The underwriting function
- Premium-to-surplus ratio (capacity ratio)
- A capacity ratio that indicates an insurer's financial strength by relating net written premiums to policyholders' surplus - Too high when it reaches 300% or 3-to-1
Application
- A legal document that provides information obtained directly from an applicant requesting insurance and that an insurer can use for underwriting and claim handling purposes
Account underwriting
- A method of underwriting in which all of the business from a particular applicant is evaluated as a whole; evaluates all lines of business as a whole
- Return on equity (ROE)
- A profitability ratio expressed as a percentage by dividing a company's net income by its net worth (book value). Depending on the context, net worth is sometimes called shareholders' equity, owners' equity, or policyholders' surplus.
Supporting business
- A submission may be more acceptable if applicant has desirable supporting business
Loss exposure
- Any condition or situation that presents a possibility of loss, whether or not an actual loss occurs
staff underwriters
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 activities participate in industry associations conduct education and training
line underwriters
select insureds classify and price accounts recommend or provide coverage manage a book of business support producers and insureds coordinate with marketing efforts
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 Capacity is increased by an increase in policyholders' surplus
Policyholders' surplus -
Under statutory accounting principles (SAP), an insurer's total admitted assets minus its total liabilities
ensuring adequate policyholders surplus
insurance company must have this in order to increase its written premium volume if an insurers underwriting practices generate policy premiums that exceed losses and expenses, then the policy holders surplus will increase, thereby increasing capactiy ensure this by adhering to underwriting guidelines, making certain that all loss exposures are correctly identified and charging adequate premiums
types of underwriters
line underwriter and staff underwriter
Nonfinancial Measures -
link an organization's business strategy and its outputs to its performance; evaluate individual underwriters and underwriting departments based on actions rather than results
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
- Underwriting policy (underwriting philosophy)
- A guide to individual and aggregate policy selection that supports an insurer's mission statement - Translates insurer's mission and goals into specific strategies that determine the composition of the insurer's book of business Staff underwriters work with other departments (Actuarial, Claims, Marketing, Risk Control) to come up with policy
- Predictive modeling
- A process in which historical data based on behaviors and events are blended with multiple variables and used to construct models of anticipated future outcomes
Combined ratio (aka combined loss and expense ratio)
- A profitability ratio that indicates whether an insurer has made an underwriting loss or gain 100% means - Every premium dollar is being used to pay claims and cover operating costs, with nothing remaining for insurer profit >100% means - An underwriting loss occurs: more dollars are being paid out than are being taken in as premiums <100% means - An underwriting profit occurs because not all premium dollars taken in are being used for claims and expenses
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
- 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 - Staff underwriters are responsible for determining insurer's need for reinsurance, selecting reinsurers, negotiating terms and conditions of treaties, and maintaining the insurer's relations with its treaty reinsurers
Underwriting audits
- A review of underwriting files to ensure that individual underwriters are adhering to underwriting guidelines - Focus: proper documentation, adherence to procedure, classification, rating practices, etc
- Trending
- A statistical technique for analyzing environmental changes and projecting such changes into the future
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
Regulation - Ways regulation affects underwriting policy:
- 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 saved 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
Recommend or Provide Coverage
- Line underwriters get information about a company's risk management program to ensure they're filling the gaps of insurance coverage - May offer narrower coverage than requested instead of declining risk - Collaborate with producers to give insured requested coverage
functions of predictive modeling
- Multiple data variables of individual risks are developed to rank the relative likelihood of insurance loss - Data variables are based on underwriting guidelines along with the insurer's loss experience, loss data collected from external sources, and underwriting expertise - The ranking or score developed from the data variables is a predictable measure of future profit potential based upon the account's characteristics
Production underwriting
- Performing underwriting functions in an insurer's office as well as traveling to visit and maintain rapport with agents and sometimes clients High hit ratio might indicate any of the following: Competition is easing Rates are inadequate Underwriter has skill set for production underwriting
- Reinsurance
- Reinsurance treaties may exclude certain classes of business or loss exposures covered by policy forms created by the insurer (rather than an advisory organization)
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 Rapid growth results in a reduction in policyholders' surplus to pay for expenses generated by that growth because of SAP
Information efficiency
- The balance that underwriters must maintain between the hazards presented by the account and the information needed to underwrite it
Mix of business
- The distribution of individual policies that compose the book of business of a producer, territory, state, or region among the various lines and classifications
- Loss development
- The increase or decrease of incurred losses over time
Line underwriter
- Underwriter who is primarily responsible for implementing the steps in the underwriting process Evaluate new submissions for acceptability Renewal underwriting Work directly with producers and applicants
Staff underwriter
- Underwriter who is usually located in the home office and who assists underwriting management with making and implementing underwriting policy
Underwriting submission
- Underwriting information for an initial application, or a substantive policy midterm or renewal change
- Account classification
- process of grouping accounts with similar attributes so they can be priced appropriately - Line underwriters make sure all the information needed to classify an account is obtained and accounts are priced properly - Price must be competitive and allow for profitability
Financial Capacity
- refers to the relationship between premiums written and the size of the policyholders' surplus, which is an insurer's net worth
5) Implement the Underwriting Decision 3 tasks:
1) Communicate underwriting decision to producer 2) Issue any required documents Binder Certificate of insurance 3) Record applicant data for policy issuance, acctg, stats & monitoring
steps in underwriting process
1) Evaluate the Submission Sources of underwriting information: Producers, Applications, Inspection Reports, Government Records, Financial Rating Services, and Loss Data 2) Develop Underwriting Alternatives Counteroffer Require risk control measures Change insurance rates, rating plans, or policy limits 3) Select an Underwriting Alternative Underwriting authority Supporting business Mix of businesss Consider whether accepting the submission supports insurer's goals for mix of business Producer relationships Regulatory restrictions 4) Determine an Appropriate Premium Loss costs 5) Implement the Underwriting Decision 3 tasks: 1) Communicate underwriting decision to producer 2) Issue any required documents Binder Certificate of insurance 3) Record applicant data for policy issuance, acctg, stats & monitoring 6)Monitor underwriting decisions
Guarding against adverse selection Adverse selection example
: Property owners in areas clone to coastal storms purchase windstorm coverage or increase limits only before hurricane season underwriters minimize the risk of adverse selection by carefully selecting the applicants whose loss exposures they are willing to insure, charging appropriate premiums for applicants they do accept with premiums that accurately reflect their loss exposures.
Hazard -
A condition that increases the frequency or severity of a loss Underwriters must understand the activities, operations and character of each applicant to make decisions regarding the acceptance, coverage amounts, conditions, and price Trade-offs are necessary Typically, and underwriter evaluates submissions for commercial lines while expert systems (aka knowledge or rule-based systems) are used to evaluate personal lines submissions because these submissions tend to be similar
Combined ratio (aka combined loss and expense ratio) -
A profitability ratio that indicates whether an insurer has made an underwriting loss or gain
Retrospective rating -
A ratemaking technique that adjusts the 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 Counteroffer with different policy limits Suggest lower limits Use facultative reinsurance (see below)
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
Binder -
A temporary or oral agreement to provide insurance coverage until a formal written policy is issued
- Market conduct examinations -
An analysis of an insurer's practices in four operational areas: sales and advertising, underwriting, ratemaking, and claim handling - Regulators conduct these to ensure insurers adhere to the classification and rating plans they filed
Manuscript policy -
An insurance policy that is specifically drafted according to terms negotiated between a specific insured (or group of insureds) and an insurer
6) Monitor Underwriting Decisions
Ensure that satisfactory results are achieved Underwriter must be alert to changes in insureds' loss exposures Triggering events that may indicate a change in the account: May need to repeat underwriting process upon renewal Monitor books of business Identify aggregate problems in a deteriorating book of business
types of nonfinancial measures
Expert systems (aka knowledge-based systems) - Computer software programs that supplement the underwriting decision-making process. These systems ask for the information necessary to make an underwriting decision, ensuring that no information is overlooked. Selection - an underwriter's book may be required to have certain percentage of highly desirable, average, or below average accounts Product or Line of Business - measure product or line of business mix to determine insurer's appetite Pricing - pricing standards enable insurers to determine levels of premium adequacy by comparing premiums charged to the established pricing standards Accommodated Accounts - accepting substandard exposures in return for other, more profitable accounts Is an underwriter making excessive accommodations and can he/she ensure the producer has increased volume or fulfilled other promises in exchange for the accommodations? Retention Ratio - the percentage of expiring policies that an insurer renews Measure this by policy count, premium volume, or both Low retention indicates deficiencies in the way insurers do business (ex. Poor serve to producers, noncompetitive pricing, unfavorable claim service)
Distortions Created by Underwriting Cycle
Hard market vs. soft market Insurers can't always predict when the market will shift to a different phase
Distortions Created by Major Catastrophic Losses
Major hurricanes, earthquakes, etc. occur too irregularly to be predicted annually (floods are predicted over a 100 year period) Likely to cause an underwriting loss but does not necessarily indicate inadequate underwriting
Purposes of Underwriting Guidelines
Provide for Structured Decisions - Identify major considerations underwriters should evaluate for each type of insurance - Ensure Uniformity and Consistency - Submissions that are identical in every respect should elicit the same response from difference underwriters - Synthesize Insights and Experience - Staff underwriters include approaches they have taken un writing particular classes and lines of business - Distinguish Between Routine and Nonroutine decisions - Routine decisions are those for which the line underwriter clearly has decision-making authority according to the underwriting guidelines - Nonroutine decisions involve submissions that fall outside the underwriter's authority - Avoid Duplication of Effort - If one problem has been identified and solved, use that in other similar situations
- Research the Market
Research fundamental markets in which the insurer should target - Evaluation of these items: - 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
Distortions Created by Delays in Loss Reporting and Loss Development
Reserved losses - included in incurred losses and reflected in the combined ratio A considerable amount of time may pass between loss reporting and claim settling Can result in understatement of losses in one year and overstatement in another year that appear in the combined ratio
Distortions Created by Changes in Premium Volume
Restrictive underwriting policy usually reduces premium volume - increases expense ratio Less restrictive underwriting policy increases premium volume - book of business may be underpriced
- Activities that maximize ROE:
Setting return thresholds - establish ROE threshold against which capacity allocation proposals are evaluated - Redirecting focus on target business classes - insurer may decide to stop pursuing one class of business and use capacity elsewhere Adjusting underwriting policy based on jurisdiction
Markets served:
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
Loss costs
The portion of the rate that covers projected claim payments and loss adjusting expenses Based on classification system that combines similar loss exposures into same rating category Misclassification can produce adverse results Allows insurer to develop adequate premium to pay losses and operating expenses and to produce a profit
Hit Ratio( aka success ratio) -
The ratio of insurance policies written to those that have been quotes to applicants for insurance; determines how well underwriters are meeting their sales goals High hit ratio might indicate any of the following: Competition is easing Rates are inadequate Underwriter has skill set for production underwriting Low hit ratio may indicate: Competition is increasing
Review and Revise Pricing Plans
Update rates continually (subject to regulatory constraints) to respond to changes in loss experience, competition, and inflation - Staff underwriters combine prospective loss costs with an insurer-developed profit and expense loading to create a final rate used in policy pricing - The lower the expense loading, the more efficient production and account-selection processes are
purposes of underwriter audits
Used to monitor line underwriters' adherence to practices and procedures outlined in the underwriting guidelines Selecting accounts at random or reviewing files with notable claims Used to monitor statistics for books of business Provides information on effectiveness of underwriting guidelines
National Association of Insurance Commissioners (NAIC)
an association of insurance commissioners from the 50 U.S states, the district of columbia, and the 5 U.S territories and possessions, whose purpose is to coordinate insurance regulation activities among the various state insurance departments
to achieve profitability the underwriting function serves additional purposes:
guarding against adverse selection ensuring adequate policyholders surplus enforcing underwriting guidelines
Retention Ratio :
the percentage of expiring policies that an insurer renews Measure this by policy count, premium volume, or both Low retention indicates deficiencies in the way insurers do business (ex. Poor serve to producers, noncompetitive pricing, unfavorable claim service)
Underwriting authority
the scope of decisions that an underwriter can make without anyone receiving approval from someone at a higher level