean the applicant has suffered previous losses and the current insurer has imposed a higher deductible to return more of the risk to the applicant
-a high deductible may also be a problem if the applicant has decided to repair the damages from losses that fall below the deductible. The UW may not learn of such losses and of the hazards that gave rise to them, and left unaddressed, those hazards may represent a large loss waiting to happen
-if the applicant’s current policy carries a large deductible, the UW should ask about all losses and not only losses in excess of the deductible
>the UW should check a commercially available database of personal property claims for losses involving theft or a suspicion of fraud on the part of an applicant or insured. If the applicant’s name should be found in the database, then the UW may follow-up with the Broker or agent about the applicant’s utmost good faith and whether the finding implies a moral hazard
-an UW needs to be careful with accusations of moral hazard, as failure to exercise caution in this regard may expose the insurer to a claim by the applicant for defamation of character
-denied claims should also be investigated as could identify a moral hazard, and can also identify a physical hazard that could cause legitimate claim if the UW were to accept the risk
-loss experience to be analyzed in terms of two basic elements - frequency and severity
-the frequency of loss is an important measure of how often losses are likely to occur, the more frequent, the more likely a severe or shock loss is to occur. The more costly a loss is likely to be, the more seriously the UW must consider whether to accept the risk or whether measures can be taken to reduce the likelihood of a severe loss
-less control over severity than frequency, no control over inflation or repair costs, among the many factors that may determine the final size of a claim, thus an UW might require, as a condition of coverage, that the applicant implement recommendations by the loss control inspector to reduce hazards that could give rise to a severe loss

Question 9

“frequency”

Answer 9

this is a measure of how often losses are likely to occur in the future. Assuming the average size of loss is constant, the higher the loss frequency, the worse the loss experience

Question 10

“severity”

Answer 10

this is the average size of the losses. The larger the loss, the higher the loss severity is said to be. And assuming the loss frequency is constant, the higher the loss severity, the worse the loss experience

Question 11

The Underwriting Process:
1. Evaluating the Risk
- Claims History - UW frequency and severity

Answer 11

-UW must understand frequency and severity as:
>descriptions of a risk’s loss experience
>measures of the exposure that the risk poses or would pose to the insurer; and
>determinants of the price and other terms under which the insurer might insure the risk

Question 12

The Underwriting Process:
1. Evaluating the Risk
- Claims History - Fraudulent Claims

Answer 12

> increase insurance premiums
cause direct economic loss to a community when the fire department, police, and doctors are called on
cause direct economic loss to individuals and families through physical damage to insured property
cause indirect economic loss by the increase in insurance premiums and the increased cost of products and services needed to repair physical damage
result in unnecessary death or bodily injury to the general public and to emergency responders

Question 13

The Underwriting Process:
1. Evaluating the Risk
- Financial Factors: Mortgages

Answer 13

-property is often used as security for a loan; a loan secured by an interest in property is called a mortgage
-the financial strength of an applicant or insured in part reflects the number and quality of the mortgages on the property
-risks with more than 2 mortgagees must be carefully reviewed and may in any event be unacceptable to many insurers
-in addition any risk with a mortgagee that is not a well-known lending institution must also be carefully reviewed

Question 14

The Underwriting Process:
1. Evaluating the Risk
- Physical Factors: An Overview of COPE

Answer 14

The factors to be assessed in any physical risk: COPE - Construction, Occupancy, Protection, Exposure

C - Construction
>includes a description of the types of material used in the walls and roof of the applicant’s or the insured’s building
>residential homes primarily constructed of frame or frame with brick veneer or solid brick
>high-rise apartment or condo buildings are primarily of hollow concrete block or fire-resistive construction
>other aspects of construction may include the size of the building, its age, the number of storeys, and the type of heating system and fuel used

O - Occupancy
>use of the property by its occupants, number of occupants, the space each occupies, the hazards associated with each occupancy, and any measures taken to reduce those hazards

P - Protection
>includes both public and private protection
>Public protection is based on town grades assigned to each municipality, which is based on the availability and effectiveness of fire hydrants, the municipal water supply and pressure, and the expertise and response time of the fire department
>town grades 1-4 are considered protected; town grades 5-8, semi-protected; and town grades 9 and 10 unprotected
>Private protection includes sprinklers or other extinguishing systems and fire-alarm systems

E - Exposure
>refers to the chance the applicant or insured will suffer a loss as a result of proximity to one of more other risks or potential causes of loss to the applicant

Question 15

The Underwriting Process:
1. Evaluating the Risk
- Physical Factors: COPE and a Single-Family Dwelling
>Construction

Answer 15

Questions for a Single-Family Dwelling:

> Construction:
-is the size of the dwelling inappropriate or perhaps disproportionate to the neighbourhood? A larger house may mean greater exposure to other houses
-is the construction standard, or is it odd or unusual (like an environmentally friendly home made of old auto tires
-how is the home heated? Are non-standard fuels used, such as wood or corn pellets? Is the home heated by oil and are the oil tanks above or below ground?
-what is the age of the dwelling? The older the dwelling, the drier and more flammable is any wood used in its construction and the greater possibility of faulty or older high-risk wiring or other construction flaws
-is the dwelling currently under construction or undergoing renovations? That heightens the risk of a fire or other insured loss
-size and configuration of the dwelling and the corresponding likelihood of loss
-increased value should be reflected in an increased amount of insurance and additional premium

Question 16

The Underwriting Process:
1. Evaluating the Risk
- Physical Factors: COPE and a Single-Family Dwelling
>Occupancy

Answer 16

Questions for a Single-Family Dwelling:

> Occupancy
-how many families occupy the dwelling? the greater the number of people, the greater amount of activity that could lead to a fire or other loss
-if the owner of the dwelling is not the sole occupancy, then is the dwelling leased to other occupants, or rented month-to-month? The longer the term of the lease, the more likely the tenant is to display some care or sense of responsibility for the accommodations
-if the dwelling is leased, does the owner require the tenant to have tenants legal liability insurance? How often does the owner see the inside of it? Tenants legal liability insurance protects the tenant against liability for damages caused by an insured peril to the premises they occupy. It also shows responsibility on the part of the tenant. And the more often the owner visits, the more likely they are to notice any behaviour or problems with the building itself that could give rise to loss
-is there a home business in the residence? Home businesses and associated property are not normally covered under homeowners policies
-is the dwelling vacant or unoccupied? Losses are more likely to occur if a dwelling is vacant or unoccupied, it may be a target for vandals or occupied by vagrants

Question 17

The Underwriting Process:
1. Evaluating the Risk
- Physical Factors: COPE and a Single-Family Dwelling
>Protection

Answer 17

Questions for a Single-Family Dwelling:

> Protection
-is the dwelling in an unprotected, semi-protected, or fully protected area? details should be obtained about water supplies, water pressure, professional or volunteer fire departments, and the distance of the dwelling from the nearest fire hall and fire hydrant
-does the dwelling have sprinklers? they are more common in multi-unit dwellings and condominiums than in detached homes
-does the dwelling have fire alarms? they are becoming more common in detached homes as part of security systems
-is the alarm local or monitored? If it is monitored, who is doing the monitoring and how reputable is the service?

Question 18

The Underwriting Process:
1. Evaluating the Risk
- Physical Factors: COPE and a Single-Family Dwelling
>Exposure

Answer 18

Questions for a Single-Family Dwelling:

> Exposure
-is the dwelling detached, semi-detached, or part of row housing?
-If it is detached, how far is it from its neighbours? This determines how likely a loss in one dwelling is to affect other dwellings close by
-is the dwelling located in an area prone to natural hazards such as earthquakes or tornadoes?
-is the dwelling located in a flood plain? Laws generally prevent new construction in flood plains, but many dwellings remain on flood plains
-does the insurer’s policy cover sewer backup? SBU is generally excluded from homeowners policies; coverage for SBU may be added by endorsement

Question 19

The Underwriting Process:
1. Evaluating the Risk
- Heritage and Historic Dwellings

Answer 19

-three main reasons that insurers may hesitate to insure a heritage or historic building:
1. Heritage buildings carry higher risks due to old wiring, piping, heating sources, foundations, and roofs
2. In the case of a claim, it may be too costly for insurance companies to replace the materials of designated heritage sites
3. Heritage buildings may require specific types of repairs with specific materials due to the various acts and bylaws in the different jurisdictions that apply once a building has been designated a heritage building

-in the event of a total loss to a heritage building, there is usually no legal requirement to replicate the original structure if it is rebuilt - but the agreement and bylaws need careful review to ensure that is the case
-in the event of a partial loss, the cost of repair is significantly higher than similar repairs to a modern building, so it is important that the amount of insurance be adequate to the risk
-obtaining accurate building replacement cost is important and requires the skills of knowledgeable appraiser who understands such nuances of heritage construction and reconstruction such as:
>handmade bricks
>ornate hand-cut stone work
>elaborate fittings in plaster, stone, cast iron, or wood
>antique lighting fixtures
>antique flooring
>antique or stained-glass windows
>slate roofing
>custom trim work (interior and exterior)

-to rebuild heritage and historic buildings with such nuances will likely require:
>highly skilled craftspeople, from decorative artists and muralists to stonemasons
>hard-to-match materials, such as hand-hewn timbers an vintage brick shapes
>extra time to rebuild, because of the labour-intensive process of historic renovation; and
>additional professional services, to help with such matters as recertification and recovery of tax benefits

Question 20

The Underwriting Process:
2. Making the Underwriting Decision

Answer 20

-a good UW does not approach their work mechanically - deciding for or against a risk and what terms are acceptable by simply matching the risk to the appropriate page of the UW or line guide
-a good UW always seeks to understand a risk and its context as thoroughly as time and resources permit, and they are then creative as possible or necessary to insure the risk on terms acceptable to both the insurer and the insured

-generally an UW rejects a risk only if forced to by one or more of three considerations:
1. the risk is of a class not permitted by the UW or line guide or in some other way falls short of minimum requirements specified in the UW or line guide
2. market conditions or competitive considerations. for example, if the insurance cycle turns toward a hard market after a period of excess capacity in the market (soft market), an UW may be forced to reject an otherwise acceptable risk simply because the insurer has been forced to keep its total premiums to within an acceptable ratio or its surplus or capital
3. the risk is, on its own merits, too flawed to be accepted, and it is not possible to negotiate terms on which the risk could be made acceptable

-if none of these considerations obliges an UW to decline a risk outright, then they may negotiate terms under which the risk can be made acceptable
-there are many tools available to improve the risk: deductibles, premium rates, modifications of coverage, and implementation of recommendations by the loss control department to improve the risk, among many others
-making an UW decision thus becomes a skillful blending or options in an effort to find terms agreeable to both the insurer and the applicant that will make the risk acceptable

Question 21

The Underwriting Process:
3. Pricing the Risk

Answer 21

-premiums cannot be too low or the insurer will pay out more than it takes in and will ultimately go out of business
-premiums cannot be too high or the insurer will be undercut by their competitors
-insurer must have enough money to indemnify insureds for their losses, for other expenses, as well as a reasonable profit
-if the insurer needs $1.00 for each $100 of exposure to a certain risk but charges that risk only $0.95, then it must charge an additional $0.05 for each $100 of exposure to another risk to ensure it will have enough money for all of its needs

Question 22

The Underwriting Process:
3. Pricing the Risk
- Ratemaking

Answer 22

-price of insurance is based on historical data about incurred losses
-statistical techniques are applied to these data to develop a forecast of the rates needed to provide sufficient premium for future losses
-these statistical techniques are applied not by UWs but by actuaries, in a process called ratemaking
-in ratemaking, actuaries analyze the frequency and severity of past claims, estimate the ultimate cost of settling outstanding claims, and estimate the cost of future claims
-thus ratemaking is prospective rather than retrospective, it must use yesterday’s statistics to calculate today’s premiums to pay tomorrow’s losses
-with the development of more sophisticated analytical tools, the data cover more areas of information, and the calculation of rates to address all of the insurance company’s concerns and projections is becoming more detailed, however, this has not eliminated the need for intuition and experience
-major components of any rate are:
>anticipated costs of settling claims
>the acquisition costs of the business, such as commissions, and
>the cost of administering the process, including taxes levied on the premiums
-a rate will be adequate when:
>the actuarial forecast of future losses based on past losses is accurate for the population; and
>the sample represented by a particular book of business is representative of the population

Question 23

“rate”

Answer 23

-amount charged to an insured that reflects the expectation of loss for a covered risk, insurance company expenses, and profit. In other words, it is the basis of premium calculation for the insurance provided for the exposure

Question 24

“actuary”

Answer 24

-one who specializes in the mathematics of insurance, mortality rates and the like

Question 25

“ratemaking”

Answer 25

the process of compiling and analyzing data to establish rates that accurately reflect the level of risk. Usually performed by actuaries

Question 26

The Underwriting Process:
3. Pricing the Risk
- Ratemaking
- Considerations in Ratemaking: Perils and Hazards

Answer 26

-risks analyzed for their COPE factors
-non-hazardous occupancies in well-constructed, well-protected buildings with no serious exposures attract lower rates than hazardous occupancies in poorly-constructed and protected buildings facing serious exposures
-thus, all hazards become relevant to the process of determining rates for the classes of risk that are exposed to those hazards, two examples:
1. Geographic variations can bring about differences in rates even between classes of risk that are otherwise similar. For example, larger cities or in urban areas, generally the odds of vandalism or malicious mischief are dramatically higher than in smaller cities and towns or in rural areas - tends to increase rates for property insurance in urban areas
-the effects of a hazard on rates can be mixed - for example, fire can spread quickly between buildings in densely built urban areas, which by itself would suggest higher rates for fire coverage, but urban areas also tend to be well served by fire hydrants and professional fire departments, so that fire losses are more often partial than total, which would tend to reduce rates for fire coverage in urban areas
-conversely, response times for emergency services such as police and fire departments tent to be slower in rural areas, which makes total losses more likely than in urban areas - tends to increase rates for fire coverage in rural areas
2. In Canada, the majority of windstorm and hail events occur in Alberta, the southern Prairies, and southern Ontario. all large-loss hail events recorded in Canada have occurred in AB
-insureds in high-risk hail zones can expect to see not only coverage restrictions, but also rate increases

Question 27

“rating”

Answer 27

the process by which underwriters apply the rates developed by actuaries to the information that underwriters have gathered to determine premium for individual risks

Question 28

“premium”

Answer 28

the price of insurance protection for a specified risk for a specified period of time

Question 29

The Underwriting Process:
3. Pricing the Risk
- Rating

Answer 29

-the rate produced by the actuaries for a given class is then subjected to another process called rating, in which an UW applies the actuarial, or “manual” rate to a particular risk within the class according to the insurer’s underwriting philosophy, the competition in the marketplace, and the characteristics of each risk
-the modified rate for a particular risk is applied to the amount of insurance for that risk to determine the premium
>example - if the risk were insured against fire for $100,000 at a modified rate of $0.50 per $100 of insurance, the fire insurance premium would be ($0.50 per $100 of insurance) x ($100,000 of insurance) = $500
-thus the job of rating for the underwriter is essentially to determine whether a particular risk is better or worse than the average risk in the class and by how much; then modify the manual rate to reflect how the particular risk compares to the average risk

Question 30

The Underwriting Process:
3. Pricing the Risk
- Ratemaking - Considerations in Rating: Insurance to Value

Answer 30

-because most fire insurance losses are partial losses, many insureds may be inclined to purchase amounts of insurance far below the total value of their property - but adequate for their estimate of the size of loss they are likely to incur, which would cause the premiums of those willing to gamble on the likely size of a loss being subsidized by the premiums of those less likely to gamble, which is unfair
-practical solution has been for insurers to assume that insureds have bought insurance one the full value of their property which allows the ratemaking process to assign uniform rates to similar risks within groups
-the chance of a coinsurance penalty, applied mostly in commercial policies, helps encourage this insurance to value
-still, an UW who is modifying the actuaries’ manual rate for a particular risk needs to be confident in the value of the insured property if they are to be confident in the premium charged for the insurance
-a professional insurance appraisal is the best way to determine a building’s replacement cost, but most insureds find this too expensive to have done regularly, so instead, for personal property risks and for simple commercial risks, most insurers require completion of an estimator or calculator - a formula devised by professional appraisers, that estimates replacement cost based on features such as the size and location of the dwelling
-estimators and calculators are strictly guides, and if they are not used properly, residences can be drastically underinsured
-most valuation tools acceptable to insurers can produce accurate valuations, but they can be only as accurate as the detail entered by the user
-an inaccurate valuation completed by a broker or underwriter could result in improper coverage being applied, which could cause an improper premium to be charged