Insurance underwriting

CHAPTER-4

What is Underwriting?What is Underwriting?

The assessment or verifying the level of risk is called selection or underwriting.

Underwriting :- U :- Understanding N :- Necessary D :- Details & E :- Evolving R :- Rational W :- Weightage of R :- Risk & I :- Important T :- Truths I :- Influencing N :- Normal G :- Grade

The process of insurance underwriting is as follows:

Collect information about the applicant

Analyse the risk associated

Estimate the potential exposure

Determine the probability of loss

Accept (or reject) the proposal

Classify and rate into a risk group to calculate the premium

Issue the insurance policy

Sources of information about the proposer

Proposalform

Tax consultants/IT authorities

Additionalinformation

questionnaire

Insuranceagent

Medicalexamination

report

Informationon the

proposer

Proposal

• Personal information:

• Medical information:

• Agent’s remarks:

Agent’s Confidential Report

What is the need for underwriting ?

ØUnderwriting is needed to assess the risk & to decide whether risk is acceptable at Standard rate or with extra premium or with some restrictions or to decline the risk.

ØOnce the nature of insured lives is decided

premiums will be charged accordingly.

What will happen if the risk is wrongly assessed?

Premiums will be charged either less or moreA lower premium affects the solvency of the fund & cost of additional risk have to be borne by the rest of the policyholders.i.e. If lower premium is charged, Insurer’s claim experience will not be as anticipated & it will have adverse effect on Insurer’s funds to meet the additional claims & profits.

A higher premium charged would not be fair to the proposer.

Insurance cover will not be allowed to proposer at appropriate rate.

Insurance may be given to a person who is uninsurable (Anti selection)

Terms of acceptanceIf there are no additional risk factors (adverse features) affecting mortality then the proposal would be accepted at Ordinary Rate (O.R.) or Standard Rates.

If there are additional risk factors (adverse features) proposal will be accepted with suitable extra premium/restrictions (modified terms) or declined.

Classification of Risks

• Hazards – These are the factors which affect the risk. They are as follows.

Physical Hazards1) Age Premiums are based on age & as age increases probability of death increases. Therefore age is an important factor.

eg. Person aged 25 years will be at lesser risk compared to person of 50 years age.

Overweight at advanced age & underweight at young age need careful assessment.

eg. Proposer aged 20 years & underweight will be at higher risk of death due to Tuberculosis or Asthma compared to proposer aged 40 years & underweight. eg. If proposer is 50 years old, overweight & having cardiac problem then risk is more than person who has cardiac problem but not overweight.

Certain risk increase with age & certain risk decrease with age. eg. Risk on the life of an underweight person at younger age is of decreasing type. 2) Sex Mortality of female lives is greater than male lives at younger ages. eg. This is due to the inadequate care in maternity cases among poor & uneducated sections.

3) Build It reflects the health of the proponent. eg. If a proposer is underweight then chances of Tuberculosis is high & if a proposer is overweight then chances of Hypertension or Heart problem is high. 4) Physical conditionMedical Report provides the data regarding blood pressure, pulse etc. which will reveal the condition of important systems of the body.

eg. Hypertension may result into Paralytic Stroke or Heart attack. eg. High Pulse rate suggests the tendencies towards heart problem.

5) Physical impairments

These are the hazards which affect the mortality (probability) of the death.

eg. If proposer is Blind, Deaf, Paralysed or having poliomyelitis then he is prone to accident. 6) Personal history

Gives the information about health & life style of person.

eg. If proposer is a habitual smoker then the chances of his suffering from Lung disease are higher compared to non- smoker. eg. Similar is the case with an alcoholic whose chances of suffering from Kidney & Liver problems are more.

7) Family History Reveals the hereditary diseases like diabetes & cardiac illnesses. eg. If proposer’s parents had Diabetes then his chances of suffering from Diabetes are greater.

Occupational Hazard It arises out of one’s occupation. eg. 1) Flight duties on aircraft. 2) Working at heights. 3) Working with high speed machine. Proponents involved in above jobs are prone to accident. Nature & place of job have effects on the worker.eg. 1) Inhalation of dangerous fumes. Therefore people working in chemical factories are likely victims of various respiratory diseases such as Tuberculosis or Asthma. 2) people working with high voltage electricity are prone to electrocution & burns. 3) People working in mine industries Suitable extra premiums are charged.

MORAL HAZARDIt refers to the intentions of the proposer.It exists when the intention is to take undue advantage.It has to be judged with reference to life style, income, reputation , need for insurance etc.

It is not measurable.

If moral hazard is suspected suspect no amount of extra premium will be appropriate & the proposal has to be declined.

Examples of moral hazard1) First insurance for large amount at advanced age.2) Large insurance with inadequate income.3) widow with no income & having major children.4)Insurance proposed by someone on the life of another without insurable interest.5) Nomination in favour of a stranger.6) Medical examination at place other than residence or office place.

FINANCIAL UNDERWRITINGFINANCIAL UNDERWRITING

Assessment of proposer’s financial standing.

It is necessary to check whether income is sufficient to support the insurance.

The source of income, age & amount of insurance plays a vital role.

The process of insurance underwriting

We calculate the allowable insurance after multiplying the average of last 3 financial years income by age relatedmfactors.

Age group of the Proponent

Cover as a multiple of Average of 3 years’ Annual Income

Age up to 30 years 22 times

Age up to 40 years 17 times

Age up to 50 years 12times

Age 51 years & above 10 times

Depending on the sum proposed the proposal will be underwritten at different levels as follows.

( Standard Life)

Sum proposed Level

Up to 10 lacs Branch office

Up to 25 lacs Divisional office

Up to 60 lacs Zonal office

Above 60 lacs Central office

Numerical Rating SystemNumerical Rating System

Standards are laid down for each factors such as height, weight, pulse etc.

Variations are given values.

Values are then grouped & tabulated showing the extra mortality.

Depending on the extra mortality extra premium is charged. Variation up to 20% - Standard or First Class 20% to 35% - Class I 40% to 60% - Class II & so on.

Types of DecisionTypes of Decision

Acceptance at Ordinary Rates or Standard Rates Standard life & tabular rates of premium. eg. Proposer has no adverse features & hence proposal is accepted at standard rates. Acceptance with ExtraSubstandard life & the premium is increased by the amount of extra eg.If proposer is having Diabetes then depending on the values of fasting blood sugar & post lunch blood sugar suitable extra premium is charged.

Liens

v Acceptance with LienSubstandard life.The risk is not permanent

throughout the term. it is going to decrease after few years.

Sum Assured would be reduced to the extent of lien, if death occurs within the specified period.

Lien could be constant or decreasing.

Contd. Acceptance with Modified Terms Life is substandard.Proposed plan & term is not allowed.A different plan or term or reduced S. A. or a combination of these is allowed.Certain plans are accepted without risk cover eg. Jeevan Suraksha eg. If proposer has deformity due to disease & two limbs are affected. Then Risk plans are not allowed. Simple Endowment plan can be offered with some restriction according with the nature of deformity.

Acceptance with ClauseHere clause is imposed to restrict the risk cover if death occurs due to specific reasons. e.g. First pregnancy, Full Medical Report at vesting, Suicide clause, clause 4 B.e.g. Female proponent under Cat III, housewife up to age 30 clause 4B is imposed so that if death occurrs as a result of internal self injury, suicide or attempted suicide, insanity, accident other than an accident in public place or murder at any time on or after the date on which risk on the policy has commence before the expiry of 3 years from the date of this policy, then only premiums will be refunded.

Postpone Proposal is not be accepted at present but can be reconsidered in near future. Fresh Medical Report & other special reports will required if reports are not valid at future date.eg. If proposer who is pregnant for more than 24 weeks then proposal will be postpone until 3 months from date of delivery if menstruation has started.

Decline Risk on the life of proposer is too heavy to be insured.eg. If proposer is suffering from Cancer, AIDS, Quadriplegic having income arising out of farming.

Non-Medical UnderwritingNon-Medical Underwriting

Why insurance is allowed under Non Medical?

Even after medical examination more than 90% proposals are accepted at Ordinary Rates

Unavailability of Qualified doctors.

The insurer will save on medical fees & devise some standard format of Proposal Form which will elicit major information relating to his Income, Personal & Family History, Health & Habits which will help the underwriter to assess the risk & safeguard from adverse selection.

Non Medical Express SchemeNon Medical Express Scheme

Applicable to undertakings operating for minimum period of 3 years.Average turn over of Rs. 50 crore.Submission of leave record for the last 3 years is necessary.Maximum Sum under consideration is Rs. 10 lacs.Scheme is applicable to LIC employees also.

Safeguards adopted in non-medical businessBecause the chances of adverse selection are greater with

medical underwriting, insurance companies• practice the following safeguards:• a restriction on selection (female lives,);• putting limits on the sum insured;• a restriction on maximum entry age, maximum term ,

maximum age at maturity;• a restriction on the types of insurance plans(high/low)

allowed;• limiting cover to certain categories of lives (based on

education, social and economic background) ,class of lives eligible (to individuals employed in reputable organisations, who have undergone a medical exam at the time of recruitment, for whom leave records are maintained, and they have completed at least one year of service etc.); and requiring a moral hazard report from an officer of the insurer.

INSURANCE ON FEMALE LIVESINSURANCE ON FEMALE LIVES

Female category – I Working & educated females.Professionals such as Doctors, Lawyers, C.As etc.Treated on par with males i.e no limit on insurance.

Female category – IIIncome through businessUnearned income attracting Income tax.eg. Income from House property, Share, Bonds etc. Maximum insurance allowed is Rs. 1 crore.

Female Category – III

Single women, Widows are covered.

self employed women such as vegetable vendor, fisher women etc. are covered.

Married women are covered for 10 lacs if husbands are adequately insured.

Women observing pardah are not considered.

Human life value (HLV)

• human life is priceless and no amount of money can compensate for the value of a human being.

• Through human life value (HLV) the insurance company tries to measure the economic value of a person or how much the person is worth in monetary terms.

Income replacement method

• This method takes into consideration the future income earning potential of a person during the remaining years of their working life, so that in the event of their untimely death their family will not suffer financial loss.

Step 1:Total future incomeStep 2:Calculate the present value of F.I.

In summary, this method equates human life value to the present value of future earnings.

Pricing and calculating the premium

• Pricing refers to the calculation of the premium that will be charged on the insurance policy.

• life insurance the premium charged is based on the mortality rate as revealed in the mortality tables

Pricing elements

• Mortality rates

• Loading

expenses

• Income from investment of premium

• Benefits promised

The policyholder can pay the premium in a number of ways

• Single premium plan:• Level premium plan: yly hly qly mly/sssFlexible premium plan:terms and conditions for

flexibility depend uponthe insurance company ( Generally increase by 5% annually )

Calculating premiums

• Calculate the risk premium

• Based on the risk premium, calculate the level premium

• Deduct the expected interest on investments to calculate the net premium

• Add the loadings

• Arrive at the gross premium to be charged

Calculating bonuses

There are four types of bonus given by insurance companies.

• simple revisionary bonus;

• compound revisionary bonus;

• terminal bonus; and

• interim bonus.

Simple revisionary bonus

• The insurance company declares this bonus and adds the declared bonus to the sum insured. This is paid out at the time of the claim or the maturity of the policy, or at any other time as specified by the insurance company.

Compound revisionary bonus

• Under this method the insurance company computes the annual bonus on a compound interest basis, i.e. the bonus is added to the sum insured and the next year’s bonus is calculated on the enhanced amount.

Terminal bonus

• This bonus is given by the insurance company as an incentive to the insured to continue with the company long-term until the end of the policy. For long-term policies, of say 20, 25 or 30 years, the insurance company may give a terminal bonus on maturity along with the sum insured and the regular bonuses that are declared by the company every year.

Interim bonus• A valuation has to be made every year by

insurance companies, by law. Policies on which death claims are

made or which mature between the two valuation dates also contribute to the surpluses, As these policies have left the insurance company’s books before the valuation date, they will not participate in the process of valuation. However, insurance companies pay an ‘interim bonus’ to such policies at the rates as at the last valuation. In India the payment of interim bonus is made mandatory under section 112 of the Insurance Act 1938.

The agent’s role in underwritingAgents are called primary underwriter because they

are in direct contact with the proposer.Agent must disclose all facts which are material to

the risk & see to it that the proposer also discloses all material facts.

Agent’s confidential report is the first Moral Hazard Report which safeguard insurer from Moral Hazard.

Underwriter will use the data from Agents report & Proposal form.

Agent owes the responsibility to the insurer & the insured.

Always remember that - - - - - - - - “The contract of Insurance is based on Uberrima Fides i. e. the principle of Utmost Good Faith whereby proposer is required to disclose all the information in full in the proposal form for proper assessment.

Underwriting At Glance

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