Assignment 8: The Underwriting Function Flashcards
Underwriting
The process of selecting insureds, pricing coverage, determining insurance policy terms and conditions, and then monitoring the underwriting decisions made
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
The overarching purpose of underwriting is for a profitable book of business to be developed and maintained
Additional Purposes of the Underwriting Function
- Guarding against adverse selection
- Ensuring adequate policyholders’ surplus
- Enforcing underwriting guidelines
Adverse Selection
In general, it is the tendency for people with the greatest probability of loss to be the ones most likely to purchase insurance
Policyholders’ Surplus
Under statutory accounting principles (SAP), it is an insurer’s total admitted assets minus its total liabilities
This must be adequate if an insurer wishes to increase its written premium volume
Capacity
The amount of business an insurer is able to write, usually based on a comparison of the insurer’s written premiums to its policyholders’ surplus
Underwriting Guidelines (Underwriting Guide)
A written manual that communicates an insurer’s underwriting policy and that specifies the attributes of an account that an insurer is willing to insure
Underwriting Authority
The scope of decisions that an underwriter can make without receiving approval from someone at a higher level
This varies considerably by insurer and by type of insurance
Line Underwriter
An underwriter who is primarily responsible for implementing the steps in the underwriting process – primarily responsible for making day-to-day risk selection decisions
Their focus is evaluating new submissions and renewal underwriting
Staff Underwriter
An underwriter who is usually located in the home office and who assists underwriting management with making and implementing underwriting policy
Their focus is managing the risk selection process
Line Underwriters Activities
- Select insureds
- Classify and price accounts
- Recommend or provide coverage
- Manage a book of business
- Support producers and insureds
- Coordinate with marketing efforts
Staff Underwriters Activities
- Research the market
- Formulate underwriting policy
- Revise underwriting guidelines
- Evaluate loss experience
- Research and develop coverage forms
- Review and revise pricing plans
- Arrange treaty reinsurance
- Assist others with complex accounts
- Conduct underwriting audits
- Participate in industry associations
- Conduct education and training
Selecting Insureds
Underwriters’ effective account selection is essential to attaining the following goals:
- Avoiding adverse selection
- Charging adequate premiums for accounts with higher-than-average chance of loss
- Selecting better-than-average accounts for which the premium charged will be more than adequate
- Rationing an insurer’s available capacity to obtain an optimum spread of loss exposures by location, class, size of risk, and line of business
(Task for line underwriters)
Account Classification
The process of grouping accounts with similar attributes so that they can be priced appropriately
(Task for line underwriters)
Manuscript Policy
An insurance policy that is specifically drafted according to terms negotiated between a specific insured (or group of insureds) and an insurer
(Task for line underwriters – Recommend or provide coverage)
Production Underwriters
Underwriters with a blend of responsibilities of special agents and line underwriters; they usually confer personally with producers and assist them with developing accounts that are acceptable to the insurer
Research the Market
Includes an ongoing evaluation of the following:
- Effect of adding or deleting entire types of business
- Effect of expanding into additional states or retiring from states presently serviced
- Optimal product mix in the book of business
- Premium volume goals
(Task for staff underwriters)
Underwriting Policy (Underwriting Philosophy)
A guide to individual and aggregate policy selection that supports an insurer’s mission statement; it is developed within the context of markets insurers serve (standard, nonstandard, or specialty)
Standard Market
Average to better-than-average accounts for which the standard premium is at least adequate
Nonstandard Market
Higher-risk applicants who are charged a higher-than-average premium
Specialty Market
Accounts that have unique needs, such as professional liability, that are not adequately addressed in the standard market
Advisory Organization
An independent organization that works with and on behalf of insurers that purchase or subscribe to its services
Prospective Loss Costs
Loss data that are modified by loss development, trending, and credibility processes, but without considerations for profit and expenses
(Evaluation of this is a task for staff underwriters)
Loss Development
The increase or decrease of incurred losses over time
Trending
A statistical technique for analyzing environmental changes and projecting such changes into the future
Treaty Reinsurance
A reinsurance agreement that covers an entire class or portfolio of loss exposures and provides that the primary insurer’s individual loss exposures that fall within the treaty are automatically reinsured
(Task for staff underwriters)
Referral Underwriters
When an application exceeds a line underwriter’s authority, they can review and approve the risk – staff underwriters function as these
Underwriting Audit
A review of underwriting files to ensure that individual underwriters are adhering to underwriting guidelines
They focus on proper documentation; adherence to procedure, classification, and rating practices; and conformity of selection decisions to the underwriting guide and bulletins
Ways Insurers Grant Underwriting Authority
Underwriters: Experience and positive results
Producers: Experience, profitability, and contractual arrangements (may be only for certain types of insurance within specific coverage limits)
Managing General Agents (MGAs): When appointed, they assume decentralized underwriting authority, which capitalizes on an MGA’s familiarity with local conditions
Automated Underwriting Systems
Depending on the type of insurance, these can be used to encode underwriting guidelines
What Underwriting Policy Determines
The composition of the insurer’s book of business, including:
- lines and classes of business that the insurer will offer
- amount of business the insurer is willing to write
- rating philosophy and forms the insurer will apply
- territories to be developed
Constraints of Underwriting Policy
- Financial Capacity
- Regulation
- Personnel
- Reinsurance
Financial Capacity as a Constraint of UW Policy
An insurer’s financial capacity refers to the relationship between premiums written and the size of the policyholders’ surplus, which is an insurer’s net worth
National Association of Insurance Commissioners (NAIC)
An association of insurance commissioners from the fifty U.S. states, the District of Columbia, and the five U.S. territories and possessions, whose purpose is to coordinate insurance regulation activities among the various state insurance departments
Premium-to-Surplus Ratio, or Capacity Ratio
A capacity ratio that indicates an insurer’s financial strength by relating net written premiums to policyholders’ surplus
It is too high if it exceeds 3-to-1 (or 300%)
Statutory Accounting Principles (SAP)
The accounting principles and practices that are prescribed or permitted by an insurer’s domiciliary state and that insurers must follow; these rules are often conservative
Return on Equity (ROE)
A profitability ratio expressed as a percentage by dividing a company’s net income by its net worth (book value). Net worth varies depending on the context (shareholders’ equity, owners’ equity, or policyholders’ surplus)
It is a key financial ratio used by insurance regulators for solvency surveillance (acceptable ratio is typically between 5-15%)
This is maximized by
1. Setting return thresholds
2. Redirecting focus on target business classes
3. Adjusting underwriting policy based on jurisdiction
GAAP vs. SAP in Computing ROE
GAAP uses average owners’ equity as the net worth for ROE; SAP uses average policyholders’ surplus as the net worth for ROE
Regulation as a Constraint of UW Policy
Regulation affects underwriting policy in several ways:
- Insurers must be licensed to write insurance in each state in which they write insurance
- Rates, rules, and forms must be filed with state regulators
- Some states specifically require underwriting guidelines to be filed
- If consumer groups believe that the insurance industry has not adequately served certain geographic areas, regulatory focus on insurance availability can lead to requirements to extend coverage to loss exposures that an insurer might otherwise not write
Market Conduct Examinations
An analysis of an insurer’s practices in four operational areas: sales and advertising, underwriting, ratemaking, and claim handling
Personnel as a Constraint of UW Policy
Insurers require the talent of specialists to market their products effectively, underwrite specific lines of business, service their accounts, and pay claims for losses that occur (must have sufficient number of properly trained underwriters)
Reinsurance as a Constraint of UW Policy
The availability and cost of adequate reinsurance can influence underwriting policy
Purposes of Underwriting Guidelines
- Provide for structured decisions (identifying major considerations to evaluate for each type of insurance)
- Ensure uniformity and consistency
- Synthesize insights and experience
- Distinguish between routine and nonroutine decisions
- Avoid duplication of effort
- Ensure adherence to reinsurance treaties and planned rate levels
- Support policy preparation and compliance
- Provide a basis for predictive models
Predictive Modeling
A process in which historical data based on behaviors and events is blended with multiple variables and used to construct models of anticipated future outcomes; it assigns a rank/score to all variables present
Purposes of Underwriting Audits
Staff underwriters conduct periodic audits to monitor line underwriters’ adherence to the practices and procedures outlined in the underwriting guidelines
They provide staff underwriters with information on the effectiveness of the underwriting guidelines
Application (for insurance)
A legal document that provides information obtained directly from an applicant requesting insurance and that an insurer can use for underwriting and claims handling purposes
Underwriter
An insurer employee who evaluates applicants for insurance, selects those that are acceptable to the insurer, prices coverage, and determines policy terms and conditions
Underwriting Submission
Underwriting information for an initial application, or a substantive policy midterm or renewal change
Steps in the Underwriting Process
- Evaluate the Submission
- Develop Underwriting Alternatives
- Select an Underwriting Alternative
- Determine an Appropriate Premium
- Implement the Underwriting Decision
- Monitor Underwriting Decisions
UW Process Step 1: Evaluate the Submission
Evaluate a submission’s loss exposures and associated hazards; aim for information efficiency; use evaluation tools
Loss Exposure
Any condition or situation that presents a possibility of loss, whether or not an actual loss occurs
Hazard
A condition that increases the frequency or severity of a loss
Information Efficiency
The balance that underwriters must maintain between the hazards presented by the account and the information needed to underwrite it
Principal Sources of Underwriting Information
- Producers
- Applications
- Inspection Reports
- Government Records
- Financial Rating Services
- Loss Data
- Premium Audit Reports
- Claims Files
Premium Audit (Report)
Methodical examination of a policyholder’s operations, records, and books of account to determine the actual exposure units and premium for insurance coverages already provided
Underwriting Profit
Income an insurer earns from premiums paid by policyholders minus incurred losses and underwriting expenses
Underwriting Evaluation Tools
- Telematics
- Predictive Analytics
- Predictive Modeling
- Catastrophe (CAT) Modeling
- Internet of Things (IoT)
UW Process Step 2: Develop Underwriting Alternatives
An underwriter can either accept a submission as is, reject a submission, or make a counteroffer; if a counteroffer is made, modifications must be chosen
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 types of modifications are:
1. Require risk control measures
2. Change insurance rates, rating plans, or policy limits
3. Amend policy terms and conditions
4. Use facultative reinsurance
Rating Plan
A set of directions that specify criteria of the exposure base, the exposure unit, and rate per exposure unit to determine premiums for a particular line of insurance
Experience Rating
A rating plan that adjusts the premium for the current policy period to recognize the loss experience of the insured organization during past policy periods
Schedule Rating
A rating plan that awards debits and credits based on specific categories, such as the care and condition of the premises or the training and selection of employees, to modify the final premium to reflect factors that the class rate does not include
Retrospective Rating
A ratemaking technique that adjusts the insured’s premium for the current policy period based on the insured’s loss experience during the current period; paid losses or incurred losses may be used to determine loss experience
Facultative Reinsurance
Reinsurance of individual loss exposures in which the primary insurer chooses which loss exposures to submit to the reinsurer, and the reinsurer can accept or reject any loss exposures submitted
Agency Reinsurance
An alternative to facultative reinsurance where the producer divides insurance among several insurers
UW Process Step 3: Select an Underwriting Alternative
Involves weighing a submission’s positive and negative features including:
- Loss exposures contemplated in the insurance rate
- Risk control measures
- Management’s commitment to loss prevention
- Underwriting authority
- Supporting business
- Mix of business
- Producer relationships
- Regulatory restrictions
Supporting Business
A submission that is marginal by itself might be acceptable if the applicant has other desirable business (called supporting business)
Account Underwriting
A method of underwriting in which all of the business from a particular applicant is evaluated as a whole
Mix of Business
The distribution of individual policies that compose the book of business of a producer, territory, state, or region among various lines and classifications
UW Process Step 4: Determine and Appropriate Premium
Ensure that each loss exposure is accurately classified so that it is properly rated, with the appropriate premium charged
Loss Costs
The portion of the rate that covers projected claim payments and loss adjusting expenses
UW Process Step 5: Implement the Underwriting Decision
This generally involves three tasks:
1. Underwriting decision is communicated to the producer
2. Issuing any required documents (binder or certificates of insurance)
3. Record data about the applicant for policy issuance, accounting, statistical, and monitoring purposes
Binder
A temporary written or oral agreement to provide insurance coverage until a formal written policy is issued
Certificate of Insurance
A brief description of insurance coverage prepared by an insurer or its agent and commonly used by policyholders to provide evidence of insurance
UW Process Step 6: Monitor Underwriting Decisions
Existing policies are usually monitored in response to one or more triggering events:
- Substantive policy change requests
- Significant and unique loss occurrences
- Risk control and safety inspection reports
- Premium audit results
Measuring Underwriting Results
Can be done through both financial measures (combined ratio) and nonfinancial measures
Combined Ratio
A profitability ratio that indicates whether an insurer has made an underwriting loss or gain
From an insurer’s perspective, the lower it is, the better (under 100% → underwriting profit)
Pitfalls of Combined Ratio
Combined ratio can be distorted by changes in:
- Premium volume (often driven by changes in underwriting policy)
- Major catastrophe losses
- Delays in loss reporting
- Underwriting Cycles
These factors make it difficult to evaluate the effectiveness of underwriting
Underwriting Cycle
Historical cycle where periods of underwriting profits have been followed by underwriting losses (as measured by the combined ratio)
Profits → reduction of premiums to increase market share → … → eventual underwriting losses →increase premium rates to increase profits
Underwriting Nonfinancial Performance Standards
- Selection
- Product or line-of-business mix
- Pricing
- Accommodated accounts
- Retention ratio
- Hit ratio
- Service to producers
- Premium-to-underwriter
Hit Ratio
The ratio of insurance policies written to those that have been quoted to applicants for insurance; it provides information about the insurer’s competitiveness in the current insurance market
Inordinately high/low hit ratios might require further investigation
Production Underwriting
Performing underwriting function sin an insurer’s office as well as traveling to visit and maintain rapport with agents and sometimes clients
