Study 1: Introduction to Underwriting

Question 1

Define Insurance

Answer 1

Insurance - A contract where one party (insurer), for monetary consideration agrees to reimburse the other party (insured) for a loss.

Question 2

What is the definition of an underwriter? and what are the 3 main elements of underwriting?

Answer 2

Insurance professional employed to accept or reject risk on behalf of an insurer.
3 main elements are:
-Accepting or rejecting risk
-Investing Capital
-Implementing the strategic plan

Question 3

How does an insurance company make profit?

Answer 3

To survive and make profit, the insurer 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, the insurer must seek insurers that pose acceptable risks of loss and avoid insureds that pose unacceptable risks of loss.

Question 4

Describe how an underwriter is an investor of capital.

Answer 4

• Responsible for investing shareholder capital, they invest the insurers capital in those risks they accept and decline to invest capital in those risks they reject.
• Regulators limit the amount of promises an insurer can accept. Insurers cannot accept an infinite amount of risk because insurer does not have infinite amount of capital
• Like stockholders, u/w’s try to invest in risks that will generate highest rate of return.

Question 5

How can underwriters build a profitable portfolio? (5)

Answer 5

They need a strategic plan, This will involve identifying:

• The types of risk the insurer wants to pursue
• The lines of insurance it wants to underwrite
• The reinsurance it can arrange
• The amounts of insurance it will offer for different types of risk
• The approach it will take to pricing, among other considerations

Question 6

What is a line guide? (1) What criteria must an underwriter consider when assessing a risk? (7)

Answer 6

Line guide specifies the criteria that an underwriter must consider when accepting or rejecting a risk. It is a listing of the maximum amounts of exposure an insurer is prepared to accept on various classes of risk.

The criteria they must consider includes:

• Licensing
• Types of business
• Lines of insurance
• Territory
• Capacity
• Reinsurance
• Pricing

Question 7

Licensing

Answer 7

An important consideration for the underwriter is where the insurer is licensed to accept business. (Ex: underwriter working and licensed in Ontario cant seek business in BC)

Federally licensed underwriters can accept business anywhere in Canada. Once an underwriter is federally registered and authorised to do business, the provinces will almost automatically grant it provincial licences when the underwriter applies for them.

Question 8

Types of business

Answer 8

Underwriters should know what type of business there insurers seek. Some seek a broad range of business, where as others have expertise in a segment of the broader marker and may cater specifically to that niche.

Question 9

Lines of Insurance - what two criteria have an affect on the lines of insurance criteria?

Answer 9

The lines of insurance an insurer offers are aspects of two criteria:

• Licensing - The insurer can only offer those lines of insurance specified in its licence
• Types of business - the lines of insurance underwriters are authorized to offer affect the type of business they pursue.

Question 10

Territory - what must an underwriter consider when it comes to territory?

Answer 10

• An underwriter must know which territories the employer considers desirable or acceptable areas.
• Some territories may be more prone than others to certain kinds of environmental hazards (flooding, earthquakes, etc.)

Question 11

Capacity - What criteria is used for underwriters to determine the amount of insurance they are allowed to authorize for certain risks?

Answer 11

Capacity - every insurer has a max amount it will allow underwriters to commit to the best risks.

The amounts they may authorize for different risks are set out in a matrix or table of limits. The amounts are determined by criteria such as:
- The occupancy of the risk - Nature of some businesses pose inherently greater risks of loss than do others.

• The level of public fire protection - The fire underwriters survey grades towns in Canada based on availability and effectiveness of fire hydrants. A table of limits describe town grades 1-4 as protected, 5-8 as semi protected, and 9-10 as unprotected from fire protection
• Type of construction - A table of limits is likely to establish a max amount of insurance for fire resistive construction and fractions of that amount for more hazardous types of construction such as wood.

Question 12

Reinsurance - what is reinsurance? What are the two types of reinsurance? benefits of reinsurance?

Answer 12

• Reinsurance is insurance for insurers
• Two types are Facultative reinsurance and Treaty.
• Facultative: reinsurance of risks on an individual case by case basis subject to acceptance or rejection by insurer
• Treaty: agreement between insurer and reinsurer to reinsure a block or portfolio of business
• A benefit of reinsurance is that it increases their capacity to accept and underwrite risks. The amount of discretion over reinsurance that an insurer allows its underwriters is typically reflected in its line guide

Question 13

What is the difference between a facultative reinsurance underwriter and a Treaty reinsurance underwriter?

Answer 13

• Facultative underwriter - might not have quite as much info about an individual risk as does the insurers underwriter but the underwriting analysis undertaken by both parties is comparable
• Treaty underwriter- must consider whole portfolios of insurers risk. They will draw on their knowledge of business, the economy, and what is trending to reach a decision

Question 14

Pricing

Answer 14

• Insurers differ in the amount of discretion they allow underwriters over pricing. Some have elaborate rating manuals that fix rates for various classes of business and allow the underwriter little freedom to deviate from price. Some insurers recommend rates but allow underwriters more latitude to adjust the rates.
• A book of business refers to when a smaller brokerage owns its own book of business and enters into a partnership with a larger organization

Question 15

What is the difference between a file underwriter and portfolio underwriter? What does it mean when insurers are “giving brokers the pen”?

Answer 15

• File underwriter - underwrite individual risks
• Portfolio underwriter - underwrites and is responsible for a group of risks
• Insurers “giving brokers the pen” means vesting underwriting authority in their brokers within specified limits

Question 16

How do underwriters apply the line guide? In other words, how do they assess the risk?

Answer 16

They use the line guides criteria to determine whether a risk is acceptable. They ask questions for each criteria such as the following:

• (Length of time in business)- who is the applicant? is it financially stable?
• (Type of loss)- What kind of loss might the applicant occur? is it first party loss or third party loss?
• (Perils)- What perils does the risk face?
• (Physical hazards) - what physical hazards does the risk have that make loss of some kind likely?
• (Moral hazard) - Does the risk present a moral hazard?
• (Required info) - How much info is needed to make a decision?

Question 17

When will an underwriter reject a risk?

Answer 17

The need for premiums imposes a bias on the underwriter to try and write as much business as possible. Underwriters tend to look for ways to say yes. Generally then, an underwriter will reject a risk only if forced to by one or more of three considerations:

1) The risk is of a class not permitted by the line guide
2) Market conditions or competitive considerations require it (Hard market vs Soft market)
3) The risk is to flawed to be accepted and it is not possible to negotiate terms on which the risk could be accepted

Can use tools such as deductibles, premium rates, modifications of coverage, implementation of recommendations to try and make risk acceptable

Question 18

Pure risk vs speculative risk - what are the differences? What is the basic test to determine if something is insurable?

Answer 18

Risk - chance of loss

Pure risk - chance of loss but no chance of gain (Insurable)

Speculative risk - change of loss and a chance of gain (not insurable) An example of speculative risk is gambling

Basic test to determine if something is insurable is to ask following questions:

• Is there a chance of loss?
• Is there a chance of profit?

If the answer to first one is yes and second one is no. Than its insurable

Question 19

What are the three broad categories of insurable risk?

Answer 19

1) Personal Risks - chance of loss arising from a persons own bodily injury, loss of life, income because of death, disability, old age, unemployment
2) Property Risks - Chance of loss arising from destruction of or damage to property ( Direct losses or indirect losses) Indirect losses can be business interruption
3) Liability Risks - Chance of loss arising from an individuals obligation to pay damages because of the injury or death of another or damage to another property

Question 20

Liability risks - Insureds obligation (5)

Answer 20

The obligation of the insured to third parties would be based primarily on the individuals negligent acts in relation to:

• His or her conduct
• The operation of automobiles, aircraft’s, etc
• The ownership or occupancy of property
• The manufacture of products
• The rendering of professional services

Question 21

What are the three classes of insurance?

Answer 21

1) Personal Lines -insurance relating to individuals in their private capacity. (Homeowners form, personal automobile, etc)
2) Commercial Lines - Insurance related to commercial operations, such as stores, professional offices, trucking operations, etc.
3) Special Risks - insurance related to marine exposures, aviation, and high risk industrial operations