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CAS Online Course 1 > Assignment 8: The Underwriting Function > Flashcards

Assignment 8: The Underwriting Function Flashcards

1
Q

Underwriting

A

The process of selecting insureds, pricing coverage, determining insurance policy terms and conditions, and then monitoring the underwriting decisions made

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2
Q

Book of Business

A

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

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3
Q

Additional Purposes of the Underwriting Function

A
  • Guarding against adverse selection
  • Ensuring adequate policyholders’ surplus
  • Enforcing underwriting guidelines
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4
Q

Adverse Selection

A

In general, it is the tendency for people with the greatest probability of loss to be the ones most likely to purchase insurance

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5
Q

Policyholders’ Surplus

A

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

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6
Q

Capacity

A

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

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7
Q

Underwriting Guidelines (Underwriting Guide)

A

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

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8
Q

Underwriting Authority

A

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

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9
Q

Line Underwriter

A

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

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10
Q

Staff Underwriter

A

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

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11
Q

Line Underwriters Activities

A
  • Select insureds
  • Classify and price accounts
  • Recommend or provide coverage
  • Manage a book of business
  • Support producers and insureds
  • Coordinate with marketing efforts
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12
Q

Staff Underwriters Activities

A
  • 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
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13
Q

Selecting Insureds

A

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)

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14
Q

Account Classification

A

The process of grouping accounts with similar attributes so that they can be priced appropriately

(Task for line underwriters)

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15
Q

Manuscript Policy

A

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)

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16
Q

Production Underwriters

A

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

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17
Q

Research the Market

A

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)

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18
Q

Underwriting Policy (Underwriting Philosophy)

A

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)

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19
Q

Standard Market

A

Average to better-than-average accounts for which the standard premium is at least adequate

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20
Q

Nonstandard Market

A

Higher-risk applicants who are charged a higher-than-average premium

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21
Q

Specialty Market

A

Accounts that have unique needs, such as professional liability, that are not adequately addressed in the standard market

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22
Q

Advisory Organization

A

An independent organization that works with and on behalf of insurers that purchase or subscribe to its services

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23
Q

Prospective Loss Costs

A

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)

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24
Q

Loss Development

A

The increase or decrease of incurred losses over time

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25
Q

Trending

A

A statistical technique for analyzing environmental changes and projecting such changes into the future

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26
Q

Treaty Reinsurance

A

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)

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27
Q

Referral Underwriters

A

When an application exceeds a line underwriter’s authority, they can review and approve the risk – staff underwriters function as these

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28
Q

Underwriting Audit

A

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

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29
Q

Ways Insurers Grant Underwriting Authority

A

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

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30
Q

Automated Underwriting Systems

A

Depending on the type of insurance, these can be used to encode underwriting guidelines

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31
Q

What Underwriting Policy Determines

A

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

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32
Q

Constraints of Underwriting Policy

A
  • Financial Capacity
  • Regulation
  • Personnel
  • Reinsurance
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33
Q

Financial Capacity as a Constraint of UW Policy

A

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

34
Q

National Association of Insurance Commissioners (NAIC)

A

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

35
Q

Premium-to-Surplus Ratio, or Capacity Ratio

A

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%)

36
Q

Statutory Accounting Principles (SAP)

A

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

37
Q

Return on Equity (ROE)

A

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

38
Q

GAAP vs. SAP in Computing ROE

A

GAAP uses average owners’ equity as the net worth for ROE; SAP uses average policyholders’ surplus as the net worth for ROE

39
Q

Regulation as a Constraint of UW Policy

A

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

40
Q

Market Conduct Examinations

A

An analysis of an insurer’s practices in four operational areas: sales and advertising, underwriting, ratemaking, and claim handling

41
Q

Personnel as a Constraint of UW Policy

A

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)

42
Q

Reinsurance as a Constraint of UW Policy

A

The availability and cost of adequate reinsurance can influence underwriting policy

43
Q

Purposes of Underwriting Guidelines

A
  • 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
44
Q

Predictive Modeling

A

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

45
Q

Purposes of Underwriting Audits

A

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

46
Q

Application (for insurance)

A

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

47
Q

Underwriter

A

An insurer employee who evaluates applicants for insurance, selects those that are acceptable to the insurer, prices coverage, and determines policy terms and conditions

48
Q

Underwriting Submission

A

Underwriting information for an initial application, or a substantive policy midterm or renewal change

49
Q

Steps in the Underwriting Process

A
  1. Evaluate the Submission
  2. Develop Underwriting Alternatives
  3. Select an Underwriting Alternative
  4. Determine an Appropriate Premium
  5. Implement the Underwriting Decision
  6. Monitor Underwriting Decisions
50
Q

UW Process Step 1: Evaluate the Submission

A

Evaluate a submission’s loss exposures and associated hazards; aim for information efficiency; use evaluation tools

51
Q

Loss Exposure

A

Any condition or situation that presents a possibility of loss, whether or not an actual loss occurs

52
Q

Hazard

A

A condition that increases the frequency or severity of a loss

53
Q

Information Efficiency

A

The balance that underwriters must maintain between the hazards presented by the account and the information needed to underwrite it

54
Q

Principal Sources of Underwriting Information

A
  • Producers
  • Applications
  • Inspection Reports
  • Government Records
  • Financial Rating Services
  • Loss Data
  • Premium Audit Reports
  • Claims Files
55
Q

Premium Audit (Report)

A

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

56
Q

Underwriting Profit

A

Income an insurer earns from premiums paid by policyholders minus incurred losses and underwriting expenses

57
Q

Underwriting Evaluation Tools

A
  • Telematics
  • Predictive Analytics
  • Predictive Modeling
  • Catastrophe (CAT) Modeling
  • Internet of Things (IoT)
58
Q

UW Process Step 2: Develop Underwriting Alternatives

A

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

59
Q

Counteroffer

A

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

60
Q

Rating Plan

A

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

61
Q

Experience Rating

A

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

62
Q

Schedule Rating

A

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

63
Q

Retrospective Rating

A

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

64
Q

Facultative Reinsurance

A

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

65
Q

Agency Reinsurance

A

An alternative to facultative reinsurance where the producer divides insurance among several insurers

66
Q

UW Process Step 3: Select an Underwriting Alternative

A

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

67
Q

Supporting Business

A

A submission that is marginal by itself might be acceptable if the applicant has other desirable business (called supporting business)

68
Q

Account Underwriting

A

A method of underwriting in which all of the business from a particular applicant is evaluated as a whole

69
Q

Mix of Business

A

The distribution of individual policies that compose the book of business of a producer, territory, state, or region among various lines and classifications

70
Q

UW Process Step 4: Determine and Appropriate Premium

A

Ensure that each loss exposure is accurately classified so that it is properly rated, with the appropriate premium charged

71
Q

Loss Costs

A

The portion of the rate that covers projected claim payments and loss adjusting expenses

72
Q

UW Process Step 5: Implement the Underwriting Decision

A

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

73
Q

Binder

A

A temporary written or oral agreement to provide insurance coverage until a formal written policy is issued

74
Q

Certificate of Insurance

A

A brief description of insurance coverage prepared by an insurer or its agent and commonly used by policyholders to provide evidence of insurance

75
Q

UW Process Step 6: Monitor Underwriting Decisions

A

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

76
Q

Measuring Underwriting Results

A

Can be done through both financial measures (combined ratio) and nonfinancial measures

77
Q

Combined Ratio

A

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)

78
Q

Pitfalls of Combined Ratio

A

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

79
Q

Underwriting Cycle

A

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

80
Q

Underwriting Nonfinancial Performance Standards

A
  • Selection
  • Product or line-of-business mix
  • Pricing
  • Accommodated accounts
  • Retention ratio
  • Hit ratio
  • Service to producers
  • Premium-to-underwriter
81
Q

Hit Ratio

A

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

82
Q

Production Underwriting

A

Performing underwriting function sin an insurer’s office as well as traveling to visit and maintain rapport with agents and sometimes clients

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