A proposal is an application for an insurance cover. Every time a proposal is received, the insurer will not grant the cover at the spot. The insurer will make a decision as to the admissibility of the proposer to the pool of policyholders. This is because the insurer also act as a trustee. It has to ensure that every new policy into the pool has similar exposure to the risks as the other. This process of verifying the level of risk in each new entrant and determining the terms of admission is called 'underwriting'.
Need of underwriting
The underwriting process is an important one in any insurance office, life or non-life. If the risk is wrongly assessed, the premium charged would not be appropriate. A lower premium affects the solvency of the fund. The cost of the additional risk, not recovered from the proposer would have to be borne by the rest of the policyholders. That is not fair to them.
If the underwriter finds that the individual proposed to be insured has no adverse features affecting mortality and other factors relating to insurability, the risk is considered as a normal or standard or first class life. The premium charged would be as per tabular rates. Otherwise, the terms of acceptance of the proposal would be different. In some cases, the insurer may refuse to grant insurance. The word decline is used when the underwriter decides to refuse insurance. A decision to charge a premium higher than necessary would not be fair to the proposer, because of the principle of utmost good faith. 'Underwriting' has implications of fairness to the insurer and to policyholders, individually and collectively.
Underwriting In Life Insurance
Underwriting is the name given to the procedure of:
- assessing the risk which people bring to the pool;
- deciding whether or not to accept the risk, or how much to accept;
- determining the terms, conditions and scope of the cover to be offered; and
- calculating a suitable premium.
A decision to charge a premium higher than necessary would not be fair to the proposer, because of the principle of utmost good faith. Underwriting has implications of fairness to the insurer and to policyholders, individually and collectively. The insurance company carries the risks of the person insured in accordance with the policy terms and conditions. Hence the underwriters have to be extra careful in choosing the individuals to be insured from the group of proposers and in setting a fair price in line with the risk that each individual presents to the pool.
Principles of Underwriting
Underwriting has to do with the selection of subjects for insurance in such a manner that general company objectives are met. The main objective of underwriting is to see that the risk accepted by the insurer corresponds to that assumed in the rating structure. There is often a tendency toward adverse selection, which the underwriter must try to prevent. Adverse selection occurs when those most likely to suffer loss are covered in greater proportion than others.
In some types of insurance major underwriting decisions are made in the field, and in other types they are made at the home office. In the field of life insurance the agent's judgment is not accepted as final until the home office underwriter can make a decision, for the life insurance contract is usually non-cancelable, once written.
In the field of property and liability insurance, on the other hand, the contract is cancel-able if the home-office underwriter later finds the risk to be unacceptable. It is not uncommon for a property and liability insurer to accept large risks only to cancel them at a later time after the full facts are analyzed.
The insurance underwriter must tread a thin line between undue strictness and undue laxity in the acceptance of risk. The underwriter's position is not unlike that of the credit manager in a business corporation, in which unreasonably strict credit standards discourage sales but overly weak credit standards invite losses.
The insurer must decide upon certain standards, terme. and conditions for applicants, project estimated losses and expenses through the anticipated period of coverage, and calculate reasonably accurate rates to cover these losses and expenses. Since many factors affect losses and expenses, the underwriting task is complex and uncertain. Bad underwriting has resulted in the failure of many insurers.
Underwriting In Non-Life Insurance
The underwriting of non-life insurance is very complicated. Commercial Insurances range from small shops and factories to large MNC's (Multi-National Companies) The main task is that underwriter has to evaluate the hazard associated with the risk, which is being proposed. In small cases he may be able to do this by simply reading a proposal form. A local Inspector is asked to call and see the shop or factory.
In large cases, this is not possible. Details of the risk cannot be confined to a proposal form since there is too much information to condense, no matter how large the form may be. The insurance companies may take the help of brokers in these cases. Broker can prepare the case for underwriter. He will inspect the sites and prepare plans and reports on the relevant aspects of the risk. Various detailed documents are passed on to the underwriter and negotiation is done on the terms, conditions, cover and price.
Several sources of information are available to the underwriter regarding the hazards of commercial applicant for property and liability insurance.
(a) Application Containing the Insurers Statements: The basic source of underwriting information is the application, which varies for each line of insurance and for each type of coverage. The broader and more liberal the contract, usually more detailed information is required. The questions on the application are designed to give the underwriter the information needed to decide whether to accept the exposure, reject it or ask for additional information.
(b) Information from the Agent or Broker: In some line of non-life insurance, the agent may exercise his underwriting authority. For commercial insurances, the profit sharing contracts are also entered with the agents, whereby the agent derives a special incentive if the business brought by him has resulted in a profit to the company.
(c) Prior Experiences: The past history of claims is also a source of information. In case of existing clients where the claims experience has been unfavorable, the insurance company penalizes i.e. loads premium for new businesses or renewals of the existing ones.
(d) Inspection: Surveys are also conducted by the company's specialists/ consultants to find the accuracy of information contained in the proposal form.