What are the additional purposes underwriting serves to achieve profitability?
- Guarding against adverse selection
- Ensuring adequate policyholders’ surplus
- Enforcing underwriting guidelines
What is the main purpose of underwriting?
To develop and maintain a profitable book of business.
How do underwriters minimize the effects of adverse selection?
Underwriters minimize the effects of adverse selection by carefully selecting the applicants whose loss exposures they are willing to insure, charging appro- priate premiums for the applicants that they do accept with premiums that accurately reflect the loss exposures, and monitoring applications and books of business for unusual patterns of policy growth or loss.
Under statutory accounting principles (SAP), an insurer’s total admitted assets minus its total liabilities. Formula: Assets - Liabilities
Policyholders’ Surplus
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. The maximum safe premium volume based on surplus.
Underwriting Authority
The scope of decisions that an underwriter can make without receiving approval from someone at a higher level. Limits the decisions an underwriter may make without approval from a superior. Authority levels vary by GRADE LEVEL.
Line Underwriter
Underwriter who is primarily responsible for implementing the steps in the underwriting process. Makes direct operating decisions.
Staff Underwriter
Underwriter who is usually located in the home office and who assists underwriting management with making and implementing underwriting policy. Advises, supports, and services line underwritings
What limits an insured’s capacity?
Regulatory guidelines and the insurer’s own voluntary constraints.
How do underwriters ensure adequacy of the policyholders’ surplus?
Adhering to underwriting guidelines, making certain that all loss exposures are correctly identified, and charging adequate premium for accepted applications.
What is the main focus of staff underwriters and who do they work with?
Managing the risk selection process. They work with the line underwriters and coordinate decisions with other departments to manage the insurance product, pricing, an guidelines.
What is the main focus of line underwriters and who do they work with?
Evaluating new submissions and renewal underwriting. They work with producers and applicants.
Line underwriter activities.
- Select insured
- Classify and price accounts
- Recommend or provide coverage
- Manage a book of business
- Support producers and insureds
- Coordinate with marketing efforts
Staff underwriter activities.
- 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 audits
- Participate in industry associations
- Conduct education and training
Which goals does effective account selection attain?
- avoid adverse selection
- charging adequate premiums or accounts with higher than average chance of loss.
- selecting better-than-average accounts for which the premium charged will be more than adequate
- rationing an insured’a available capacity to obtain an optimum spread of loss exposures by location, class, size of risk, and line of business.
The process of grouping accounts with similar attributes so that they can be priced appropriately.
Classification.
What happens if a risk is classified incorrectly?
If too high, insured may leave carrier.
If too low, premium is inadequate.
Why do underwriters sometimes have to determine an applicant’s insurance needs?
Some applicants use alternate risk transfer for some exposures but use insurance for others. Underwriters have to ask questions to make sure there are no gaps. They may have to broaden coverage as a result.
Why do underwriters sometimes have to narrow coverage?
Producers sometimes request broader coverage than the insurer offers. Instead if declining coverage, the insurer may propose higher deductibles or fewer causes of loss.
An insurance policy that is specifically drafted according to terms negotiated between a specific insured (or group of insureds) and an insurer.
Manuscript policy.
What do production underwriters do?
Confer personally with producers and assist them with developing accounts that are acceptable to the insurer.
Staff underwriters’ market research includes an ongoing evaluation of which items?
- effects of adding or deleting entire types of business
- effects of expanding into additional states or retiring from states presently serviced
- optimal product mix in the book of business.
- premium volume goals
A guide to individual and aggregate policy selection that supports an insurer’s mission statement.
Underwriting policy.
Explain the factors to consider in extending underwriting authority to producers
Insurer’s philosophy, the experience and profitability of the producer, and the type of insurance involved
Describe the purpose of underwriting and the effect of adverse selection on the insurance selection process
Purpose of underwriting is to develop and maintain a profitable book of business for the insurer. Adverse selection occurs when applicants for insurance present a higher-than-average probability for loss. To minimize the effects of adverse selection, underwriters must select those risks that meet company guidelines and charge premiums that adequately reflect the policyholders’ exposure to loss
What factors may affect an insurer’s reliance on producers to field underwriter?
the producer involved, the types of business, and the marketing system used
What are the steps in the underwriting decision-making process?
1) Evaluate loss exposures,
2) Determine underwriting alternatives,
3) select an underwriting alternative, 4) determine the appropriate premium,
5) Implement the underwriting decision,
6) Monitor the loss exposures
What four major modifications can be made or recommended to make a submission more acceptable to an underwriter?
1) require loss control measures,
2) change insurance rates, rating plans, or policy limits,
3) amend policy terms and conditions,
4) use facultative reinsurance
Distinguish between line and staff underwriting positions
Line underwriters are primarily responsible for implementing the steps in the underwriting process. Line underwriters are generally in branch or regional offices. Staff underwriting activities usually take place at the home-office level and involve assisting underwriting management with making and implementing underwriting policy
Describe the major line underwriting activities
Underwriters are responsible for implementing the steps in the underwriting process, which include evaluating loss exposures, determining appropriate premiums, and monitoring loss exposures. Underwriters also assist with determing appropriate coverage and provide ongoing service to producers and policyholders
Describe the major staff underwriting activities
Researching the market, researching and developing coverages, evaluating underwriting experience, reviewing and revising rating plans, formulating underwriting policy, preparing underwriting guides, conducting underwriting audits, and assisting in education and training
Explain how financial capacity affects underwriting policy
If a particular type of business is experiencing a level of losses that exceeds the level anticipated by the rate, the insurer might decide to stop pursuing that class of business. When establishing underwriting policy, insurers must also consider the effect of catastrophic losses and might decide to limit their writing of a given type of insurance in a particular territory
Explain how regulation affects underwriting policy
Regulation affects rate levels and forms used by insurers. If rate levels within a territory are inadequate in relation to claim costs, an insurer might decide to withdraw from that type of insurance within the specific judgement
Explain how personnel and physical resources affect underwriting policy
Insurers require a sufficient number of properly trained underwriters with specialized expertise in those types of insurance the company provides. Insurers also must have personnel where they are needed.
Explain how reinsurance affects underwriting policy
The price and availability of reinsurance treaties might affect which type of insurance is written
How do underwriting guides direct an insurer’s underwriting activities?
Underwriting guides provide for structured decisions and identify the major elements that line underwriters should evaluate for each type of insurance
Explain why and how underwriting audits are usually conducted
These audits determine whether underwriters are properly implementing underwriting policy. They are conducted by one underwriter or a team of underwriters from the home office who review selected policies
IIA Insurance Company recognizes that the combined ratio should not be the sole measure used to evaluate underwriting performance. Describe other, nonfinancial measures available to IIA
Other measures available include reviewing adherence to selection and pricing standards; the product mix; the number of accommodated risks written; the retention ratio or the number of policies renewed out of the total available for renewal; and the success ratio that indicates how many policies were written out of the total number of quotations for coverage that were provided. Standards for service to producers are another measure of performance
1-3 Describe the approaches underwriters take to ensure that the policies of accepted applicants adhere to underwriting guidelines.
If loss exposures, risks, or policy limits on an application exceed an underwriter’s authority, he or she will seek approval through supervisory and management ranks within the underwriting department.
2-3. Some underwriting guides contain systematic instructions for handling particular classes of commercial accounts. Describe the instructions such guides might include.
Such underwriting guides identify specific hazards to evaluate, alternatives to consider, criteria to use when making the final decision, ways to implement the decision, and methods to monitor the decision. The guides may also provide pricing instructions and reinsurance-related information.
2-4. Explain how staff underwriters are involved in the development of coverage forms
Staff underwriters work cooperatively with the actuarial and legal departments to develop new coverages and modify existing coverage forms developed by advisory organizations.
3-1. Explain why it is important that underwriters operate within their assigned levels of underwriting authority.
Compliance with levels of authority ensures that the insurer accepts applicants within its underwriting policy.
3-2. Describe how insurers communicate underwriting authority through underwriting guidelines.
A notation next to a specific classification in the underwriting guide might indicate that a senior underwriter must review and approve an application from that classification before it is processed further. Depending on the concerns that underwriting management places on a classification, underwriting approval might be required from the line underwriter’s branch manager or a staff underwriter at the home office.
4-1. Describe the components of an insurer’s financial capacity.
An insurer’s financial capacity refers to the relationship between premiums written and the size of the policyholders’ surplus or the insurer’s net worth.
4-2. Explain how rapid premium growth can cause insurers to experience excessive premium-to-surplus ratios.
Rapid premium growth results in a reduction in policyholders’ surplus to pay for expenses generated by that growth, due to conservative statutory accounting principles used in insurance. This constraint often precludes premium expansion unless the insurer purchases reinsurance or obtains more capital.
4-3. Identify four ways that regulation may affect underwriting policy.
Regulation may affect underwriting policy in these ways:
1) Insurers must be licensed to write insurance in each state in which they do business.
2) Rates, rules, and forms must be filed with state regulators.
3) Underwriting guidelines are required to be filed in some states.
4) 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.
4-4. Describe the types of underlying insurance forms that may concern reinsurers.
Reinsurers may expressly exclude reinsurance coverage for loss exposures covered by underlying manuscript forms developed for a particular insured or covered by underlying forms developed independently of an advisory organization.
5-1. 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 the insurer writes.
5-2. Contrast routine underwriting decisions with nonroutine underwriting 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.
5-3. Explain how compliance with underwriting guidelines ensures adherence to reinsurance treaty limitations.
Compliance with underwriting guidelines ensures that coverage limits and accepted loss exposures will not exceed the insurer’s treaty reinsurance, because staff underwriters reflect those treaty limitations in the guidelines.
5-4. Describe the potential advantages of using predictive modeling in making underwriting decisions.
Predictive modeling can provide a consistent way to review individual applications that improves the overall profitability of a book of business. It can also help in managing a large book of business for which conducting an in-depth underwriting review on every account would be too costly.
5-5. Explain how underwriting audits provide staff underwriters with information on the effectiveness of existing underwriting guidelines.
Underwriting guidelines that are not being following may be either outdated or considered unrealistic, which could indicate that a critical review for updates is required.
6-1. What are the steps in the underwriting process?
6-1. The underwriting process entails these six steps:
a. Evaluate the submission
b. Develop underwriting alternatives
c. Select an underwriting alternative
d. Determine an appropriate premium
e. Implement the underwriting decision
f. Monitor underwriting decisions
6-2. List five principal sources of underwriting information.
Any five of these are principal sources of underwriting information:
1) producers
2) insurance applications,
3) inspection reports,
4) government records,
5) financial rating services,
6) loss data,
7) field marketing
8) personnel,
9) premium auditors,
10) claim files,
11) production records,
12) consultants’ reports.
6-3. What four major modifications might an underwriter recommend to make a submission more acceptable?
An underwriter may suggest these modifications to a submission:
- Require loss control measures
- Change insurance rates, rating plans, or policy limits
- Amend policy terms and conditions
- Use facultative reinsurance
6-4. What factors beyond the content of a submission itself must an underwriter consider before selecting an underwriting alternative?
The underwriter must consider these factors before selecting an alternative:
1) Underwriting authority-Whether the underwriter has the necessary underwriting authority
2) Supporting business-Whether an otherwise marginal submission might be acceptable if the other insurance components of the applicant’s account-the supporting business-are desirable
3) Mix of business-Whether accepting the application supports the insurer’s goals for mix of business
4) Producer relationships-Whether the relationship between the underwriter and the producer
is based on mutually shared goals
5) Regulatory restrictions-Whether any state regulations restrict underwriters’ ability to accept or renew business, and whether any federal and state privacy laws restrict the type and the amount of information about an applicant that an underwriter can obtain
6-5. Why is it important for the underwriter to correctly classify each loss exposure in a submission when determining the appropriate premium?
Accurate classification ensures a pooling of loss exposures whose expected loss frequency and loss severity are similar. Misclassification can produce adverse results, including insufficient premium to cover losses and expenses, inability to sell policies because prices are higher than competitors’ prices, and charges that the insurer has violated regulations prohibiting unfair trade practices.
6-6. Why should underwriters monitor underwriting results of territories or geographic areas?
Monitoring territorial underwriting results can help the insurer to target areas for future agency appointments in profitable regions. Poor results could indicate areas from which the insurer might withdraw or in which the insurer might raise rates, if permitted by regulators
6-7. Rachel is a personal insurance underwriter for Acme Insurance Company, an insurer using the independent agency system. One day, she receives a request for automobile insurance from a client of one of Acme’s newly appointed agents. The applicant is a twenty-four-year-old single male who was previously insured by a direct writer. The application indicates no accidents or traffic violations in the previous three-year period. Rachel 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.
a. List the external and internal sources of underwriting information that Rachel might use to reach her decision.
b. What factors will determine how much and what kinds of information Rachel might request?
These answers apply to questions regarding Rachel’s underwriting decision:
a. Beyond the application, Rachel can use these sources to obtain additional underwriting information (other possible sources do not relate directly to personal auto insurance):
-The producer may have firsthand knowledge of the applicant and may know the applicant’s reputation in the community.
-Government records include motor vehicle reports, criminal court records, and civil court records. Motor vehicle records (MVRs) are a fundamental information source for auto underwriting.
-Production records of individual producers, indicating loss ratio, premium volume, mix of business, amount of supporting business, length of service, and industry experience, help underwriters make decisions about the quality of the applicants that the producer is submitting.
In personal auto underwriting, for example, the mix of business indicates whether
a particular producer is submitting an inordinately large percentage of young drivers or drivers with poor driving records.
b. The amount of time required to receive the information and the cost to acquire the information are important considerations. Underwriters must balance the degree of hazard with how much information is needed and the cost to acquire the information.
7 -1. What do insurers use the combined ratio to measure?
7 -1. Insurers use the combined ratio to measure the success of underwriting activities.
7-2. What would an underwriter conclude about each of the following combined
ratios?
a. A combined ratio of exactly 100 percent
b. A combined ratio of greater than 100 percent
c. A combined ratio of less than 100 percent
a. Exactly 100 percent-Every premium dollar is being used to pay claims and cover operating costs, with nothing remaining for insurer profit.
b. Greater than 100 percent-An underwriting loss occurs; more dollars are being paid out than are being taken in as premiums.
c. Less than 100 percent-An underwriting profit occurs; not all premium dollars taken in are
being used for claims and expenses.
7 -3. An insurer that becomes more restrictive
7 -3. An insurer decides to make its underwriting criteria more restrictive. Explain how this change affects premium volume and the insurer’s combined ratio.
An insurer that becomes more restrictive in its underwriting criteria will usually see a reduction in premiums written. Because incurred losses remain outstanding from the prior period that had a less restrictive underwriting policy, the loss ratio component of the combined ratio will likely deteriorate.
With this reduction in premiums written, the expense ratio will increase, even though the
insurer’s underwriting expenses might have remained relatively unchanged.
7 -4. List some aspects of an insurer’s operations that are affected by the underwriting cycle.
The underwriting cycle affects premium levels, capital allocation strategies, investment strategies, and insurer profitability.
7-5. How do pricing standards benefit insurers?
Pricing standards enable insurers to determine levels of premium adequacy by comparing premiums charged to the established pricing standards. Insurers also track the extent to which their underwriters deviate from the insurer’s established pricing for specific classifications. This information might be useful in determining the extent to which the underwriter’s book of business is underpriced or overpriced and where pricing adjustments might be made, should market conditions
change.
7 -6. Insurance Company has incurred 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.
a. Determine Insurance Company’s trade-basis combined ratio.
b. What does this ratio indicate regarding Insurance Company’s use of its
premium dollars?
These answers are based on Insurance Company’s financial data:
a. Insurance Company’s trade basis combined ratio would be calculated:
Incurred losses and Incurred
loss adjustment expenses/Earned premiums + incurred underwriting expenses/Net written premiums
14MM/20MM + 5MM/25MM = .70+.20 = .90 or 90%
b. The ratio indicates that Insurance Company has an underwriting profit because not all of its premium dollars are being used for claims and expenses.
What effect does rapid growth have on policyholder surplus?
Results in a reduction of policyholder surplus to pay for expenses generated by that growth.
Insurers seek to write lines of business that maximize return on equity. Which activities help realize maximization?
A. Setting return thresholds
B. redirecting focus on target business classes
C. Adjusting underwriting policy based on jurisdiction.
Which method of calculating return on equity do stock insurers use and which do mutual insurers use?
Stock: SAP & GAAP
Mutual: SAP
How can’t he availability and cost of reinsurance influence underwriting policy?
Reinsurance treaties may not cover certain lines, classes of business. Cost for some risks may be prohibitive.
Also concerned about underlying policy forms. May not cover manuscript forms.
What are the 8 purposes of underwriting guidelines?
• 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
What are the purposes of underwriting audits?
- determine if line underwriters are following underwriting policy.
- promote uniformity and consistency in underwriting
Standards - measure underwriting results
- identify unused or conflicting guidelines
How do predictive models work?
-multiple data variables of each risk are developed by using underwriting guidelines, insured’s loss experience, loss data collected from external sources, and underwriting expertise. The score created can help rank the likelihood of a loss and predict profit potential.
-
What are the principal sources of underwriting information?
-producers (most relied upon)
-inspection reports
-government records
(MVR, RMV)
-financial rating services (Dun & Bradstreet, S&P)
-loss data (loss run)
What information can loss runs provide?
Loss frequency and severity, types of losses, possible seasonality, trends in loss experience, and inductions of management’a attention to prompt loss reporting.
What are some other sources of underwriting information?
- field marketing personnel
- premium auditor (examine operations, books to determine actual loss experience)
- claim files
- production records (producer’s loss ratio, premium volume, mix of business, amount of supporting business, length of service, industry experience. This shows quality of applicants.
- Consultants reports
What is schedule rating?
Debits and credits are awarded to a submission based on categories of business characteristics, such as the are an condition of the premises and these selection and training of employees.
Why are the factors that need to be considered when deleting an underwriting alternative?
- underwriting authority
- supporting business
- mix of business (distribution of individual policies that constitute a book of business of a producer, state, or region among the various type of insurance and classification of Insureds
- producer relationships
- regulatory regulations
What are the three steps in implementing the underwriting decision?
Communicating the decision to the producer.
Issue documents (binder or certificate of insurance)
Record information - into database/system
How does an underwriter monitor individual policies?
Usually involves trigger events such as adding a new driver or adding location, significant or unique losses.
The underwriter may need to decide whether to renew a policy.
Risk control and safety inspections may be followed up on to make sure they met requirements.
Premium audits may be conducted which may disclose larger loss exposures than originally contemplated, unacceptable operations, new products, new operations, or financial problems.
How do underwriters monitor a book of business?
Evaluate for quality and profitability
a. Identify specific problems for each type of insurance, which can be subdivided into class of business, territory, producer, and other policy subgroups.
b. use premium and loss statistics to identify aggregate problems in deteriorating book of business.
What factors can distort the combined ratio?
Changes in premium volume, major catastrophic losses, delays in loss reporting and loss development, the underwriting cycle
How do changes in premium volume affect the combined ratio?
Restrictive underwriting leads to reduced premium volume. Claims are still paid from policies written during less restrictive underwriting. This leads to a higher combined ratio.
How do distortions created by delays in loss reporting affect the combined ratio.
They reduce the value of the information provided by the combined ratio. Delays in loss reporting and settlement can result in an understatement of losses in one year and an overstatement in another year that appear in the combined ratio.
How do distortions created by the underwriting cycle affect the combined ratio.
Soft Cycle/Underwriting losses: may need to increase rates and become more restrictive to increase profits to maintain the surplus. Lower premium volume would lead to higher combined ratio.
How can an insurer reposition itself when underwriting cycles change?
With effective underwriting and financial management. The insurer would have to change underwriting guidelines and change its allocation of capital to underwriting.
What are some nonfinancial measures used to measure an insurer’s results?
- Selection (adherence to selection guidelines)
- Product line or business mix (mix that fits with insurer’s appetite)
- Pricing (tracking extent of deviation from established pricing)
- Accomodated Accounts (excessive accomodations? What is insurer getting in return?)
- Retention ratio
- Hit ratio
- Service to producers (compare to targeted level of performance)
- Premium to underwriter (is underwriter assuming their share of work compared with other underwriters?)
What can a low retention rate indicate?
Serious deficiencies in the way insurers do business, including poor service to producers, noncompetitive pricing, or unfavorable claims service.
What is the “hit ratio?”
A nonfinancial measure used to determine how well underwriters (or the insurer as a whole) are meeting their sales goals. Ratio of policies written to policies quoted.
What does a high “hit ratio” indicate?
- Competition is easing
- Rates are inadequate or lower than other carriers’
- Coverage is broader than other insurers
- Underwriter has the skill set for production underwriting
- Underwriting selection criteria are deteriorating
- An extremely good relationship exists between the insurer and the producer
What does a low “hit ratio” indicate?
- Competition is decreasing.
- Rates are higher than other carriers’
- Coverage or forms are too restrictive
- Underwriter does not have the skill set for production underwriting
- Underwriting selection criteria are too stringent
- A poor relationship exists between the insurer and the producer
An insurance company needs to hire an employee with knowledge of insurance policy forms and the ability to relate policy provisions to the loss exposures of individual policyholders. The person will also prepare premium quotes and process cancellations.Which one of the following employees would best suit the company’s needs?
Choose one answer.
A. Line underwriter
B. Staff underwriter
C. Producer
D. Premium auditor
Line underwriter
Underwriting guidelines include acceptable approaches to evaluating applicants and the overall desirability of a particular type of risk or class of business. Which one of the following purposes of underwriting guidelines is served by these approaches?
Choose one answer.
A. Proper issuance
B. Uniformity of selection decisions
C. Structured decision making
D. Adherence to procedures
Uniformity of selection decisions
Staff underwriters share research of the market responsibilities with actuarial and marketing departments. Research includes an ongoing evaluation of which one of the following?
Choose one answer.
A. Revision to coverage forms
B. Average loss ratio for a book of business
C. Optimal product mix in the book of business
D. The hit ratios by underwriter
C. Optimal product mix in the book of business
Who will draft a manuscript policy or endorsement that is worded to address the specific needs of the insured?
Line underwriter
Specialty insurers such as those offering surety bonds, aviation insurance, and livestock mortality insurance usually grant underwriting authority through the
Centralization of underwriting authority
While developing goals for its book of business, an insurer’s staff decides to increase its market share of workers compensation insurance in the construction industry. This type of underwriting activity is known as
Formulating underwriting policy
