Underwriting Basics, 4th Edition Course
Building condition and construction techniques (commercial property risk characteristic)
- older poses more risk; deterioration of a structure over time; building codes; use of heating systems; old buildings of 5 or more stories present excessive fire hazards due to their height and outdated
For underwriting to function, communication must be 3 things:
-comprehensible -credible -relevant
paid losses
amounts the insurance company has spent to pay claims for covered losses
spread of risks
avoid large financial losses by not insuring too many risks of one type in any one location
frequency
deals with a large number of losses occurring for a single account
regulatory costs
expenses such as taxes, costs for licenses, and fees
geographic location (physical hazard)
physical features of the land where the risks are located
cost and time to obtain information
very important in a complete insurance application -important to consider time and cost when deciding whether it is required
$ Recovery amount formula
$ Recovery = (Loss x Coinsurance percentage) - Deductible
Formula used to determine the percentage of loss the insured would recover
% Recovery = Insurance Carried/ Insurance Required
Formula for how much Insurance company will pay
(Insurance Carried/Insurance Required) x Loss - Deductible
After receiving policy changes, underwriters:
-acquire additional information, as necessary -evaluate the information and develop alternatives -select and implement the most appropriate alternative
Modifications: additional clauses
-add special clauses to the policy -coinsurance clause: requires insureds to share in any losses under certain conditions -requirement could be added that no other insurance be purchased -requirement could be added that the insured provide special reports to keep the insurance company informed about the status of the covered business
limit of insurance (commercial property risk characteristic)
-all commercial insureds must have adequate limits of insurance -minimum acceptable level is usually 50% of the property's replacement cost -underwriters use coinsurance to write at least the minimum amount of insurance (if an insured carries less than a stated percentage of insurance to value of the covered property when a loss occurs, the insured will contribute proportionately with the insurance company for the loss)
stock (property risk)
-all stock owned by a commercial operation is covered -stock held for sale, no matter its stage or manufacture -supplies used in the manufacturing process, including cleaning solvents, packaging materials, and machine oils
employment history
-applicant's ability to afford and maintain the property to be covered and relationship between the individual's occupation and potential loss -individuals who use their homes to operate a business have increased exposures to losses and may not be eligible for homeowners insurance -occupations with extensive travel present increased exposures to theft losses at dwellings while insureds are away and the places they visit while they are there -insurance companies prefer to insure individuals who have been employed by the same company or in the same occupation for at least 2 years
facultative reinsurance
-ceding company must approach the reinsurer for a separate contract for each insured it wants to cede -both the ceding company and the reinsurer underwrite each individual risk -reinsurer has the option to reject a risk rather than accept all risks of a particular class as in the case of treaty reinsurance -ceding company not obligated to offer any class of risks to a reinsurer; ceding company may select those risks for which reinsurance is desired -less formal arrangement than treaty reinsurance; general form of agreement in advance -agreement specifies broadly what types of risks will be ceded and accepted -terms of each individual facultative reinsurance agreement are negotiable as to amounts, rates, and commissions -underwriters required to approach reinsurers before offering policies to applicants
modifications: rate adjustments
-commercial lines underwriters may be able to either increase or decrease rates by applying credits or charges -personal lines: premiums may be subject to a surcharge if an MVR indicates an applicant for auto insurance was involved in an accident not reported on the application
When an insurance company's premium volume is increasing, its expense ratio will tend to ___. When the premium volume is decreasing, the expense ratio will tend to ___.
-decrease -increase
forms of modifications
-deductibles - may need to apply higher deductibles- technique for controlling smaller losses; fewer losses will be paid because the deductibles will exceed the amount of some losses -coverage limitations -rate adjustments -reduction in hazards -addition of special policy clauses
Examples of administrative-type changes (may not require underwriters' attention):
-deleting mortgagees or other loss payees from policies -dropping coverages that are not required by law -replacing vehicles with similar vehicles
Risk characteristics used to evaluate personal auto insurance risks
-driving record -age -driving experience -use of vehicles -types of vehicles -personal stability *driving record is usually the single most important risk characteristic
Condition of dwellings to be insured
-dwelling's age -electrical systems/appliances -proper maintenance and updating
open competition
-essentially no rate regulation at all but is subject to insurance department action if the results are detrimental to either policyholders or insurance companies
Examples of changes that are out of an underwriter's control:
-excessive claim frequency or severity -changes in risks, as when insureds under homeowners policies open business offices in their homes -decisions by the insurance company to no longer write particular lines of business
Cancel or nonrenew the policies
-final alternative when permitted by state law -chosen only when changes are so integrated into the risks that their omission is impossible -in some states, underwriters may have to wait until the renewal dates and nonrenew the policies rather than cancel them
pro rata facultative reinsurance
-focus is on underwriting individual risks rather than all risks in a group or class; ceding company may choose to cede or not to cede a particular risk, and the reinsurer may choose to accept or not accept any risk offered -surplus share reinsurance but for individual risks -ceding company decides how much of each risk it wants to keep and how much it wants to cede, and then premiums and losses are shared in those same proportions
personal characteristics
-homeowners policies are considered personal contracts; there are personal characteristics of applicants Positive factors: -credit standing: no credit problems -criminal record: none -personal activities: nonhazardous
Business income or extra expense
-if a commercial building is damaged by a covered peril, owner or tenant may not be able to conduct business there for some time (sales and company earnings reduced) -loss of these earnings may be protected by business income coverages -if a building sustains covered damages, the owner or tenant may have to spend extra amounts to avoid shutting down the business or to minimize the time during which the business is shut down; loss of funds for these purposed may be protected by extra expense coverage
What should underwriters examine when endorsements to existing policies are requested?
-information that might indicate changes in how those risks are classified -characteristics that determine whether the risks still fall within insurance company underwriting guidelines
excess of loss treaty reinsurance - per occurrence basis
-insurance company retains only a certain amount total; the excess of loss reinsurance would cover the remainder -example: insurance company's retention is $50,000 total -buildings of two insureds are demolished by fire for a total of $200,000 -insurance company retains only $50,000 total -excess of loss reinsurance covers the remainder
Facultative reinsurance - excess of loss basis
-is available only on a per risk basis only when the loss exceeds the ceding company's retention limit
Modifications commonly used by commercial property underwriters
-larger deductibles to eliminate or reduce theft losses -requests for applicants to correct maintenance or housekeeping problems before their policies will be written
type of occupancy (commercial property risk characteristic)
-look at past loss experience -occupancy risks classified as low risk, average risk, or high risk
Alternatives available to underwriters when policy changes are requested:
-make the changes exactly as requested -offer modifications to the requested changes -unacceptable changes can sometimes be made acceptable if underwriters offer counter proposals -decline to make the requested changes -cancel or nonrenew the policies
What does the insurance industry indicate about age and driving experience?
-male drivers under age 25 are involved in more frequent and severe losses than other people with more driving experience; risk is higher when less experienced drivers are principal drivers rather than occasional drivers because total road mileage of principal drivers is greater -female drivers have represented less of a risk than male drivers because women tended to drive fewer miles, to drive less during evening hours, and to take fewer driving risks than men -today, differences in loss rates of males and females are decreasing, and some states mandate unisex premium rates -elderly drivers will not be insured with the company as long as younger drivers; likely experience deteriorating reflexes that can lead to auto accidents -elderly drivers usually drive fewer miles and during times when roads are less congested -middle-aged drivers are generally the safest class of drivers -newly licensed middle-aged driver presents a similar risk to that of a younger inexperienced driver (lack of confidence and may be overly cautious)
offer modifications to requested changes
-may be modified to meet company standards
Claim history
-past loss activity tends to be a good predictor of future loss activity -look at unrelated losses - related is not a good sign -with risks that have had losses from uncontrollable perils, underwriters might use higher deductibles or require that loss prevention steps be taken
Criteria for evaluating identified alternatives
-profitability potential -spread of risks -supporting lines of business -producer pressures -regulatory pressures
telematics device
-some insurance companies give their customers this option -attaches to an auto's onboard diagnostics system -transmit data about a vehicle's movements that can be used to monitor driving habits, such as miles driven, speeding, and excessive braking
Legal requirements related to solvency involve the following:
-surplus requirements for various lines of coverage -annual reports to state insurance departments -periodic audits of insurance companies
Legal requirements relating to solvency involve the following:
-surplus requirements for various lines of coverage -annual reports to state insurance departments -periodic audits of insurance companies
Tenants' improvements and betterments
-tenants of commercial buildings may improve those properties to adapt them to their specific needs - may include improvements that are part of the buildings and cannot be removed when the tenants leave
Reasons why in-force/continuous underwriting before policy renewal
-the account was marginal when it was written -the insurance company's underwriting philosophy has changed since policy was written -physical characteristics of the insured property have changed since policy was written -coverage has proven to be unprofitable for the insurance company -policy may be changed
surplus share treaty
-the amount shared by the companies is not stated as a percentage -ceding company establishes a dollar amount it will retain; reinsurer accepts any amount above that figure for each policy, usually up to some other specified limit or multiple -amount of policies vary, so the fact that a reinsurer will accept a stipulated percentage of the retention amount does not mean it is always ceded that amount -the reinsurer shares only in any surplus over the retention limit -may be made with more than one reinsurer; limits of each succeeding "layer" must be used up before another surplus share treaty is considered
construction
-types of materials in homes being insured to see if they meet building codes and standards for the areas in which they are located (brick may be viewed as most acceptable with respect to fire hazards) -quality of construction - builders' reputations
Make the changes exactly as requested
-underwriters make changes as requested, provided the quality of the risks do not suffer as a result of those changes -changes may require rerating or reclassifying
How do written premiums work?
-written premiums are placed in unearned premium reserve accounts by insurance companies -as protection is provided, the premiums are earned by those companies and the money is transferred from the reserve accounts to the insurance companies' general accounts
5 categories of property risks
1. Buildings 2. Stock 3. Business personal property 4. Tenants' improvements and betterments 5. business income or extra expense
Why are all losses of concern to underwriters?
1. Insurance companies incur expenses whenever they settle claims, regardless of their size. 2. many small losses may warn of circumstances that could lead to larger losses
2 basic types of professional liability
1. Malpractice 2. Errors and omissions (E&O)
2 risk characteristics used when evaluating homeowners risks
1. Physical risk characteristics 2. people risk characteristics
3 steps to making the underwriting decision
1. Which alternative will be most profitable? 2. Will it meet the spread-of-risk criterion? 3. Are there supporting lines of business, producer pressures or regulatory pressures to consider?
4 Categories of expenses
1. acquisition costs 2. servicing costs 3. administrative costs 4. regulatory costs
2 primary sources of information for commercial property underwriters
1. applications 2. insurance producers
4 People risks (when evaluating homeowners risks)
1. attitude toward the property 2. claim history 3. personal characteristics 4. employment history
3 occasions in which underwriters review individual risks
1. before a policy's renewal 2. when a policy may be changed 3. when a loss occurs and a claim is submitted
4 risk characteristics used to evaluate commercial property risks
1. building condition 2. construction techniques 2. type of occupancy 3. limit of insurance 4. financial condition
4 physical risk characteristics
1. construction 2. geographical location 3. protection 4. condition
reasons for reunderwriting
1. frequent losses - overall loss ratio problems for particular lines of business, particular coverages, or particular geographical areas; underwriters use insurance company's underwriting standards 2. severe losses - look for common characteristics that have caused the severity; accounts with severe losses can be reunderwritten,; similar risks with the same potential for severe losses can be reunderwritten 3. loss problems with specific coverages; identify problem characteristics and take preventive actions on policies that have experienced losses to avoid future losses that involve specific coverages
Options available for accepting risks with modifications as alternatives to rejection:
1. increase the deductibles 2. add exclusions eliminating problem properties or perils 3. provide coverage on an actual cash value basis instead of on a replacement cost basis 4. require that unsafe conditions be corrected before the policies will be written
5 systems to handle rate regulations
1. open competition 2. file and use 3. use and file 4. mandatory rates 5. prior approval
3 types of incurred losses
1. paid losses 2. paid loss adjustment expenses 3. outstanding loss reserves
3 types of risks homeowners insurance programs cover
1. people who own the homes in which they reside 2. tenants or renters (leased) - cover personal property in dwellings or apartments; if two or more tenants reside in the same place, both require policies to cover their individual loss exposures 3. condominium unit owners
2 ways excess of loss treaties may be written
1. per risk basis 2. per occurrence basis
4 risk characteristics looked at before making decisions about applicants for commercial liability insurance
1. personal characteristics - financial records of paying business obligations 2. business reputation - how a business entity is known to pay its bills, serve its customers, and respond to the community; Better Business Bureau Rating; how long the business has been in operation, type of business, previous insurance losses 3. physical condition of the premises 4. types of operations or services
3 parts of homeowners application
1. personal information 2. description of the dwelling 3. insurance information
Alternative actions for underwriters in consultation with management following reunderwriting reviews
1. place restrictions or conditions on coverages 2. increase deductibles on all policies within certain groups 3. reclassify groups of policies - misclassified or devalued groups 4. cancel or nonrenew policies - last resort; specific policies within a specific group rather than all policies in the group 5. discontinue working with the producers - if problem is severe enough and improvement is unlikely
Three broad markets/primary risk categories of personal auto insurance based on driving records:
1. preferred risks 2. standard risks 3. substandard risks
6 general classifications of commercial liability insurance risks
1. premises and operations liability exposures 2. products or completed operations liability exposures 3. indirect or contingent liability exposures 4. autos, watercraft, or aircraft liability exposures 5. work-related liability exposures 6. contractual liability exposures
2 ways facultative reinsurance may be written
1. pro rata facultative reinsurance 2. excess of loss basis
2 categories of treaty reinsurance
1. pro rata treaty reinsurance or proportional reinsurance 2. excess of loss reinsurance/excess reinsurance/nonproportional reinsurance
2 types of pro rata treaties
1. quota share treaty 2. surplus share treaty
4 Alternatives for underwriters after frequency and severity of losses are reviewed and their weights evaluated
1. take no action - if no loss frequency or severity problems 2.remove coverages or covered persons, items, or locations; used most often when there are frequency problems but no potential for future severity problems 3. use higher deductibles - most effective in cases where frequent small losses are reported; higher deductibles reduces premiums 4. cancel or nonrenew the policies
3 sources of information for underwriters other than the application
1. the producer 2. inspection reports 3. photographs (may be ordered in conjunction w inspection reports)
Government regulations have two major purposes addressed by rate regulations:
1. to achieve financial stability for insurance companies 2. to protect policyholders
Monitoring decisions once they have been made is done for two primary reasons:
1. to determine whether those decisions were the correct decisions 2. to determine whether those risks have changed, because risks usually do so over time
2 types of reinsurance agreements
1. treaty reinsurance 2. facultative reinsurance
2 primary goals of underwriters when handling reinsurance needs
1. write business that generates enough premiums to be profitable 2. spread that business in such a way that their companies' exposures to losses are minimized
2 categories of outstanding loss reserves
1.end of present period 2. end of prior period Current Period Paid Loss Adjustment Expenses + Current Period Outstanding Losses - Prior Period Outstanding Losses = Current Period Incurred Losses
What is the breakeven point for combined ratio?
100% -lower than 100% is favorable, and higher than 100% is unfavorable
If more info is needed than the 2 primary sources of info for commercial property underwriters, what is used?
2 specialized types of inspection reports: -financial reports - may be obtained from Dun and Bradstreet, Inc.; contains info about a business's financial stability -Engineering reports - provide info about physical condition of a building, a business's operations, maintenance, housekeeping, and safety procedures -recommendations for improvements and comments about the desirability of risks
eligibility standards
Conditions that must be met in order for an individual or group to be considered eligible for insurance coverage.
What types of reports are generally required for commercial liability risks?
Engineering reports - inspections of physical conditions or the premises or safety programs in effect at the premises; usually include an analysis of operations, identification of any hazards, and recommendations for improvements
guidelines
Government regulation may occur in the form of guidelines issued by state insurance departments concerning various underwriting considerations, such as cancellation, nonrenewal, eligibility for coverage, and discriminatory activities
Insurance required formula (including coinsurance)
Insurance Required = Replacement cost x Coinsurance percentage
Formula for how much the insured needs to pay for coinsurance
Insured's Amount = Loss - ((Loss x Coinsurance percentage) - Deductible)
Formula for how much Insured Must Bear
Loss - ((Insurance Carried/Insurance Required) x Loss - Deductible)
common loss ratio formula
Loss Ratio = Incurred Losses/Earned Premiums
profitability potential
What will be the potential profitability to the insurance company if I choose this alternative? -rank alternative actions according to their potential profitability
accommodation
accepting a risk ex: underwriter accepts the risk to discourage the insured from moving all the business to another insurance company; require underwriting skills and experience to find ways to control whatever hazards make such risks marginal -may come from producer pressures or regulatory pressures
Modifications: coverage limitations
accomplished by excluding certain perils from policies
treaty reinsurance
accounts for a much greater proportion of reinsurance premium volume than does facultative reinsurance -treaty arrangement: formal agreement or treaty is entered into by the ceding company and the reinsurer; agreement stipulates that for a certain group or class of business, the ceding company will grant some portion to the reinsurer and the reinsurer will accept what is offered -after treaty is signed, neither party has an option about that particular class of business; stated amount of business will be ceded and will be accepted -reinsurer does no underwriting of individual risks -risk is evaluated by the ceding company's underwriters on the basis of the company's normal underwriting practices, and the reinsurer accepts what is ceded -gives the ceding company underwriters the advantage of not having to consult with the reinsurer before being able to accept the business
When a policy has no specific provisions that might control moral hazards, underwriters may:
add policy provisions
unfair discrimination laws
address essentially the same issues as similar federal legislation -ex: discriminating against prospective insured's age, gender, or marital status, race, national origins, geographic locations, occupations
acquisition costs
advertising costs, commissions, costs for inspection reports, and any other costs required to put business on the books
quota share treaty
agreement under which the reinsurer accepts a stated percentage of every exposure it has agreed to reinsure under the treaty -the reinsurer shares in the premium, insurance amount, and losses for all risks the ceding company accepts -almost guarantees the reinsurer will not be selected against -does NOT involve underwriters -agreements reached in advance by company executives and become essentially accounting procedures -underwriters write insurance in traditional way, and quota share treaty automatically goes into effect
paid loss adjustment expenses
amounts paid directly to third parties to settle losses; includes items such as the cost of inspection reports and attorney's fees to defend claims in court, but does not include loss payments or salaries and supplies for claim handlers
outstanding loss reserves
amounts required to be held in reserve to pay losses that have been reported but will not be paid until sometime in the future; insurance company estimates the amount of each loss payment and places that amount in a loss reserve account
servicing costs
amounts spent to keep business on the books, such as loss control activity costs
book of business
an account or client list
When an insurance company takes control of the company, what type of solvency regulation is this?
annual reports to insurance departments
hazard
anything that increases the chance of loss
Errors and Omissions (E&O)
applies to mistakes made by members of professions other than the medical profession
Pro rata treaty reinsurance
arrangement whereby the ceding company and the reinsurer share proportionately in the amount of insurance provided, the premium, and the losses -proportions held by each company are determined in advance by mutual agreement -proportions vary according to the treaty agreed on by the ceding company and the reinsurer
pride of ownership
attitude that is manifested in well-maintained property and its surroundings
One of the general categories of limitations is ___.
cancellation laws -many states' policy cancellation laws prohibit midterm cancellations by insurance companies -underwriting limit w specific time limit (usually 60 days) is permitted at the inception of a policy; policy may be cancelled for any reason during this period -beyond this period, cancellation not allowed or permitted only for a few very specific reasons -otherwise, underwriter must wait for policy renewal date, at which time the policy may be nonrenewed -nonrenewal time may also be restricted (ex: 2 years after policy inception for specific types of policies for nonrenewal in some states)
What changes might be made to a policy?
changes to: -coverages -employees -business locations -policy terms, such as a different deductible amount -vehicles
audits of underwriting departments
consist of reviews of books of business by the home office and underwriting staffs -individual risk decisions by each underwriter are evaluated -results of the audits used to educate the underwriters in making future underwriting decisions that will meet insurance company goals
Reinsurance
contractual agreement between an insurance company (called a ceding company) and one or several other insurance companies (known as reinsurers) -insurance for insurance companies -ceding company transfers part of the risks it has assumed under its contracts of insurance to one or more reinsurers -reinsurer agrees to indemnify or reimburse the ceding company for some or all of the losses the ceding company sustains under specified policies or groups of policies, according to formula established in reinsurance contract -ceding company pays the reinsurer a premium -no direct relationship with or contractual obligation between the original policyholder insured by the ceding company and the reinsurer
As the earned premium increases, the unearned premium reserve ______.
decreases by an equal amount
Final step in implementing decisions
document who made the underwriting decisions and why -ex: initialing applications, completing risk analysis forms, copies of correspondence or policies placed in the account files, most commercial companies require electronic documentation
What is the difference between loss and expense ratios?
expense ratios measure costs that are under the control of insurance companies -expense ratio is most descriptive and useful ratio for management to monitor
Expense ratios
expressions of the costs of doing business Expense ratio = Underwriting Expenses/Written Premiums
When expense ratios are based on earned premiums, they are called _____.
financial basis expense ratios
When does moral hazard increase?
financial instability
Describe what the expense ratio means.
for every premium dollar written, a certain amount was paid out in expenses 27.2% means 27 cents paid out in expenses for every premium dollar written
liability limit
for liability insurance underwriters, the maximum amount of risk exposure that may be retained
written premiums
gross amount of premium income on an insurance company's books; includes both earned and unearned premiums -made up of premiums for new business, renewals, and policy endorsements
trends
historical look; underwriters look at trends of ratios over extended periods of time; helps determine future profitability and any underwriting actions that may be required
package policies
homeowners policies; various property and liability insurance coverages are bundled into each homeowners policy -entire package must be purchased, but price is lower than would be required if the coverages were purchased separately
negative trend in loss ratios
if trend is negative or if the ratio significantly exceeds the breakeven point, a correction in risk selection philosophy may be in order
redlining
illegal activity - refusing to write business in certain geographical areas
loss ratios
important ratio used to compare an insurance company's operations from year to year; used to compare a company's results with those of other companies; important to actuaries as a tool for determining rate changes; time period usually associated with a loss ratio is one year
Mandatory rates
in some states, for some lines of insurance, the use of unique state rates may be mandatory for any company doing business in the state
named driver exclusions
in some states; these policies will not cover specified people
Use and file
in use and file states, insurers must file rates within a certain period after they are first used
Loss ratio
incurred losses/earned premiums
comprehensible
information is understood by the receiver in the same way it was intended by the originator
personal and advertising injury
injury other than bodily injury that arises out of such actions as the following: -slander -invasion of privacy -false arrest or detention -wrongful entry or eviction -libel -malicious prosecution -invasion of the right of private occupancy -copyright infringement -misappropriation of advertising ideas
What happens if an insurance company fails to maintain an adequate surplus to pay future obligations?
insurance departments could suspend the writing of all new business in their states until the situation is corrected
What is the major source of an underwriter's information?
insured's application
Reasons for account underwriting instead of monitoring insured's policies at an individual basis
insureds w many policies may take all their business elsewhere if one policy is unacceptable
administrative costs
items such as salaries and supplies
Loss ratios are calculated by looking at very large groups using the______.
law of large numbers
absolute/strict liability
liability imposed for bodily injuries or property damages that arise out of activities judged to be especially hazardous, but that do not involve negligence or the intent to cause harm
geographical location
location (ex: some homes may be more at risk for losses due to hurricanes)
joint account underwriting
look at both personal and commercial lines
What loss ratio represents the breakeven point?
loss ratio between 60% and 65% -ratios above the breakeven point are unfavorable, ratios below are favorable
Do losses mean that actions are necessary?
losses do not indicate any actions are necessary. -underwriters look at the frequency AND severity of losses
line limit
maximum amount of risk exposure that may be retained
producer pressures
may place new business with other insurance companies if they do not agree w underwriting decisions -producers w good loss ratios w their insurance companies may ask underwriters to continue questionable risks (based on underwriting credits those producers have established by producing good business)
reunderwriting
monitoring approach to review an entire book of business to evaluate the results of decisions that were made over a period of time -books of business monitored: apply to particular producers, territories, or coverages
purpose
monitoring technique that involves insurance companies' entire books of business and is based on ratio analysis
fraud or misrepresentation moral hazards
most policies contain a provision to protect the insurance company from dishonest acts by insureds -provision that usually voids the policy if coverage was obtained fraudulently or if an insured concealed material facts that would have caused the company not to issue the policy
The ____ of the changes determines whether underwriters need to monitor them.
nature
People usually have to commit ___ acts to be found legally liable.
negligent
Excess of loss treaty reinsurance
no amount of insurance is ceded -in exchange for a premium, the reinsurer simply agrees to indemnify the ceding company for losses that exceed a specified retention amount; ceding company pays for all losses within the retention amount, and the reinsurer pays the excess, up to the limit of reinsurance expressed in the reinsurance contract
positive trend in company's loss ratios
no corrections are required
Widely accepted standard for insurance company's policyholder surplus
no less than half the amount of its net written premium (two-to-one ratio) -some states have allowed ratio to be four-to-one
The most widely accepted standard for an insurance company's policyholder surplus is ____.
no less than half the amount of its net written premium, or a two-to-one ratio -in a few cases, state insurance departments have allowed the ratio to be four to one
Why are written premiums used for the expense ratio equation for underwriting purposes?
no matter how long policies are in force, the insurance company will incur expenses in connection with them; most frequently used for determining combined ratios -for accounting purposes, the expenses are assumed to occur all at once at policy issue
monitor the decision
occurs throughout the life of an insurance policy -decisions monitored through in-force underwriting, reunderwriting, and regular analysis of important insurance company ratios
Decline to make the requested changes
often used when requested changes are controlled by policy language, such as when insureds request coverage that is broader than policies permit -may be declined because insurance companies are unwilling to fulfill those requests
supporting lines of business
other insurance the same insured carries within an insurance company
bodily injury and property damage liability coverage
pays sums that insureds are legally obligated to pay as damages because of covered bodily injuries or property damages -insurance company has the right and duty to defend insureds against any suits that allege liability for damages to which the policy applies
substandard risks
people w below-average driving records or those who own certain types of vehicles that present a greater-than-average risk for the insurance company -below-average driving record: two or more auto accidents or convictions for motor vehicle violations in the past 3 years
preferred risks
people with better-than-average driving records; usually means they have no auto accidents or convictions for motor vehicle violations in the past three years
When a team of insurance department investigators reviews policies written by a company, this is an example of what type of solvency regulation?
periodic audits of insurance companies
Business personal property
personal property, other than stock that belongs to the business, is covered -forklifts, computers, office furniture -coverage usually limited to apply only on the business premises
premises and operations liability exposures
possibilities of bodily injury liability, property damage liability, or personal injury liability claims that arise out of business premises, operations in progress, or other business activities
indirect or contingent liability exposures
possibilities of liability claims that arise out of actions of others, such as employees, agents of the business, and contractors or subcontractors hired by the business
contractual liability exposures
possibilities of liability claims that arise out of contractual agreements in which a business has assumed liability
products or completed operations liability exposures
possibilities of liability claims that arise out of defects in products of the business or its completed operations
work-related liability exposures
possibilities of liability claims that arise out of employees' work-related injuries
autos, watercraft, or aircraft liability exposures
possibilities of liability claims that arise out of owning, maintaining, or using autos, watercraft, or aircraft
earned premiums
premiums the company has earned by providing insurance protection for some period of time; insurance company does not own premiums when it receives them; premiums belong to the insureds who paid them until their insurance protection is provided
inspection reports
prepared by firms in business for inspections on property to be insured -may acquire information about the character, general reputation, personal characteristics, or living habits of prospective insureds through personal interviews with their neighbors, friends, and associates
buildings (property risk)
primary protection usually provided on buildings -coverage on buildings applies to completed additions, inside and outside fixtures, permanently installed machinery and equipment, and personal property items used to maintain or service buildings
safety inspection
process of gathering information for an engineering report
producer pressures
producers want accounts to be profitable
protection (physical risk characteristic)
quality of fire and police protection is very important -cities and towns divided in numerical groups from 1-10 based on quality of their firefighting and other protective services (best is 1) -risks generally considered unprotected when they are more than five miles from a fire station and 1,000 feet from a fire hydrant; no close neighbors, trees, gullies, lack of access roads; building codes
producer loss ratio
ratio developed from comparing dollars spent by the insurance company on losses generated to amounts of premiums generated by a producer's book of business -the higher the loss ratio, the less profitable the business
public pressures
regarding policy cancellations -many insureds believe if they apply consumer pressures through their state insurance departments, this may lead to more restrictive laws -underwriters struggle between two points as a result of public pressures: insurance company profitability suffers if no underwriting corrections ca be used; if underwriting actions are taken, insurance companies must deal head-on with issues -most insurance companies nonrenew instead of cancel (cancel only used in extreme cases)
regulatory pressures
regulations that prevent insurance companies from participating in certain discriminatory practices (age, gender, racial or national origin, geographical areas)
modifications: hazard reductions
repairing broken stairs, installing fire alarms or burglar systems
morals report
request information about a prospective insured's: -character -reputation -living habits -associates -mainly the opinions of others
high risk occupancies
require special care; may be hazardous
Prior Approval
requires insurance companies to file rates with the insurance departments and receive approval before the rates may be used
cancellation and nonrenewal laws
restrict the circumstances under which insurance companies may refuse coverage -specific as to the types of notification to policyholders required, the reasons for cancellation or nonrenewal, and time periods required to notify policyholders before cancellation or nonrenewal
excess of loss treaty reinsurance - per risk basis
retention is based on the risk; insurance company's retention is a certain amount for each of the insureds in the risk (if there are multiple); reinsurer pays for amounts above the insurance company's retention Ex: insurance company: $50,000 retention -buildings of 2 insureds are demolished by a fire for a combined loss of $200,000 -insurance company's retention would be $50,000 for each of these insureds, or a total of $100,000 -reinsurer pays for amounts above $100,000
types of vehicles
risk characteristic based on their degree of financial value and performance -vehicles of high financial value frequently subject to theft; increased frequency of loss leads to increased loss severity -drivers in sports cars/luxury cars take certain risks they wouldn't in other vehicles (increased loss frequency and severity)
personal stability
risk characteristic; subjective, does not weigh as heavily as the other risk characteristics (looks at residence and employment history) -insurance companies consider people who have been employed for at least one year who have not had more than two different employers for reasons other than promotion or job betterment in the past three years as stable risks for auto insurance -individuals who often change employers for reasons other than promotion or job betterment or who move to different residences frequently may be demonstrating some degree of emotional instability, which could cause poor driving habits -frequent changes in residences: verifying information is difficult for underwriters; poor policy persistency, accounts don't remain on insurance companies' books long enough to be profitable
Underwriters have a direct impact on which expense category?
servicing costs
standard risks
somewhat better-than-substandard risks but not as desirable as preferred risks -driving records may show one accident or conviction for motor vehicle violations in the past three years
catastrophe reinsurance
specialized type of reinsurance for catastrophic losses -arrangements made by insurance company executives
When a company's policyholder surplus is not half the amount of its net written premiums and the insurance department requires the insurance company to curtail writing new business until the company can attract new capital, this is an example of what type of solvency regulation?
surplus requirements
File and use
system where insurance companies file rates with the state insurance departments and may use those rates immediately after filing -rates are subject to insurance department scrutiny and could be disapproved; if so, the companies must stop using those rates
retention amounts
the amount of liability that is acceptable to keep (not cede to a reinsurer)
severity
the dollar amount paid for a loss -severe losses themselves are not indications that underwriting decisions were not sound
What does auto accident data by the insurance industry show about people who have had auto accidents or convictions for motor vehicle violations in the past two or three years?
they are more than twice as likely to repeat them
When expense ratios are based on written premiums, they are known as ____.
trade basis expense ratios
in-force/ continuous underwriting
underwriter monitors for loss frequency and severity, who was at fault for any losses, or what type of change is being requested
account executives
underwriters who are in companies dealing with sophisticated accounts -may work closely with producers, even accompany them on sales calls
cost of doing business
underwriting limitation; having underwriters make evaluations every time policy changes are made or losses occur is expensive and impractical -insurance companies provide specific guidelines about which situations must be referred to underwriters and which may be handled by clerical staffs
when an insured has many policies with an insurance company
underwriting limitation; underwriter performs account underwriting of all insured's policies together rather than monitor each policy on an individual basis
Underwriter's alternative: rejection
used only when risks are totally unacceptable or when applicants refuse to accept modifications suggested by the underwriters
combined ratio
used to monitor insurance companies' books of business -sum of the loss ratio and the expense ratio
auto inspection reports
used to verify makes and models of vehicles -how vehicles are used -the percentage of use by each driver -driving records when MVRs are not available -acquire info about applicants' driving habits, alcohol or drug use, and physical conditions of vehicles
Malpractice
used when medical professionals (individuals or companies) make errors
When does in-force or continuous underwriting most commonly occur?
when claims are submitted
contractual liability
when two parties sign a contract where one business assumes the liability of others ex: equipment manufacturer agrees under a contract to assume the liability of a retailer if any losses occur
use of vehicles
whether it is used in business/ driven more miles -exposures to loss, high mileage -emergency situation vehicles/other uses -avoid accepting risks that involve commercial use of the vehicles other than incidental business use by salespeople (avoid ridesharing services vehicles or those that deliver goods)
Deductibles are best used when the physical hazards are ____.
within an applicant's control
select and implement the course of action
best underwriting action is selected on the basis of available information, and then the decision is communicated to the parties involved
physical characteristics inspection reports
check the actual physical condition of property ex: commercial risks report -construction of building -how well or how poorly property is maintained -loss prevention equipment -materials used in a manufacturing operation
Who is usually responsible for product design?
home office underwriting departments because product design requires expertise in legal and state requirements
field underwriting
producers are considered to be field underwriters -main function is to solicit business -expected to screen risks, select risks desirable to the company, and eliminate undesirable risks -provided guidelines and granted certain selection authority -may also include employees of the company who accompany producers to evaluate certain types of risks (may have full underwriting authority) -the "eyes" of the company underwriter, who rarely is able to see a risk firsthand
construction (physical hazard)
property insurance rates based on the type of construction materials used -ex: buildings constructed of frame materials have greater potential for frequency and severity of fire losses than brick buildings
court records
provide both criminal and civil court information -arrests, convictions, dismissals, and acquittals -civil court records: information about mortgages, business licenses, bankruptcy proceedings, tax records, and liability suits filed
motor vehicle records (MVRs)
provide information on past arrests or convictions related to driving
self-retention programs and deductibles
simplest of 3 risk management service tools -if insured retains some of dollar risk or will be required to pay a large deductible amount in the event of a loss, generally, the risk is expected to be reduced because the insured has a high investment in preventing losses
exclusions moral hazards
some exclusions may permit control of potential moral hazards
engineering reports
specialized physical characteristics reports that inform underwriters about businesses' specific physical hazards and ways to eliminate or reduce them -specialized in that the inspectors are trained to identify specific physical hazards and to recommend how they may be eliminated or reduced
cancellation moral hazards
state laws regarding when insurance may cancel policies vary
Common types of legal hazards associated with insurance underwriting practices
-absolute or strict liability -contractual liability -compulsory insurance -judicial interpretations
How to evaluate for legal hazards
-applications - may indicate absolute liability based on types of business being conducted; carefully worded applications may indicate presence of any contractual liability applicants have assumed -inspection reports -claim reports -changes in law
difference between evaluating moral hazards and morale hazards
-evidence for morale hazards is generally more objective
right of inspection (legal hazards)
-gives underwriters the right to inspect contracts, business records, property, and conduct of businesses; allows underwriters to uncover any hidden legal hazards and deal with them when possible
The role of underwriting has expanded to include such activities as:
-identifying and evaluating risks -selecting risks -pricing risks -determining policy terms and conditions
judgment rating
-individual risk basis -after determining the risk is eligible for coverage, the underwriter either computes or approves the rate to be charged
Methods to control morale hazards
-limits on the amount of recovery -exclusions -deductibles -cancellation
ways to decrease physical hazards
-loss control methods (ex: sprinkler system in building) -deductibles (reduce the insurance company's share of any losses)
reporting losses moral hazards
-loss reporting provisions require insureds to notify their insurance companies in writing as soon as possible after losses occur and to file proofs of those losses within a specified time period -policy may be voided if these requirements are not met -helps underwrite against the potential moral hazard of insureds purchasing insurance after losses have occurred, with the intention of filing claims as soon as their coverage is in force
risk management services and 3 tools
-may be provided on a fee basis or without charge 1.self-retention programs 2. effective use of deductibles 3. loss control programs
role of underwriters
-must evaluate all the information relative to the specific situation and assess the relevance of that information to their decision -expected to make decisions that will allow their insurance companies to reach their profit goals -purpose of evaluations is to look for ways to write the insurance policies and reject risks or cancel policies only when no other alternatives exist -make sure that losses are not excessive in relation to the premiums charged
Vital statistics in an insurance application
-name and address of the applicant -policy limits requested -location and description of any property involved -desired effective date
deductibles (morale hazards)
-offer higher deductibles in lieu of rejecting risks -if individuals know they will pay more for any losses, they are less likely to be indifferent and more likely to take steps to reduce the hazards -deductibles cannot be larger than insureds could realistically be expected to pay
cancellation (morale hazards)
-once a policy is in force, cancellation after the usual discovery period may be forbidden by state law -during the discovery periods, underwriters can ask applicants to correct conditions that indicate morale hazards
limits on the amount of recovery (morale hazards)
-placing upper limits for theft losses on certain items -can be used to influence more careful attitudes on the parts of applicants who appear to be indifferent to losses
judicial interpretation (legal hazard)
-potential to occur each time a case goes to court -courts make decisions after they interpret the laws of a state, and neither insurance companies nor insureds can be certain in advance what the outcomes will be -courts may sanction liabilities for which insurance companies in no way intended coverages to apply
Customer services provided by underwriters
-preparing quotes -providing advice to producers about their accounts -recommending amounts of coverage appropriate to exposures -helping to handle billings, including preparation and problem-solving -preparing endorsements -evaluating proposals -issuing new and renewal policies -canceling and nonrenewing policies
cancellation (legal hazard)
-provision that is subject to state cancellation laws -may allow underwriters to terminate policies when legal hazards are too great; may cause insureds to correct hazards within their control rather than have their policies canceled
policy provisions to control legal hazards
-right of inspection -cancellation -endorsements
increase in hazards moral hazards
-some policies allow coverage to be suspended if a hazard is increased, unless the insurance company first gives approval for the condition that increases the hazard -provision usually applies only when the increase in hazard is within the insured's control and knowledge
exclusions (morale hazards)
-underwriters may write insurance with restricted coverage and exclude certain properties under specified conditions; applicants might be persuaded to be more careful knowing their property is not covered by insurance
endorsements (legal hazard)
-used when other provisions are unsuitable -endorsements may be added to policies to exclude coverage under specified conditions; may be used when courts have interpreted original insurance contracts beyond their intent; very specific about what is excluded
In most states, underwriters are legally required to make decisions about acceptance or rejection within ___ days of the date the producers bound coverage.
60
Origin of the term Underwriter
-was conducted by individuals who were willing to accept a certain amount of the risk of loss of their personal funds to profit from a business venture -would agree to insure other people as stated in an agreement between the two parties -people taking the risk of loss would literally write their names under the agreement
2 important types of government records
1. Motor vehicle records (MVR) 2. court records
Questions underwriters ask to determine what information is required
1. What do I need to know? 2. How much do I need to know? 3. When do I need that information? 4. Where will I get that information?
3 alternatives for underwriters
1. accept risks with no modifications 2. accept risks with modifications 3. reject risks
4 underwriting steps
1. acquire the underwriting information. 2. evaluate the underwriting information 3. select and implement the course of action. 4. monitor the decision
Sources that help underwriters evaluate risks for morale hazards
1. applications 2. inspection reports 3. claims reports 4. producers 5. motor vehicle records
3 categories of moral hazards
1. financial condition: weak financial conditions of businesses or individuals may prompt them to cause losses intentionally -when businesses or individuals do not have enough cash to pay their current bills -businesses that continuously fail to make profits 2. associates -applicants' associates -if individuals are known to associate with criminals or questionable persons, the chances moral hazards exist are increased 3. moral character -previous legal convictions or highly suspicious losses -look for a clean history
5 policy provisions intended to protect insurance companies against moral hazards
1. fraud or misrepresentation 2. increase in hazards 3. reporting losses 4. cancellation 5. exclusions
5 ways to look for moral hazards
1. inspection reports, which can provide general or specialized information 2. motor vehicle records, which reveal auto accidents and traffic citations 3. insurance industry bureaus, which provide information about suspected or proven arson and theft cases 4. producer recommendations 5. claim reports
4 basic types of hazards
1. moral hazards 2. physical hazards 3. morale hazards 4. legal hazards
8 basic underwriting functions
1. risk classification 2. rating and pricing 3. product design 4. customer service 5. marketing 6. risk management services 7. in-force underwriting and reunderwriting 8. risk selection
2 major indicators of a morale hazard
1. undesirable traits - carelessness and thoughtlessness 2. poor management - poor maintenance, poor housekeeping, poor safekeeping of property
Basic function of underwriting
allow the insurance company to provide its service while it makes a profit -helps decrease chance of financial loss -prevent selection against the insurance company (adverse selection) that might cause greater losses and thereby minimize the company's profit potential -striking a balance between adverse selection and accepting only the best risks
experience rating
blend of class rating and judgment rating -underwriters begin with a manual rate and adjust it based on past loss experience
absolute/strict liability
bring about legal liability even without negligence -determined by the situation rather than by what someone has done ex: people with domesticated cats are not absolutely liable for damages their cats might cause, but people who own wild animals are absolutely liable ex: extrahazardous activities: disposing of hazardous waste materials; absolutely liable for losses, whether or not negligence is involved -strict liability usually used in relation to defective products -people injured by defective products do not have to prove negligence on the part of the product manufacturers; just have to show products were unreasonably dangerous
classification/rating/drive-by report
classifies and rates risks -used by underwriters to obtain information not available elsewhere or to verify information provided on applications -may be used to determine or verify information for underwriting auto policies, such as: -use of the car -how often drivers use the car -driving records of all drivers of the car -where the car is garaged -may be used by property underwriters to obtain facts that are observable from the exterior property -includes information such as: -the construction of the buildings -buildings' distance from fire hydrants and fire stations -how well buildings are maintained -whether buildings are located within fire protection districts -security devices outside buildings
communication
combination of what is said and how it is said -sender sends the message, the receiver perceives the message and becomes the sender, sending a message to the previous sender, who now becomes the receiver and perceives their message
credit reports
contain information about the applicants' credit card, loan, judgment, lien (a right to keep possession of property belonging to another person until a debt owed by that person is discharged), collection, and bankruptcy histories -employment information
acquire the underwriting information
deciding what information is needed, where it can be obtained, and how to obtain it
type of occupancy
describes the activities that take place within structures in the normal course of business or residence
actuarial department
determines adequate rate levels for premiums -actuaries see that rates are actuarially sound in conjunction with the risks involved
loss control programs
differ according to the type of risk involved -engineering departments of insurance companies establish loss control programs for specific insureds, and underwriters must be knowledgeable about those techniques -decided to reduce the total costs of losses in two ways: preventing losses from occurring and reducing the dollar amount when a loss does occur
morale hazards
hazards by which individuals, through carelessness or their own irresponsible actions, can increase the chances of loss -occur because people are indifferent to loss
moral hazards
hazards intentionally created by people to gain financially from insurance companies
physical hazards
hazards that arise from characteristics of properties, such as the following: -construction -external exposures -type of occupancy -geographical location
legal hazards
hazards that exist because of laws, legal regulations, or prevailing legal attitudes toward claim settlement at given times -exist because a legislature or regulatory body took actions to protect citizens -premiums are generally underwriters' only "control" for legal hazards
contractual liability
individuals and companies often enter into agreements that result in the legal hazards of contractual liability -liability of one party is transferred to another by virtue of a contract ex: lease agreement in which property owner holds the lessor harmless for any damage the lessor might do to the property (property owner assumes all liability)
What is an underwriter's first source of information?
insurance application
purpose of underwriting
not to find reasons to decline business but to "engineer" accounts so they may become acceptable risks -suggest loss control activities, appropriate coverages for risks, changes in physical conditions that will make accounts acceptable, appropriate rate changes to take exposures into consideration
adverse selection
occurs when more people with greater-than-average exposures to losses purchase insurance than people with less-than-average exposures to losses
Compulsory insurance laws
passed by state legislatures, such as laws requiring motorists to carry liability insurance -intent of these laws is to protect others -require one or more insurance companies in those states to provide compulsory insurance coverage -legal hazards arise when companies are forced by law to provide insurance for risks that would otherwise not be acceptable to those companies
company underwriting
performed by underwriters who are physically located in insurance company home offices or branch or regional offices -receive underwriting information in their offices and make underwriting decisions from there
manuscript policy
policy written especially for a unique situation
risk classification
refers to underwriters' responsibilities to classify risks properly based on their similarities, such as buildings of like construction -helps determine the proper premium -risk classification systems used for risk selection because they provide guidelines that help underwriters decide whether to accept or decline risks
claim department
responsible for processing, investigating, settling, and paying claims -inform underwriters about things that they may be able to take corrective action on and prevent future loss, resulting in better underwriting and better policyholder service
marketing department
responsible for production, while the underwriting department is responsible for selection -must work together with underwriting
class/manual rating
risks representing similar exposures to loss have been classed together -primary method of pricing insurance -each rating class reflects a difference in loss potential -underwriters use the pricing structures found in the company rating manual but do not personally determine rates for individual risks
Risk selection
selecting risks that meet their insurance companies' guidelines for acceptance; must select a profitable spread of business -helps insurance companies guard against insuring risks with greater exposure to loss than those contemplated in the companies' pricing structures
evaluate the underwriting information
set an underwriter's sights on the profitability goal as it is impacted by basic underwriting consideration and allows the underwriter to identify alternative underwriting actions
Fair Credit Reporting Act of 1971 (FCRA)
stipulates procedures to be followed by insurance companies when they gather information about applicants for insurance -applicants must be notified that investigations will be made -most insurance companies include a statement on the application that an investigation report might be ordered -if applicants request it, insurance companies must provide information about the types of investigations being conducted -if any adverse underwriting decisions, such as denials of insurance or increased premiums for insurance, result from information from credit investigations, the applicants must be informed of their rights to obtain free copies of their credit reports from the reporting agencies and to dispute the accuracy or completeness of any information within these reports -applicants must be told they have 60 days from the date they were notified of an adverse underwriting decision to ask the insurance company to disclose the nature of the information on which the action was based
credible
taken seriously; underwriters must verify the accuracy of what they are communicating and what is communicated to them
Why do risk class characteristics change over time?
technological improvements and the legal environment
peril
the cause of a loss
external exposures
the environment in which risks are located
Whether information is understandable has to do with:
the sources of the information and the underwriter's experience and abilities
crucial risk characteristics
those that can be directly related to the frequency or severity of losses -must understand any special hazards associated with particular risk
product design
underwriters may be required to draft unusual policies or endorsements if prospective insureds' unique situations do not fit into class, judgment, or experience rating -some aspects are a part of daily activities: policy modification required because of a request for special coverages not usually sold by the company or for coverages not usually available for other than preferred risks; exclusions may have to be removed from a policy, or unusual conditions may need to be added -make sure clients' needs are met through product designs or changes in standard policy contracts
marketing
underwriters may play a role in marketing their company's products by accompanying producers on sales calls -allows underwriters' expertise to become part of closing sales -underwriters can make more accurate evaluations of potential accounts' acceptability by viewing them firsthand -enhance products' marketing potential
relevant
underwriting communication must be relevant -reason must exist for requesting certain information and that reason must be understood by the receiver
financial reports
used primarily by commercial lines
reunderwriting
when underwriters monitor an entire book of business (ex: underwriter might monitor all business submitted by a specific producer or agency, or all business written in a certain geographical area)
in-force or continuous underwriting
when underwriters monitor individual accounts
