Ch. 4 Underwriting Risk

Premium-to-surplus ratio (capacity ratio)

A capacity ratio that indicates an insurer's financial strength by relating net written premiums to policyholders' surplus.

Market Conduct Examination

An analysis of an insurer's practices in four operational areas: sales and advertising, underwriting, ratemaking, and claims handling.

National Association of Insurance Commissioners (NAIC)

An association of insurance commissioners from the 50 U.S. states, the District of Columbia, and the five U.S. territories and possessions, whose purpose is to coordinate insurance regulation activities among the various state insurance departments.

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.

Adverse selection

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

Nonfinancial Measures for Underwriting Results:

Selection Product or Line of Business Mix Pricing Accommodates Accounts Retention Ratio Hit Ratio Service to Producers Premium to Underwriter

Underwriting guidelines (underwriting guide)

A written manual that communicates an insurer's underwriting policy and that specifies the attributes of an account that an insurer is willing to insure.

Underwriting guidelines serve these purposes:

- provide for structured decisions - ensure uniformity and consistency - synthesize insights and experience - distinguish between routine and nonroutine decisions - avoid duplication of effort - ensure adherence to reinsurance treaties and planned rate levels - support policy preparation and compliance - provide a basis for predictive models

Staff Underwriting Activities

-Performing market research -Formulating underwriting policy -Revising underwriting guidelines to reflect changes in underwriting policy -Evaluating loss experience -Researching and developing coverage forms -Reviewing and revising pricing plans -Assisting others with complex accounts -Conducting underwriting audits

Line underwriting activities:

-selecting insureds -classifying and pricing accounts -recommending or providing coverage -managing a book of business -supporting producers and customers -coordinating with marketing efforts

6 Steps in the Underwriting Process

1. Evaluate the submission 2. Develop underwriting alternatives 3. Select an underwriting alternative 4. Determine an appropriate premium 5. Implement the underwriting decision 6. Monitor the underwriting decision

Greatview Insurance Company has underwriting expenses of $5 million, incurred losses and loss adjustment expenses of $14 million, net written premiums of $25 million, and earned premiums of $20 million. As a result, its combined ratio is 90 percent. Explain what this ratio indicates.

A combined ratio of 90 percent indicates that Greatview has an underwriting profit because not all of its premium dollars are being used for claims and expenses. To be specific, only 90 cents of every premium dollar is used for claims and expenses.

Hazard

A condition that increases the frequency or severity of a loss.

Underwriting policy (underwriting philosophy)

A guide to individual and aggregate policy selection that supports an insurer's mission statement.

Predictive modeling

A process in which historical data based on behaviors and events is blended with multiple variables and used to construct models of anticipated future outcomes.

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.

Combined Ratio

A profitability ratio that indicates whether an insurer has made an underwriting loss or gain.

Counteroffer

A proposal an offeree makes to an offeror that varies in some material way from the original offer, resulting in rejection of the original offer and constituting a new offer.

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.

Underwriting audit

A review of underwriting files to ensure that individual underwriters are adhering to underwriting guidelines.

Rating plan

A set of directions that specify criteria of the exposure base, the exposure unit, and rate per exposure unit to determine premiums for a particular line of insurance.

Measuring Underwriting Results Summary:

An insurer's underwriting results are a key indicator of its profitability. However, the combined ratio, a widely used measurement, can be distorted by changes in premium volume, major catastrophic losses, and delays in loss reporting and loss development. Nonfinancial measures are useful in evaluating individual underwriters' and underwriting departments' performance. Such measurements include selection, product or line of business mix, pricing, accommodated accounts, retention ratio, hit ratio, service to providers, and premium to underwriter.

Composite rating

An optional insurance pricing approach that uses a premium base other than the one specified in the rating manual to price an entire account.

Staff underwriter

An underwriter who assists underwriting management with making and implementing underwriting policy.

Line Underwriter

An underwriter who is primarily responsible for implementing the steps in the underwriting process.

Loss exposure

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

How can existing policies be monitored?

Be on the look out for one or more triggering events that may indicate a change in the account, such as these: Substantive policy change requests Significant and unique loss occurrences Risk control and safety inspection repots Premium audit results

Clarissa is a personal insurance underwriter for an insurer that uses the independent agency system. One day, she receives a request for automobile insurance from a client of one of the insurer's newly appointed agents. The applicant is a 24-year-old single man who was previously insured by a direct writer. The application indicates no accidents or traffic violations in the previous 3-year period. Clarissa suspects that the field underwriting may have been inadequate and believes that additional information is needed because the applicant is new business for the company. List the external and internal sources of underwriting information that Clarissa might use to reach her decision.

Beyond the application, Clarissa can use these sources to obtain additional underwriting information regarding this prospective auto insurance policy: The producer may have firsthand knowledge of the applicant and his reputation in the community. Government records, including motor vehicle reports, criminal court records, and civil court records, may be helpful. Financial rating services provide information about an applicant's financial status, which is important underwriting information. The applicant's loss data from the prior insurer can be used to verify information provided on the application and to predict future losses.

3 steps usually included in implementing the underwriting decision:

Communicate the underwriting decision to the producer Issue any required documents Record data about the applicant and the policy for policy issuance, accounting, statistical, and monitoring purposes

Financial Measures for Underwriting Results:

Distortions Created by Changes in Premium Volume Distortions Created by Major Catastrophic Losses Distortions Created by Delays in Loss Reporting and Loss Development

What financial relationship is CRUCIAL in evaluating insurer solvency?

Financial Capacity. The relationship between premiums written and policyholders' surplus

The premium-to-surplus ratio is one of those key ratios to evaluate solvency. When is it considered too high?

It is considered too high when it exceeds 300% or 3-to-1.

Why is it important for underwriters to operate within their assigned levels of underwriting authority?

It's important for underwriters to operate within their assigned levels of authority to ensure that they have the level of experience and expertise to make decisions regarding risk selection and pricing that are appropriate and comply with the insurer's established underwriting guidelines.

Line underwriters are often called on to help producers acquire new customers. What are some ways they can do this?

Line underwriters can support producers by explaining how coverages will respond to different types of losses and what endorsements can be added to provide coverage not included in standard policies.

Martina works in the Underwriting Department of a national insurer. Her main duties involve analyzing existing accounts to make sure insureds are using applicable risk control or retention techniques to complement their insurance coverage. She also provides advice to producers wondering how their clients' coverages might respond to specific events or losses. Identify the type of underwriter Martina would be classified as and what specific duty she is performing.

Martina would be considered a line underwriter, and her main duties would fall under recommending or providing coverage.

Premium Audit

Methodical examination of a policyholder's operations, records, and books of account to determine the actual exposure units and premium for insurance coverages already provided.

Underwriters can use various sources to obtain the information needed to evaluate a submission:

Producer Applications Inspection or risk control reports Government records Financial rating services Loss data Premium audit reports Claim files

What types of modifications are usually included in counteroffers?

Require risk control measures Change insurance rates, rating plans, or policy limits Amend policy terms and conditions Use facultative reinsurance

3 ways insurers seek to maximize their ROE?

Setting return thresholds Redirecting focus on target business classes Adjusting underwriting policy based on jurisdiction

Hit ratio (success ratio)

The ratio of insurance policies written to those that have been quoted to applicants for insurance.

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.

Information inef

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 cost

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

Underwriting authorty

The scope of decisions that an underwriter can make without receiving approval from someone at a higher level.

State regulators perform market conduct examinations to verify that insurers are adhering to their filed classification and rating plans. T/F?

True. This is why state regulators perform market conduct examinations.

Think about the types of information underwriters need when deciding whether to accept a request for coverage. What are some sources of that information?

Underwriters can use many sources of information when it comes to deciding whether a request for coverage should be accepted. Such sources include the account's producer, applications, inspection reports, government records, financial rating services, loss data, premium audit reports, and claim files for existing accounts.

Summary of UW guidelines:

Underwriting guidelines establish the acceptable parameters of applicants who wish to obtain an insurer's products. They can provide for structured decisions and ensure consistency in overall underwriting decision making. Underwriting audits are a quality control check for uniform application of underwriting guidelines and can aid efforts to improve and update the guidelines.

Explain how underwriting guidelines provide a structure for underwriting decisions.

Underwriting guidelines provide a structure for underwriting decisions by identifying the major considerations underwriters should evaluate for each type of insurance an insurer writes.

Aside from ensuring that underwriting guidelines are being followed, why might an underwriting audit be conducted?

Underwriting audits can provide insight into whether underwriting guidelines need to be updated or enhanced. They can also illuminate why guidelines are not being followed or are ineffective as currently written.

Aside from weighing a submission's positive and negative features, what other factors should also be considered before selecting an underwriting alternative?

Underwriting authority Supporting business Mix of business Producer relationships Regulatory restrictions

Underwriting Submission

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

Have you noticed any effects regulation may have had on the underwriting process in your work?

You may have seen regulation's impact on the underwriting process through any of these ways: Insurers must be licensed to write insurance in each state in which they write insurance. Rates, rules, and forms must be filed with state regulators. Some states specifically require underwriting guidelines to be filed. If consumer groups believe that the insurance industry has not adequately served certain geographic areas, regulatory focus on insurance availability can lead to requirements to extend coverage to loss exposures that an insurer might otherwise not write.

Major constraining factors on underwriting policy:

financial capacity regulation personnel reinsurance