Study 1: Introduction to Underwriting - Summary

Question 1

The three main elements of underwriting

Answer 1

• Accepting or rejecting risk
• Investing capital
• Implementing the strategic plan

Question 2

The underwriting function

Answer 2

• Underwriter: an insurance professional employed to accept or reject a risk on behalf of an insurer
• Insurers assume risk on behalf of an insured in exchange for a premium. To make a profit, they must offer coverage to insureds that, as a group, are likely to incur less in losses than they pay in premium
• Some underwriters work directly for an insurer, others work for a series of insurers through a Managing General Agent (MGA)

Question 3

Underwriters as an investor of capital

Answer 3

• Insurers risk losing capital if they must indemnify an insured for a loss
• Underwriters effectively invest insurer capital when selecting risks
• The acceptance of a risk leaves less capital or underwriting capacity (the maximum limit of liability the insurer agrees to assume) available for other risks

Question 4

To build a profitable portfolio of insureds who are less likely to incur in loss what they pay in premium, the insurer needs a strategic plan to identify:

Answer 4

• 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 risks of different types and sizes; and
• the approach it will take to pricing, among other considerations.

Question 5

The line guide

Answer 5

Specifies the criteria that an underwriter must consider when accepting or rejecting a risk. Refers to the maximum amounts of exposure an insurance company is prepared to accept on various classes of risk.

Question 6

Criteria of the line guide

Answer 6

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

Question 7

Licensing

(The line guide)

Answer 7

• Must consider where the insurer is licensed to accept business
• Ex. provincially licensed insurers can only accept business in the province where they are licensed, but federally licensed insurers can accept business anywhere in Canada

Question 8

Types of business

(The line guide)

Answer 8

• Some insurers seek a broad range of business (i.e. homeowners to businesses, small risks to large, ordinary occupancies to high hazard, etc.)
• Other insurers specialize in a small segment of the market only (ex. farms, motorcycles, trucking etc.)

Question 9

Lines of insurance

(The line guide)

Answer 9

• Does the insurer offer all lines of insurance or only some?
• Ex. some insurers only offer auto, some offer auto and property and liability, others don’t offer auto at all, etc.

Question 10

Territory

(The line guide)

Answer 10

• Underwriter must consider the geographical area or territory in which a risk is located
• Some territories are more prone to certain environmental hazards (i.e. flood, earthquake). Some are urban, others are rural.
• Underwriter must know which territories their employer considers acceptable to solicit and accept business

Question 11

Capacity

(The line guide)

Answer 11

• How much capital is available to the underwriter to invest in various kinds of business?
• Insurers have a maximum amount of insurance it will allow underwriters to commit to the best risks. For others, it will be a fraction of the maximum for bests risks.

Question 12

The amounts of insurance an underwriter may authorize for risks of varying types are set out in a matrix or table of limits. The amounts are determined by criteria such as the following:

(Related to Capacity in the line guide)

Answer 12

• The occupancy of the risk: the nature of some businesses pose greater risks of loss or damage than others (ex. an explosives manufacturer is more hazardous than a shoe store).
• The level of public fire protection: availability and effectiveness of fire hydrants, the water supply, and response time of fire departments.
• The type of construction: chances of total loss depend on a building’s construction (ex. wood frame buildings suffer more frequent and severe losses than concrete structures).

Question 13

Reinsurance

(The line guide)

Answer 13

• Reinsurance is insurance for insurers
• Facultative reinsurance: negotiated between an insurer and a reinsurer on an individual risk or policy
• Treaty reinsurance: agreement between an insurer and reinsurer for a block or portfolio of business
• Reinsurance increases an insurer’s capacity - allows underwriters to invest greater capital

Question 14

Pricing

(The line guide)

Answer 14

• The underwriter must ensure the premium the insurer receives is proportionate with the risk the insurer accepts
• Some insurers allow underwriters to determine pricing while others have strict rating manuals

Question 15

File underwriter

Answer 15

An underwriter responsible for underwriting individual risks

Question 16

Portfolio underwriter

Answer 16

An underwriter responsible for groups of risks

Question 17

Assessing the risk

Answer 17

• Applying the line guide means using its criteria to assess whether to accept or reject a risk, and what terms might make a risk acceptable
• Underwriter’s assessment involves many considerations, which vary depending on the nature of the risk

Question 18

Questions an underwriter might ask to assess a risk

Answer 18

• Length of time in business: Who is the applicant? If a business, how long have they been in operation? Are they financially stable? Well managed?
• Type of loss: What kinds of loss might the applicant incur? What is their loss history?
• Perils: What perils does the risk face? What events in the course of their life or business could give rise to a loss?
• Physical hazards: What physical hazards does the risk have that make loss of some kind more likely? Is an inspection required?
• Moral hazard: Does the risk present a moral hazard? Is there a possibility of fraud? Does the poor state of general repair indicate increased danger from carelessness?
• Required information: How much information is needed to make a decision? Is the application enough or is an inspection needed?

Question 19

Making a decision on whether to accept or reject a risk

Answer 19

• Even with all necessary information, accepting or rejecting a risk is still complicated
• Insurer must seek insureds that pose acceptable risks of loss but avoid insureds that pose unacceptable risks of loss

Question 20

An underwriter will reject a risk only if forced to by one or more of three considerations

Answer 20

1. The risk is of a class not permitted by the line guide or falls short of minimum requirements specified in the line guide
2. Market conditions or competitive conditions require them to reject it (ex. a hard market requires the underwriter to be more selective)
3. The risk is, on its own merits, too flawed to be accepted, and it is not possible to negotiate terms that would make it acceptable

Question 21

What is risk?

Answer 21

• Risk, in simple terms, means the chance of loss
• Speculative risk: there is a chance of loss and there is a chance of profit (ex. a business venture, gambling)
• Pure risk: the chance of loss but no chance of profit (ex. the chance of being in an automobile collision)

Question 22

Insurable risk

Answer 22

Insurance is concerned only with pure risk. Speculative risk is uninsurable.

To determine if something is insurable, ask:

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

If the answer to the first is yes and the second is no, it may be insurable.

Question 23

Three types of insurable risks

Answer 23

1. Personal risks
2. Property risks
3. Liability risks

Question 24

Personal risks

Answer 24

Encompass the chance of loss arising from a person’s own bodily injury, loss of life, or loss of income because of:

• Death
• Physical disability (resulting from accident or sickness)
• Old age
• Unemployment

Question 25

Property risks

Answer 25

Encompass the chance of loss arising from the destruction of or damage to property. Losses are of two types:

• Direct losses are those involving damage to or destruction of the property insured.
• Indirect losses occur because of direct losses (ex. loss of rental income after a fire)

Question 26

Liability risks

Answer 26

Encompass the chance of loss arising from an individual’s legal obligation to pay damages because of the injury or death of another or damage to another’s property. This obligation is based primarily on the individual’s negligent acts or legal liability in relation to

• his or her conduct;
• the operation of automobiles, aircraft, boats, snowmobiles, trains, trucks, and other vehicles;
• the ownership or occupancy (or both) of property;
• the manufacture of products; or
• the rendering of professional services.

Question 27

Three classes of general insurance sold by insurance companies

Answer 27

1. Personal lines—insurance relating to individuals in their private capacity. Included are the private dwelling, dwelling contents, automobiles, seasonal dwellings, boats, jewellery, furs, vacation travel insurance, major medical and surgery costs, and so on. Some insurers and insurance agents and brokers may subdivide this class into two departments if warranted by volume: personal automobile and personal property.
2. Commercial lines—insurance relating to commercial operations, such as stores, professional offices, trucking operations, construction vehicles and contractors, large commercial operators, and many other similar businesses.
3. Special risks—insurance relating to marine exposures, aviation, and high-risk industrial operations.