underwriting management (5th semester)

7/31/2019 Underwriting Management (5Th Semester)

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UNDERWRITINGMANAGEMENT

MOHAMMAD IRSHAD

M.A. ACII (LONDON)

CHARTERED INSURER

HAILEY COLLEGE OF BANKING & FINANCE, UNIVERSITY OF PUNJAB Page 1


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CHAPTER - 1CHAPTER - 1

FINANCIAL & LEGAL ENVIORNMENTFINANCIAL & LEGAL ENVIORNMENT

INTRODUCTIONINTRODUCTION

This chapter describes the environment in which insurance organizations operate and the

issues, influences and implications that arise from it.

A FINANCIAL SERVICES AUTHORITY (FSA)A FINANCIAL SERVICES AUTHORITY (FSA)

WHAT IS FSA?WHAT IS FSA?

The FSA is the single super regulator established by the UK government. It is not only

concerned with insurance but also with financial and investment activities. It is an independent

body having statutory powers under the Act of the Parliament. It is funded by charges (fees)

and levies on those it regulates.

WHY FSA WAS CREATEDWHY FSA WAS CREATED

It was created in response to EU Directive (Insurance Mediation Directive IMD) approved by

the EU Parliament on 30.9.2002 with members countries given 2 years to implement it. Its

objectives were;

Tackle the inability of insurance intermediaries to operate freely throughout the Europe.

To create a single market in insurance across Europe.

AIMS AND GOALSAIMS AND GOALS

Maintain confidence in the UK financial system.

Promote public understanding of that financial system.

Secure right degree of protection for consumers.

Contribute to reducing financial crime.



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RISK-BASED APPROACHRISK-BASED APPROACH

FSA will carry out a risk assessment of all firms, examining factors such as its size, type and

range of products sold, and who its customers are before deciding the level of risk it poses to

the FSAs objectives.

AUTHORIZATION OF INSURERSAUTHORIZATION OF INSURERS

With effect from 14.1.2005 all existing and new insurers wishing to do business will have to

obtain authorization from FSA otherwise it will be considered a criminal offence. FSA can

refuse to grant authorization if;

It believes that any director, controller or manager is not a fit and proper person.

Insurer does not have sufficient financial resources.

POWERS OF INTERVENTIONPOWERS OF INTERVENTION

FSA can intervene on the following grounds;

To protect the policyholders against the risk that insurer might be unable to meet its

liabilities/expectation of its policyholders.

If it appears that insurer has broken a rule.

Misleading or inaccurate information has been supplied.

Reinsurance arrangement is not satisfactory.

Director/Controller or Manager is not fit or proper person (as far as his honesty,

reputation, competence and capabilities and financial soundness).

FSA POWERS INCLUDE;FSA POWERS INCLUDE;

Restrict new business.

Control investment.

Appoint a Trustee to control assets.

Limit premium income.

Require an actuarial report.

Demand specified documentation.

Suspend or terminate authorization.



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FSA HANDBOOKFSA HANDBOOK

It is collection of publication containing rules and guidance for regulated firms.

INSURANCE CONDUCT OF BUSINESS RULES (ICOB)INSURANCE CONDUCT OF BUSINESS RULES (ICOB)

These rules are the requirements relating to the business processes involved in selling and

administering general insurance e.g.

Marketing.

Sales.

Providing literature to customers on products and

Handling claims

B CAPITAL AND SOLVENCYB CAPITAL AND SOLVENCY

A company who wants to operate needs resources and at start-up it will face immediate costs

of;

Premises acquisition.

Raw material or stock.

Wages for employees. Utilities and service costs.

For insurance all the above considerations apply but insurance is a unique business. Insurance

claims are accidental and outside the direct control of the policy holder. Due to certain

techniques a certain level of claims costs can be predicted. But due to catastrophes such

predictions/forecasts may not be stable.

The matching of capital reserves to liabilities is a highly technical process. Factors which can

influence are;

Extent of reinsurance cover.

Value of claims equalization reserves.

The nature of the business accepted (higher risk business with more claims experience

requires greater capital to save).

Projected growth of the insurance portfolio.

SOLVENCY REQUIREMENTSOLVENCY REQUIREMENT



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Insurance companies are required to maintain adequate financial resources with a minimum

margin of solvency to guard against poor financial results due to;

Adverse underrating results or

Unexpected losses from investments.

Essential elements in a margin of safety test are;

Application of a formula to premiums or claims to determine the required margin of

solvency and

Computation of assets less liabilities.

Computation of above will tell whether insurer has sufficient available assets to cover the

required margin of solvency.

LLOYDS CAPITAL BASE AND SOLVENCYLLOYDS CAPITAL BASE AND SOLVENCY

Lloyds is a society of members both individual and corporate, who underwrite insurance in

groups, known as Syndicate. Syndicates are run by Managing Agents. Capital to Syndicates is

provided by the Underwriting Members of Lloyds. Their liability is unlimited accepting

insurance risks for profit or loss.

SOLVENCYSOLVENCY

FSA has delegated substantial part of its Regulatory activity to the Council of Lloyds and

focuses on a supervisory role.

Solvency test of every Syndicate is conducted by a recognized Accountant approved by the

Council of Lloyds and submitted to the Council. Underwriting member is required to show

that their assets at Lloyds are sufficient to meet their underwriting liabilities.Over and above Lloyds will have to demonstrate that each member has sufficient assets plus

solvency margin. Lloyds have also to show that it has sufficient centrally held assets to cover

any aggregate shortfall from this test.

UNDERWRITING LLOYDS UNIQUE SYSTEMUNDERWRITING LLOYDS UNIQUE SYSTEM

All premiums received are paid into premium trust fund held by the Syndicates

Managing Agents.



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Payments of claims, reinsurance premium and underwriting expenses are made from

this fund.

No payment may be made to members until all liabilities have been met.

Members are individually liable for claims on their underwriting liabilities to the full

extent of their assets over and above those in their trust fund.

CENTRAL FUNDCENTRAL FUND

There is a central fund in which members contribute annually, is available to pay valid claims if

any member fails to pay. It is supported by a reinsurance program.

C STATUTORY AND LEGISLATIVE INFLUENCESC STATUTORY AND LEGISLATIVE INFLUENCES

FINANCIAL SERVICES COMPENSATION SCHEME (FSCS)FINANCIAL SERVICES COMPENSATION SCHEME (FSCS)

This scheme compensates claimants where authorized persons are unable to pay claims against

them in connection with related activities.

In order to obtain compensation a claimant must be eligible. Eligible complainants are any

person except;

Directors and Managers of the relevant person in default.

Close relative of person excluded above.

Persons holding 5% or more of the capital of the relevant person in default.

Auditor of the relevant person in default.

Persons who are responsible for and have contributed to, the relevant person in default.

Persons whose claim arises from transactions in connection with which they have beenconvicted by an offence of money laundering.

SALIENT FEATURES;SALIENT FEATURES;

If the FSCS judges that a firm is in default it must pay compensation to all claimant affected by

the default.

FSCS may decide to reduce compensation if there is evidence to contributory negligence by the

claimant.It also includes customers of insolvent intermediaries.



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FINANCIAL OMBUDSMAN SERVICE (FOS)FINANCIAL OMBUDSMAN SERVICE (FOS)

This service was started from 1.12.2001. Firms regulated by the FSA are required to be

member of the FOS. FOS has two functions;

Compulsory jurisdiction; &

Voluntary jurisdiction.

All providers of long-term insurance in the UK will be required to be member of the FOS and

subject to its compulsory jurisdiction. Those firms not subject to compulsory jurisdiction can

opt for voluntary jurisdiction such as mortgage brokers, firm which sold travel and loan

protection plans.

With effect from January, 2005 FOS has extended to include Insurance Intermediaries.

MOTOR INSURANCE BUREAU (MIB)MOTOR INSURANCE BUREAU (MIB)

MIB was established in 1946. Under the Road Traffic Act, 1988, insurers must be member of

the organization, if they want to underwrite motor business in UK.

It assist those injured by uninsured motorists and untraced drivers. MIB receives money from

insurers to pay the claims. It is also issuing authority in the UK for International Motor

Insurance Certificates (Green Covers).

D NON-STATUTORY ISSUESD NON-STATUTORY ISSUES

ETHICSETHICS

Ethics means moral rights and wrongs of doing business. Any business would be likely to

adopt a strongly ethical stance, and for many it is possible. However, for larger organizations

such a strategy often results into difficult problems because shareholders oppose ethical action

which impact on profit.

Ethically insurers are under pressure to provide wide range of products for the widest possible

market at reasonable premiums. It is also their responsibility to invest substantial funds for

benefit of shareholders and policyholders.

Unethical conduct can have negative consequences such as adverse publicity, diminish

corporate creditability and lower staff morale. Ethical conduct can produce the opposite affect

on the business.



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SOCIAL RESPONSIBILITYSOCIAL RESPONSIBILITY

Social responsibility of an insurer can be judged by the contribution it makes to society and the

community from which its customers are drawn. It involves customer-friendly underwriting

policies which seek to provide protection wherever possible. For industrial risks, it means

providing advice on risk improvement program, to make uninsurable or undesirable risk into

acceptable one. Moreover, insurers involvement in public health, education, the arts and a

wide range of other community activities is worthwhile means of social involvement and

favorable publicity.

MARKET AGREEMENTMARKET AGREEMENT

There are many market agreements amongst insurers, as to how their underwriting

activities/businesses are carried out on day to day basis. It covers various issues such as;

Sharing or pooling of data, such as claims experience.

Rules on the transfer of business between insurers.

Cancellation requirements and mechanism for cooperation on issues of mutual interests.

E INTERNATIONAL BUSINESSE INTERNATIONAL BUSINESS

Due to globalization multinational companies expanded rapidly. The world-wide (internet) and

satellite television has transferred attitude to international trade.

There are four main considerations, insurer pay particular attention to when considering

entering a foreign market;

Availability and quality of local agents.

Potential for a joint venture.

Possibility of operating through a local company.

Trading through a local subsidiary/opening a local branch.

F UNDERWRITING CYCLESF UNDERWRITING CYCLES

Insurance market cycles

Higher profits

(increased investments)

Higher prices higher capacity

For that class

Capacity lower process



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Withdrawn

Lower profits

(or losses)

POINTS TO NOTE;POINTS TO NOTE;

When insurances experience higher profits in a market sector or class of business there

is a desire to increase investment in that class in order to accept more of the profitable

business leading to more profit.

As market-wide capacity increases premium levels are reduced as insurer strive to

maintain market share.

Reduced premium income affects profits and fixed costs increase.

Capital available for investment and investment income reduced in line with premiumincome.

Withdrawal of capacity will cause premiums to rise as supply of insurances reduces in

relation to the demand for cover. This will leads to higher profits for insurers.

ECONOMIC CYCLEECONOMIC CYCLE

Economic cycle also affects the insurers. In a recession, policyholders tend to be more claims

conscious and their may be an increased likelihood of fraudulent claims. Increased claims arealso likely, with correspondingly higher incidence of theft, malicious damage and arson fire

claims.

WEATHER RELATED CYCLEWEATHER RELATED CYCLE

Due to increase in global warming there are number of catastrophes happening throughout the

world and insurers have great concern about this situation as they are receiving claims on

regular basis. Research for the UK government in 1996 found that coastal flooding aloneresulting from sea level could produce losses of 250 million pounds for UK Property Insurers.

There is now general acceptance that Worlds climate is undergoing permanent change, which

means that the insurance market is increasingly likely to be exposed to natural perils such as

flood and windstorm. Now the premium is increasing to cover against natural disaster.

SEASONAL INFLUENCESEASONAL INFLUENCE

Season changes have also affected the customers as well as insurers. Manufacturers and

retailers will require seasonal stock increase perhaps over the Christmas, Easter of summer



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periods depending on the line of business in which they operate. It has been experienced that

20% increase in sum insured is required by the retailer for the period from November to

January. Demand for private travel insurance and cover against rainfall ruining outdoor events

is much greater during the summer.

Motor insurance claims both accidental damage losses and third party claims would be

accepted to be heavier during winter months due to icy roads and poor driving conditions.

MANAGING THE CYCLEMANAGING THE CYCLE

At the top of the insurance cycle, the so called hard market, prudent insurers can build-up

reserves from high profit to meet with down turn in subsequent years. If losses occur at the

beginning of the cycle rather than later, the insurer will not have accumulated sufficient funds

to meet with this adverse situations.Insurers use highly complex computer models to quantify the future losses by keeping inflation

into their minds especially in liability claims. Adverse position in cycle can also be maintained

by selective underwriting or placing limits either through deductibles or reinsurance.

Fixed costs such as rent of premises and salaried have an impact on unit cost per policy. It can

be reduced by increasing the number of policies.

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CHAPTER 2CHAPTER 2

STRUCTURE OF THE UNDERWRITING PORTFOLIOSTRUCTURE OF THE UNDERWRITING PORTFOLIO


In this chapter it will be examined the processes which provide the insurance organizations

with their direction and with the goals they strive (work hard) to achieve.

For success in business, planning is always required. This planning process usually operates

from the top down with greater detail at each level. Corporate objectives must fully recognize

the business environment and the organizations capabilities.

The role of underwriting management to achieve the corporate objectives involves;

Establishing optimum portfolio size.

Estimating the best time to expand or contract the accounts;

Setting prices, terms and conditions designed to achieve business targets.

Projecting and monitoring claims and administration costs.

Optimally managing renewal retention; and

The contribution of investment income.

The processes described above are continuous

A - UNDERWRITING POLICY AND CORPORATE OBJECTIVESA - UNDERWRITING POLICY AND CORPORATE OBJECTIVES

Strategic Management is the primary duty of the Board of Directors and senior executives of an

organization. A deep understanding of where the organization is now, its core capabilities,

strengths, weaknesses and the environment in which it operate combine with a clear vision of

future direction.



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Underwriting Management examine the latest corporate objectives and ensure that the current

underwriting policy is capable of delivering the results those objectives require. The policy is

reviewed continuously, receiving special attention during the annual cycle.

The objectives of an organization may be;

Market leadership of selected business classes.

100% year on year growth over a 5 year period.

Aggressive underwriting policy.

More flexible (or inclusive) policy.

Become brand leader.

Company of choice for brokers.

B DISTRIBUTION CHANNELSB DISTRIBUTION CHANNELS

Multiple channels are used by the insurer to reach the largest possible market for their products.

Commercial lines general insurance is still sold mainly through brokers.

Intermediaries do not only place cover, they also handle certain claims, issue branded policies,

carry out risk surveys and provide risk management services. The developments raise control

and quality issues for underwriters.

A single insurer may sell its product through;

Its own sales force to brokers and other intermediaries.

Through media advertising on television and in the press.

Over the internet.

By telephone through call centers, and

Wholesale to bank assurance (banks and building societies) and other corporate

connections, such as major retailers or affinity groups.

MULTIPLE DISTRIBUTION CHANNELSMULTIPLE DISTRIBUTION CHANNELS

Direct selling, without involving intermediaries, has increased in recent years. The standard

wordings policies are usually sold through intermediaries who are tailored to the specific needs

of individual clients. It is not suitable through call centers because it can create confusion.

PRICING;PRICING;



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Using the standard policy costing as benchmark the net or pure price of the insurance can be

calculated by carefully costing extensions to cover and optional modification. Then

commission is added along with other expenses and profit.

UNDERWRITING CONTROLUNDERWRITING CONTROL

For underwriting control three different approaches are required;

For direct cases computerized underwriting is used almost exclusively. This system

includes quotation and other information about the product for the customers.

For more complex and larger cases individual underwriting will still be necessary.

For wholesale schemes special underwriting skills are necessary to design policy cover,

cost it, set premium levels and monitor the performance of this business.

C CONTRIBUTION OF RESEARCHC CONTRIBUTION OF RESEARCH

There are very few industries which are confident enough to design and launch new products

before checking whether their customers will like them. Similarly few businesses (including

insurance) are confident that the service they offer is so good that they do not need to seek

customers feed back.

There is too much data available in the market but it may leads to information overload and

confusion. Such information is required to be analyzed very carefully.

DATA ACQUISITION AND PROCESSINGDATA ACQUISITION AND PROCESSING

There is no ideal structure for carrying out the information-gathering activities or for

subsequent implementation. Each organization will tailor it to suit its individual circumstances.

Key considerations include;

Degree of centralization versus devolution of underwriting activities.

Alignment of underwriting to distribution channels.

Top management structure.

To process of new product development.

Business mix of the portfolio and

The division of responsibilities between underwriting and other functions such as

marketing and development.



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The key criteria are to obtain the relevant information and channel it to those who are best able

to analyze it efficiently and act on it. The data/information may be of two types available with

the organization;

Formal research conducted by specially trained staff.

Useful information acquired by all the employees while carrying out their day to day

activities.

The first one is more focused and will be conducted on specific pre-planned questions for the

help of senior management to make decision on policy changes or new product features and

pricing. The second one is ad hoc and need careful filtering to make it needful. Such

information is gathered when underwriters, claims handlers, surveys and sales staff interact

with customers and agents.

SEGMENTATIONSEGMENTATION

Segmentation means (a process of dividing into segment/section) customers, e.g. a community

of lawyers is a segment in the society. There will be key inputs from;

Investment department (returns on investment premiums are key pricing consideration)

The marketing and development department (which may carry out a lot of the primary

research affecting underwriting policy decisions).

Claims department (which can use the experience gained in claims settlement to

comment on product performances and highlight any unexpected development).

Information technology system has facilitated the collection, storage and detailed

analysis of data. Accurate customer segmentation identifies a distinct customer group

that is relevant in deciding product specification and pricing.

DESIGN OF PRODUCTDESIGN OF PRODUCT

Research into the cover to be provided is most relevant for personal insurances. It is less in

complex commercial general insurance contracts (e.g. farm policies, shop policies, small

businesses, and hotel). Such risk needs specific contracts after surveys, negotiations involving

professional intermediaries.

Most insurance products have basic terms and conditions which are common between insurers.

For example home insurance buildings policies cover damage by fire, lightning, explosion,

earthquake, storm, flood, riot, malicious damages etc. In such cases research will focus on what

restrictions customers would accept in exchange for premium discounts or what extensionsrequired by the customers. For example, policies were introduced some year ago with premium



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for household contents calculated on the basis of number of bedrooms with an upper limit

instead of property sum insured.

The ideal way is to anticipate the demand of product through research without it would be high

risk approach.

The most popular approach relies on an in-house expert having an idea which is developed

subject to scrutiny of selected potential customers, later on. Depending on the reaction of that

focus group, decision will be taken on either test marketing or full exist.

PRODUCT DIFFERENTIATIONPRODUCT DIFFERENTIATION

The key to competitive advantage is product/service differentiation which may be exceptional,

important to have or affordable. This must be getting known to the potential customers. But it

is generally known that the average policyholder can;

Name a mere handful of insurance companies.

Find policy documentation (even plain English wordings) difficult to follow.

Note that all motor insurance certificates have identical wordings;

Struggle to comprehend rating systems, and

Be uncertain that the intangible product is value for money.

Insurers normally in their advertisements claim best cover, best value and best service but

customers have different experiences to judge such statements. Therefore insurer should

concentrate on one or more differentiators to keep its position in the minds of the target

customers. Insurer can adopt strategies for this as under;

Quality price positioning (offer less expensive premium by excluding intermediary.

Advantage positioning (classic car covers controlled by few market leaders is a good

example).

Product category positioning (Farm insurance handled by National Farmers Union

Mutual Insurance).

Competitor positioning (common approach where one insurer claims to be better than

another).

D RESOURCE CAPABILITYD RESOURCE CAPABILITY

Resource capability means availability of expert underwriting and support staff in the insurance

company. Experienced and qualified staff is required to deal with complex nature of risk

profitably by satisfying the existing potential customers in the market. There is shortage of such



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staff due to the reasons, large scale merger, down sizing and centralized underwriting portfolio

resulting into leaving experienced staff. The largest organizations will still buy in expertise

when they needed especially for new class of business.

It is very important that training of staff capable of dealing with the most complex risks clearly

requires a long term training program supported by suitable work experiences otherwise these

issues will clearly continue to impact on underwriting.

E IMPORTANCE OF ENTRY & EXIST COSTSE IMPORTANCE OF ENTRY & EXIST COSTS

There are very few insurers who have monopolies in certain product, but there is lot of

competition amongst them in many products. For example motor, where the cover is identical

and choice of premium is available for the customers in the market.

Ways to help and hinder new entrants Barriers to entry that exist for potential players in a

market are as under;

NATURAL MONOPOLY. There is a room for only one supplier of the goods/service.

(rail track)

LEGAL RESTRICTIONS. (Intermediaries are regulated in a different way).

ECONOMIES OF SCALE. Those who are already in the market their unit cost are

less).

BRAND NAMES. Perception is that consumers are buying in top quality premium

product. e.g. Virgin and Marks and Spenser.

ADVERTISING. It helps brand names near the top of their market.

SKILLS. Company who has not highly trained underwriters would not survive in the

market.

ESTABLISHMENT COSTS. Establishment of a new company required high funds at

the inception.

REINSURANCE. It will be very difficult for new entrant to get reinsurance service as

compared to already in the market.

INFORMATION TECHNOLOGY. With ever-increasing data compilations

worldwide, and their availability from commercial and government sources, the chance

of starting a new venture and finding that is rather impossible.

GOVERNMENT REGULATION.New entrants may be required to gain licenses; put

up minimum sums of capital; operate within a regulatory sphere; or suffer curtailment

of capital and profit remittance.



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PREDATORY PRICING. A conventional technique where incumbents attack new or

potential entrants to a market with price-cutting in the short term. Sometimes the mere

threat of this technique is enough.

LEAVING A MARKETLEAVING A MARKET

Farmers buy tractors, oil companies build petrol stations and railway companies lay tracks and

signals. On leaving the market tractors may be sold second hand, petrol stations may remove

their tanks but railways have zero worth because steel is scrap.

One significant component of insurance is staff and their removal depends on contract and

employment legislation and often costly. Less expensive options are to redeploy, or incase of

sale transfer them to new owner.

F RESERVING POLICYF RESERVING POLICY

Reserves are required by the insurance company to meet with the present and future liabilities

of claims and maintain its solvency margin as required under legislation. If any company fails

to meet these requirements become insolvent and ceases to operate in the market.

Claims reserving process involves claims manager, underwriting managers, accountants and

actuaries.

Key factors in deciding an insurers chosen approach to reserving are;

The purpose for which it is required;

The volume of data;

dThe class of business;

The quality of data;

The types of claim; and

The insurers usual practice and preference.

The underwriting function will require the claims reserve information for the following

reasons;

To assess the overall financial performance of the underwriting accounts;

To assess the relative profitability of the various classes of business;

To assess the adequacy of premium rates which could cover future claims costs and

company expenses;

To facilitate reinsurance decisions; and



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To measure projected expansion plans against current capacity and prevailing market

plans.

At the annual business planning stage the underwriting management will be confronted with a

large number of choices, including;

Whether it is in the organizations interest to develop certain classes of business;

Whether to stabilize or retrench others;

The effects of hard or soft markets on risk exposure in relation to premium income;

Exactly what basis should be employed for reinsurance; and

Whether to develop new markets.

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CHAPTER 3CHAPTER 3

UNDERWRITING POLICY AND PRACTICEUNDERWRITING POLICY AND PRACTICE

Sound and effective underwriting policy and practice ensures profitable account development.

Its aim should be selection of business and design of suitable products which could meet the

customers requirements in the soft market.

A UNDERWRITING CONSIDERATIONSA UNDERWRITING CONSIDERATIONS

POLICY TERMSPOLICY TERMS

A key responsibility of underwriting management is to develop insurance policies (also

referred to as products or contracts) which reflect the organizations underwriting philosophy



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and approach to business. Policy terms must satisfy all legal requirements and chosen ethical

requirements.

STANDARD OR NORMAL TERMSSTANDARD OR NORMAL TERMS

All insurers have standardized or normal policy wordings for each class of business which they

transact. These wordings have evolved and developed over a long period of time. Certain

policy wordings are still used which were being used centuries ago such as marine policy.

Some wordings were recognized by the ABI which issued Recommended practice wording

and procedure relating to Material Damage and Business interruption, commercial and

industrial insurance (known as Blue Book). Such wordings are well understood by insurers and

the market. In recent years insurer are trying towards simpler policy wordings, mainly for

personal insurance using plain English. It includes descriptions of insurer and policy holderresponsibilities, guidance on how to make claims, definition of key words and terms used.

POLICY CLAUSESPOLICY CLAUSES

There are normally 4 parts which describe the main criteria of the policy terms;

Operative clause;

Exemptions (or exceptions) clause;

Conditions clause; and

The schedule.

OPERATIVE CLAUSEOPERATIVE CLAUSE

This clause defines the terms of the contract and the extent of cover. It states;

The subject matter of the insurance;

The risks or perils covered;

The period of insurance; and

The requirement for premium to be paid.

Example is that under motor policy, authorized driver, vehicles and their contents.

The risk or perils covered are those which cause injury, destruction loss or damage. Certain

perils may be excluded for some or all policyholders and also limits in sum insured or

indemnity may be appeared for others.

Poor or adverse risks are not desirable unless insurer specializes in underwriting of such risks

i.e. proficient in balancing the risk exposure with the adequacy of premium received.



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The operative clause should define perils to be covered in detail or explained in a separate sheet

as enclosure. Each peril or risk involved is entirely represented so that underwriter could

analyze it and charge appropriate premium. Example is fire, storm and flood under property

policy.

--Period of insurance is normally 12 months.

EXCEPTIONS (OR EXCLUSIONS) CLAUSEEXCEPTIONS (OR EXCLUSIONS) CLAUSE

Exclusions may be war risk or existing damage. The criteria for exclusions are selected after

assessing whether;

Excluding particular cover available elsewhere in the market will harm sales initiative;

Such cover would price a product out of its targeted segment; and

Optional inclusion should be offered at an enhanced premium.

CONDITIONS CLAUSESCONDITIONS CLAUSES

It describes the policy holder rights and obligations. It includes equity, market practice and

need to ensure policyholder cooperation in reducing or avoiding loss. For example the policy

holder must take all reasonable steps to prevent loss of or damage to the property insured

SCHEDULESCHEDULE

It describes the precise subject matter of the policy (name and address of the policy holder) and

sum insured/limit of indemnity together with the premium.

VARIATIONS IN POLICY TERMSVARIATIONS IN POLICY TERMS

If the risk falls outside the underwriters target criteria but for which the standard terms are

generally appropriate, modification is made by using endorsements, warranties, excess for

deductibles as well as premium loading.

EXCESSES, DEDUCTIBLES, LOADINGS AND INCENTIVESEXCESSES, DEDUCTIBLES, LOADINGS AND INCENTIVES

POLICY EXCESSES

Main points are;

In excess, policy holder agree to bear the first agreed amount of any claim which is for

mutual benefit both for him and insurer.

It results into reduction in premium while eliminating small claims with administrative

savings as well as reduced claims costs for the insurer.



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Policy holder also benefits where they would not claim such as in motor claims no

claims discount even there is not excess applied.

Compulsory excesses are applied to enable insurers to keep their premiums competitive

by excluding all or part of claims of unacceptable high frequency e.g. excess applied to

motor vehicle windscreen claims.

POLICY DEDUCTIBLES

A deductible is an amount borne by the insured in each claim in return for a premium discount.

It is usually much larger than an excess and found in commercial contracts.

PREMIUM LOADINGS

By setting a level of premium commensurate with the degree of risk for standard cover, abenchmark (minimum premium to be charged) is established. Establishing this benchmark is a

critical part of the underwriting process. Standard or normal premium does not signify low

hazard but merely that is appropriate to that category of risk. An underwriter will examine in

detail all aspect of the subject matter to be insured and the degree of hazard of each risk

covered before deciding the usual premium is appropriate or whether it should be increased or

decreased.

The proposers occupation and proposed use of the vehicle will be considered. Certainoccupations attract higher terms, due to lifestyle and resultant hazard exposure. Vehicles

mileage which differs markedly from the average is also a factor and whether the vehicle is

garaged is relevant to the theft risk.

Loading in premium is applied to reflect the underwriters assessments that the enhanced

degree of hazard or risk presented by the cases under consideration justifies increase in the

premiums applicable to standard risk.

INCENTIVES

Certain incentives are given by the insurer to the insured and others. Main points are;

The purpose of incentive is to attract new customers or retain existing ones in the face

of market competition.

All incentives have a cost that must be justified within the costing of the product

involved.

One common incentive in the shape of reduced premium is the long term agreement

(LTA) in exchange for a commitment from the policyholder to keep the policy with the



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same insurer for an agreed number of years. The advantage to the insurer is a saving in

acquisition cost by retaining business, while the policyholder saves money.

Another incentives is the No Claim Discount (NCD) in motor insurance. This

discount is awarded on a sliding scale increasing each year up to maximum of 5 years if

policyholder does not make a claim. Discount of 65% are common. People do not

intend to have motor accidents but insurer believes that in addition to discouraging

small claims, NCD may encourage policyholders to be more careful.

Profit commission is another incentive offered to intermediaries, linked to the profit

made on the relevant business over and above commission.

Another incentive is volume commission to intermediaries who offered agreed volume

of business.

Free gifts, e.g. clocks, watches, pens etc. are awarded by the insurer to the

policyholders who keep the insurers name before the recipients.

FIRST LOSS INSURANCEFIRST LOSS INSURANCE

First loss policies are usually required by proposers who consider that any loss occurring from

an insured peril will not be more than a small percentage of the total value at risk. For example,

where an historic building would be replaced by one of cheaper modern construction if total

loss occurs. If loss occurs, insurer pays up to the sum insured without consideration of totalvalue at risk if it is accurately declared to them. Following a loss the sum insured can be

reinstated at an additional premium. This type of cover is only available on property for perils

including fire, storm, floods, impact and theft.

SCHEME UNDERWRITINGSCHEME UNDERWRITING

Personal insurances market is the existence of scheme to provide insurance for affinity groups.

Groups may be; Members of specific charities.

Non-profit making organizations such as National Trust.

Customers of banks, building societies.

Store chains.

Solicitors.

INSURANCES OFFERED ARE;INSURANCES OFFERED ARE;



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Home insurance.

Motor insurance.

Personal accident insurance.

Credit insurance.

Travel insurance.

Commercial insurance packages.

Due to strong competition in the market for such schemes, it is essential to predict performance

accurately and price competitively which may be smaller profit margins than on other business.

B INTERNAL AND EXTERNAL CONSTRAINTSB INTERNAL AND EXTERNAL CONSTRAINTS

Internal and external constraints which operate on underwriting policy are as under;

Scope of cover

Limits to cover

Market position

New business growth

Reinsurance retention

SCOPE OF COVERSCOPE OF COVER

EXTERNAL CONSTRAINTS;EXTERNAL CONSTRAINTS;

There are four conditions implied by law in the subject matter of the insurance;

The insured has an insurable interest in the subject matter of the insurance.

Both parties have observed the utmost good faith in their negotiations leading up to the

contract.

The subject matter of the insurance is actually in existence, and

The subject matter of insurance can be identified.

In addition to above, legislation, case law, regulations and code of practice also apply. Some

are specific to a class of business e.g. Employers Liability (compulsory insurance) Act, 1969

and the Road Traffic Act, 1960 and 1988 and both are compulsory.

Doctrine of Utmost Good Faith (Uberrima fides) is that an insured person must disclose all

material facts. That is those facts;

Which would influence the judgment of a prudent (reasonable) underwriter in fixing the

premium or determining whether or not he will accept the risk offered to him.



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A number of judges have criticized insurers on the grounds that the principle has been too

severely applied by them.

The ABI Statement of General Insurance Practice (1986) agreed by supporting insurers,

provided (amongst other things) that an insurer would not unreasonably reject a claim or

invalidate a policy, in particular, on the grounds of non-disclosures or misrepresentations

would not be used unless it was;

A material fact,

A fact within the knowledge of the proposer,

A fact which the proposer could reasonably expected to disclose.

Insurer can only provide cover for classes of business they are authorized to write by the FSA.

INTERNAL CONSTRAINTS;INTERNAL CONSTRAINTS;

These are;

The insurers executives may be unwilling to write a particular class of business either

in particular or general market because of the balance of risk and premium anticipated

does not make good enough use of available capital.

Lack of positive evidence of sufficient demand for a particular risk.

Commercial liability insurer does not accept risks from companies involved in

processes using the application of heat.

Some builders risk are acceptable under certain restrictions while other or not.

Sometime territorially, it may be prudent to restrict underwriters to those risks where

they have demonstrated their expertise.

Sometime policy may be exclude certain risk, such as Caribbean windstorm if they

seem to have to great or potential for causing large aggregate losses.

Those insurances which may be underwritten and those which must be excluded may

encompass;

Territorial limitations;

Sum insured limitations(line limits) by risk;

Sum insured limitations by zone;

Maximum indemnity limits per insured event;

Maximum annual aggregate limit of indemnity;

Limits of estimated maximum loss (EML) as a percentage of sum insured; and



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Restrictions on eligibility for cover, by product, of personal or commercial customers

with different attributes (age, occupation, trade classification etc.).

LIMITS TO COVERLIMITS TO COVER

EXTERNAL CONSTRAINTSEXTERNAL CONSTRAINTS

It is the requirement of all insurers to maintain adequate financial resources and a minimum

margin of solvency to guard against poor financial results.


It is the limits on capacity, the extent of the reinsurance program in place and on the expertise

to provide for the cover. Underwriting Management, will, therefore, set specific limits for

current underwriting policy in terms of gross and net maximum sums insured estimated

minimum losses (EML) and limits of indemnity.

MARKET POSITIONMARKET POSITION


It arises from market competitions and the insurers position in particular market or market

segment. If position is strong then it will be difficult to further expand. If another insurer has

better or monopoly position then for entry of new insurer requires, superior cover better rates or

better service (or combination of these).


What is the strength and effectiveness of the marketing function and the extent to which it

integrates and coordinates with the underwriting function?

NEW BUSINESS GROWTHNEW BUSINESS GROWTH


Solvency requirement together with strength of competitors.



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If there is not adequate financial strength, expertise and administrative competence,

professional intermediaries, risk managers and customers will cease to place new

business.


Restrictive underwriting practices (terms and pricing) compared with competitors;

Lack of effective marketing or access to distribution channels;

Poor sales performance by the in-house sales force and/or intermediaries; and

Deliberate decisions to restrict acceptance due to risk aggregation in certain

geographical locations (e.g. earthquake) or by customer type (e.g. young drivers).

Sudden unanticipated flows of business may create pressures which cannot be handled in the

short term without proper administrative support.

RETENTIONRETENTION


Different acceptance criteria are set out for different classes of business, different territories,

and sometime for different contracts or product.


Even the largest insurers will, on occasion, be unwilling to retain 100% of a risk or an account

because they perceive the exposure involved is not acceptable such a large risk (e.g. a chemical

manufacturer).

C LIAISON WITH CLAIMS FUNCTIONC LIAISON WITH CLAIMS FUNCTION

Liaison between the claims and underwriting management functions should be mandatory, not

optional. It is required for the setting of underwriting policies and during implementation,

monitoring and revision.

Underwriting Management also involves other organizational functions such as personnel,

finance, information technology, marketing, risk survey and improvement and sales. However,

relationship between claims and underwriting is pivotal.



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As claims occur, the claims function through its claims handlers can monitor;

The nature of claims, particularly those factors not captured by the insurers

management information systems;

How effectively underwriting policy is being implemented (addressing issues such as

risk acceptance),

Customers with an exceptional or above average number of claims;

Whether policy wordings are producing unanticipated claims; and

Whether added value services might be appropriate.

Claims hander can give warning of deteriorating claims experience under individual polices.

For example 3 claims from one insured in a year could result in non-renewal or change of terms

or increased premium. The claim handler should notify the underwriter if the renewal is

imminent.

Liaison between claims and underwriting has played a crucial role in countering insurance

fraud. Special market anti fraud system such as the Motor Insurance Anti-fraud & Theft

Register (MIAFTR) and the Claims and Underwriting Exchange (CUE) have an example of

this.

Ex-gratia payment policy should ensure that;

Claimants feel they have been treated equitably.

The insurer (and reinsurer) is satisfied that any payment is justified, and

The overall approach is consistent.

The ultimate responsibility for deciding whether a policy is a valid contract and what it covers

lies with the underwriters who wrote it. The same is true of ex-gratia payment.

D RISKD RISK

CLASSIFICATION AND CATEGORIZATION OF RISK;CLASSIFICATION AND CATEGORIZATION OF RISK;

Profitable underwriting depends on accurate risk assessment. Underwriting Management

identifies the risks associated with a class of business, evaluate the degree in terms of severity

and frequency and then cost the potential claims.



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POINTS TO NOTE;

Risk assessment process requires relevant and detailed statistical data which is available

from internal and external sources.

Internal data is extracted from the insurers own policy and claims record.

Externally, insurers exchange data between them.

In public domain metrological data is available.

The data must be in manageable format for judgment of the insurer.

Underwriter considers the features and characteristics of the data to assess the range of risks

within a particular class of business such as;

Underwriter classifies the risk in group to present a similar degree of hazard. For

example property insurance grouping will be according to trades of section of trades

and by cover (fire, theft, flood etc.).

The establishment of classification is first step in the process. After that underwriter

identify different aspects to present a full picture .e.g. for property insurance, building

construction, sum insured, location, quality of housekeeping etc.

ACCEPTANCE AND RENEWAL CRITERIA;ACCEPTANCE AND RENEWAL CRITERIA;

The insurer must identify the terms and conditions under which it will accept a new policy or

renew existing one.

Important points are;

Underwriting guidelines are issued by the management for commercial risks.

For personal lines there is much greater degree of computerized underwriting with

detailed guidelines provided for complex, large or non-standard risks.

Insurer set parameters of acceptability based on claims history, criminal record, trade or

occupation.

To maintain healthy business, it is essential that underwriting management regularly

audits both new and renewal acceptance.

RISK IMPROVEMENT AND SURVEY CRITERIARISK IMPROVEMENT AND SURVEY CRITERIA

Surveys are conducted by the insurer for the staff which risk is acceptable and which is not.

The survey represents an opportunity for insurer to work with the policyholder to improve the

risk. Surveys are also made to know whether there is any opportunity for the insurer to reduce



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the premiums based on claims received. If surveys are not conducted regularly there may be a

problem for the insurer. For example previously office risks were considered very favorably.

But by the passage of time it has been revealed that in most of the cases it has become

uninsurable due to theft cases, repeated strain injury, liability claims and occupational stress

liability claims.

E EXPOSUREE EXPOSURE

In case of change in the existing contracts or underwriting a new class of business, it is

essential to consider the potential impact of single risks and single events. The accumulation of

risks during the insurance year must be identified, analyzed and quantified so that an objective

judgment can be made on whether to proceed or not.

F MARKET CONDITIONSF MARKET CONDITIONS

Market conditions can be judged as under;

HARD MARKET

A hard market is one where premium rates are up and insurer are able to select which new

business they wish to underwrite. Poor quality risks become difficult to place and if accepted

terms may be harsh.

SOFT MARKET

A soft market is one where there is more capacity than demand and insurer have to compete

strongly for the business that is available. Rates fall and policyholders are able to get cover on

terms that the policyholder and/or intermediary demands, rather those preferred by the insurer.

G BINDING AUTHORITIES AND LINE SLIPSG BINDING AUTHORITIES AND LINE SLIPS

Under binding authority, carefully selected agents may accept risks of a particular class, on

behalf of the insurer, within defined limits. The insurer sets very precise limits and rules for theoperation of this authority including maximum limit and limits to accept non-standard business.

POINTS TO NOTE;

It is advantageous for agent, he will receive increased commission, greater authority

and ability to make immediate decision on risk acceptance.

It is also beneficial for insurer that more business is written and some element of

administration is removed.



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H ACCEPTANCE SLIPSH ACCEPTANCE SLIPS

Slips are used in very large risks where single insurer may not be able to accept 100% risk. It is

practice in Lloyds market in certain cases and in conventional market also. There is always a

lead underwriter who accepts the risk on a slip at the first instance by mentioning the

percentage of risk acceptable to him. Other will follow until 100% risk is accepted.

**************



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CHAPTER 4CHAPTER 4

MANAGEMENT OF EXPOSURESMANAGEMENT OF EXPOSURES


Underwriters have an important role in assessing the quantitative and qualitative aspects of risk

proposed to them. Underwriter has to ensure that the exposures (amounts such as sum assured,

that represent a potential claims against the insurer) brought to the pool and rated against

equitable standards. Underwriter is responsible to control the exposure.

A MEASURING EXPOSURESA MEASURING EXPOSURES

Insurers classify exposure by policy type and or class of business.

Property account is exposed to catastrophe (storm, flood, and earthquake) and non-

catastrophe (fire, theft, impact) risks.

Pecuniary account includes business interruption (loss of profit), personal accident and

life insurance risks. Liability account will have exposure to property damage, personal injury and financial

risks.

Steps have to be taken to measure the extent of all the above losses. Moreover, individual peril

can create liabilities across different types policies.

SINGLE RISKSINGLE RISK

For example, calculating the maximum exposure for any one single fire risk is not a case ofsimply adding together the sum insured at a single location. It invites assessing the estimated

maximum loss (EML) that is likely to occur.

EMLEML

It is an amount often expressed as a percentage of the total sum insured as well as an absolute

amount, reflecting the worst financial affect that the maximum foreseeable loss would have. An

EML could be 100% of the sum insured but it often less.



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It is possible to identify all exposure as a single fire risk for both material damage and business

interruption. This exposure can be under separate policy and the gross exposure is determined

by adding all those separate exposures together after applying EML percentage. Assessment of

EML must be accurate otherwise it will create problems for the insurer.

It is important not to overstate EML, as this can result in gross retention being on the higher

side and ultimately ceding to reinsurers premiums, which could be retained. Conversely

underwriting will over expose to the insurer and reinsurer also.

ESTABLISHING AND EML/SINGLE RISK EXPOSUREESTABLISHING AND EML/SINGLE RISK EXPOSURE

Underwriting requires skills such as processing factual information and subjective judgment

and experience in interpreting data in relation to the risk that the proposer or insured wishes to

insure/transfer. Data provided by the proposer/insurer can be supplemented with informationobtain from other sources in respect of that specific risk.

Risk information can be obtained from the following sources;

Insurance market data (ABI, Swiss Re, IUA etc.);

Own company data (claims experience for class of risk etc.).

Public sources data (government statistics, local authority statistics etc.)

Trade publications (chamber of commerce statistics etc.);

Own risk register;

Surveyors report on the specific risk;

Information on the specific risk from own staff, brokers;

Proposer special reports (e.g. medical, specialist, engineer etc.) and

Proposal form/application form.

Guidelines should be issued to surveyors on the method of EML assessment; surveyors are

encouraged to use their own judgment and experience in risk assessment. Some insurers fix

certain key factor on the assessment to a point/grading system for EML but measurement is

always subjective.

EXAMPLE: PROPERTY RISKEXAMPLE: PROPERTY RISK

When measuring a companys commitment, there are two dimensions to consider on a property

risk:

The sum insured under one or several policies covering one or more interests: for

example, if the risk in a furniture depository or a warehouse, an insurer needs to



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aggregate its potential liability under all policies covering different interests insured at

the same premises;

The nature of the risk and its vulnerability to a range of different perils the size of the

maximum potential loss related to the total value at risk (sum insured) determined by:

1. the materials used in its construction;

2. the size and height of the building;

3. its fixed fire and sprinkler protection;

4. premises contents nature, distribution, combustibility and content;

5. use of location hazardous processes and substances;

6. susceptibility of contents to smoke, beat and water;

7. explosion from any source;

8. hazards from gas or corrosive materials;9. concentration of any values in a small area; and

10. management and housekeeping capability.

Reinsurers invariably insist that the same net retention is used on any non-fire perils.

NON-FIRE PERILSNON-FIRE PERILS

Similar evaluation is applied to the assessment of non-fire perils.

The same principles are applied when considering risks whether the insurer is the lead office ornot, although the survey reports have been produced by other insurers and brokers. Internal

underwriting controls in the form of branch audits and branch referrals are also involved.

RISK ACCEPTANCERISK ACCEPTANCE

Once the EML has been calculated, an underwriting decision must be taken on the acceptability

of the risk within the gross account. This is influenced by the extent to which the risk, when

added to others within the underwriters book of business, will aggregate to produce too high

an exposure from a single risk; or from an event involving other risks likely to be affected by

the same flood, storm, earthquake etc. An important part of a underwriters skill is to quantify

overall values at risk to take a view on the amount that can be retained within the net account,

and to decide whether use of one of several risk transfer arrangements should be made so that

the possible net loss to the insurer is reduced to a manageable level.

SINGLE EVENTSSINGLE EVENTS



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Many individual losses can result from one catastrophic event, affecting a large number of

policies. Part of an insurers strategy to spread risk and smooth out losses includes writing a

range of different classes of business. However, a natural peril, such as windstorm, can cause

losses across different policy types, for example, household, commercial,fire,motor,marine and

aviation. Insurers have to acknowledge such possibilities and seek the financial stability that

catastrophe reinsurance protection can offer.

B SEASONAL AND CYCLICAL INFLUENCESB SEASONAL AND CYCLICAL INFLUENCES

SEASONAL INFLUENCESSEASONAL INFLUENCES

Seasonal demand needs the increase in sums insured at risk (e.g. retailers stock during

Christmas period) or specific demand for certain covers (e.g. travel policies in summer).

Moreover during summer season the number of visitors from different countries of the world

visit UK on holidays, therefore, stocks have to be increased many fold and there will be a need

to uplift the sums insured.

Seasonal risk also describes the increased risk under annual policies (e.g. claims under motor

policies due to adverse driving conditions during the winter months).

ECONOMIC CYCLEECONOMIC CYCLE

Inflation tends to follow a booming economy and affects property values so sums insured may

become inadequate. Similarly court awards rise and may render limits of indemnity inadequate.

WEATHER-RELATED CYCLESWEATHER-RELATED CYCLES

Due to global warming weather is changing in many parts of the world. Rising temperatures are

expected to increase flooding, coastal erosion and subsidence. Severity of windstorm incidents

is also increasing. These all are of concern for the insurer as losses may be on very higher side.

C AGGREGATIONC AGGREGATION

MEASURING AGGREGATION OF SINGLE EVENTSMEASURING AGGREGATION OF SINGLE EVENTS



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Measuring aggregation of single events is now essentially required both for the benefit of

reinsurer and insurer as the natural disasters are increasing day by day. There are the six stages

involved for measurement.

Classify aggregations according to type of policy, class of business, risk or peril;

Access zonal aggregation by geographic territory, radius or band;

Carry out event simulation relating hypothetical events to known exposures to gauge

the effect of , for example, flooding in the Thames basin or windstorm in section of the

Gulf of Mexico;

Make a statistical extrapolation based on past events that could recur, adjusting the

financial consequences for current and future conditions;

Acknowledge that single events can create exposure clashes in unrelated accounts and

make an allowance for the effect these multi-exposures can have in depressing retention

levels; and

Quantify the effect of single event on separate account aggregations arising from, say,

an earthquake, on exposures in motor, property, marine, life and pecuniary accounts.

The first stage is to assess maximum loss which could occur due to catastrophe and then

underwriters should identify any single risk exposure that is known along with business written

by other department or companies within the same insurance group. Thereafter insurer can

forecast the likely future cost of post losses.

AGGREGATION OF SINGLE RISKSAGGREGATION OF SINGLE RISKS

The purpose of aggregation of single risks means risk registration in the property record. It is

an essential underwriting process for identifying and measuring accumulation.

AGGREGATION OF LOSSES IN ONE YEARAGGREGATION OF LOSSES IN ONE YEAR

Under one account e.g. motor insurance there may be losses under different accounts e.g. a

company car fleet can expect own vehicle damage, damage to the other car, injury to the

passengers of other car and liability claims can arise, damage to the property of third party

again liability claim can arise. All such loss exposures should be aggregated, which exercise is

required to decide the retention level and business to be passed to the reinsurer.

D ENABLING CAPACITYD ENABLING CAPACITY



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Enabling capacity can be increased by taking measured that an insurer can take to maximize his

ability to underwrite risks, whilst marinating the balance between financial capacity and

exposure/claims liabilities.

VIRTUOUS CIRCLEVIRTUOUS CIRCLE

It means growth in areas with a perceived profit potential will be attractive because

increased policy volumes will probably reduce unit cost (reducing overheads etc.) which in

term allows premium reductions.

Measures that can be taken to maximize ability to underwrite risks are;

USE OF LAYERED COVERS AND DEDUCTIBLES

Sometimes, as insurer may wish to, or is obliged to, accept a block of business with potential

liabilities far in excess of its maximum capacity for any one risk. A valued customer might

expect the insurer to accept all of their business without question or the insurer may want to

write the entire risk as a way of avoiding competition.

EXAMPLE OF LIABILITY RISKS

A large petrochemical manufacturer approaches insurer A to provide a public liability limit of

500m pounds any one accident. Insurer A is able to retain 10m pounds ground up for its own

account and calculates that it is unlikely that any one incident would produce total payments in

excess of 50m pounds. The possible effect of the layering process is as follows;

first 10m pounds with insurer A;

10% of the next 40m pounds with insurer A plus 90% with a panel of proportional

reinsurers;

Next 100m pounds with specialist reinsurer X;

Next 150m pounds with specialist reinsurer Y;

Next 175m pounds with specialist reinsurer Z; and

Last 25m pounds with insurer A.

Each layer of the package would be priced by the insurer or reinsurer concerned.



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With the first layer, insurer A would calculate the whole premium in the normal way, but in the

knowledge that the entire 10m pounds could be involved in a loss and an incident could cost up

to 50m pounds.

For the next layer, when other insurers are introduced they would prepare their own premium

calculation to compare with the premium put forward by insurer A in preparing the calculation,

they would put it together in the normal way and view the first layer of 10m pounds as being

similar to a deductible on their cover. They would not be called upon to meet any claims

payments until a loss exceeds 10m pounds.

The next layer is expressed as 40m pounds in excess of 10m pounds and insurers or reinsurers

participating in this layer would acknowledge that their interest in losses would only commence

at 10m pounds, for 90% of amounts upto to 50m pounds. The pricing structure would allow for

this.The premium for the next layer, 100m pounds over 50m pounds, would again be arrived at in

the same way. However, since the loss potential is diminishing, a lower sum might be

anticipated even though the width of the layer is greater.

Once the last 28m pounds layer is reached, insurer A is sufficiently confident that the

possibility of losses reaching this level is very small. Therefore, it is prepared to participate

again, as in the worst possible circumstances its total exposure, 39m pounds, would be within

its financial capacity.

The likelihood of that last layer being involved in a loss would be considered remote but the

high variability of risk at that level required risk capital and hence justifies the further premium

charged. The loss potential has considerably diminished, so the premium for this layer will be

reduced.

Excesses and deductibles

The difference between an excess and a deductible (apart from one of scale, where the excess

will usually be a lower amount) is that the former is often imposed by underwriters as either

standard or specific to a particular case as a condition of acceptance without premium discount.

A deductible is an amount borne by the insured in return for a premium discount.

The following example shows how the insurer, or the customer, might benefit;

EXAMPLE

Customer A is a multinational and has a global insurance program providing material damage

all risks cover on its manufacturing plants throughout the world.



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It whishes to carry a 100,000 pounds deductible on each and every loss instead of insurer its

standard policy excess of 5,000 pounds. Insurer B is prepared to allow a premium reduction of

250,000 pounds for this facility. Based on its most recent five year loss experience and a newly

implemented risk control package, customer A estimates that its total annual claims falling

between 5,000 pounds and 100,000 will be 200,000 pounds. Therefore it accepts the deal,

anticipating a saving of 50,000 pounds; that is, 250,000 less 200,000 pounds.

Consider the following scenarios at the end of the period of insurance;

Actual annual total of losses falling between excess and deductible;

180,000 pounds

Premium saved 250,000 pounds

Losses not recoverable 180,000 pounds

Benefit to customer A 70,000 pounds

Actual annual total of losses falling between excess and deductible;

310,000 pounds

Losses not paid 310,000 pounds

Premium not collected 250,000 pounds

Benefit to insurer B 60,000 pounds

GROSS AND NET ACCEPTANCE LIMITSGROSS AND NET ACCEPTANCE LIMITS

If an insurer has operated for some time and built up technical reserves (funds of money put

aside to pay for future losses, added to by unearned premiums and depleted by claims

payments), it follows that the insurer can absorb larger losses than a younger insurer which has

had less time to accumulate reserves. Sound practice dictates that not all of the insurers surplus

should be distributed as dividend to shareholders; instead, the longer-term objective must be to

increase reserves 8which, in turn, increase the net underwriting capacity.

A gross acceptance limit is that amount of a risk which the insurer is able to manage, taking

into account the balance of the portfolio and the availability of reinsurance.

A net acceptance limit is that amount which the insurer retains for its own account after

recourse to reinsurance. The reinsurance arrangements are defined by the insurers net

acceptance limits and can relate to the whole of a risk, a block of business, or a part.

Example



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Underwriter K has a gross acceptance limit on good quality marine cargo business of US$. Of

this amount US$50,000 is retained for the syndicate that underwriter K represents. US$150,000

is reinsured, being within the capacity of their ten-line surplus treaty arrangement. A surplus

treaty measures its capacity in lines, where each line is equal to the insurers gross retention.

A70% quota share treaty is applied to the US$50,000 in order to involve other network

members, leaving underwriter K with a net acceptance of US$15,000.

Insurers with small and perhaps unbalanced accounts are obliged to set acceptance limits in

accordance with their restricted financial resources. While all insurers, large or small, are

constrained by solvency margin requirements and regulatory legislation, there is scope for a

cautious or an adventurous business stance. Small, newly formed insurers may put more of

their capital at risk by setting their acceptance levels at a higher level. This may help to attract

reasonable volumes of business in their chosen market.

CO-INSURANCECO-INSURANCE

Co-insurance is a means of spreading the risk whereby the organizing company (called the lead

office) issues a policy covering a risk but only retains a percentage of the risk.

Important points to note;

The reasons for using co-insurance are, possibly the risk is thought, by the leading

office to be too large for it to accept or it may be felt the risk insured is too hazardous tojustify retaining 100% or client has preferred to involve several insurers.

Since the lead office not only handles most of the administration but also is responsible

for the initiating negotiations, surveys, premium calculations and subsequent policy

changes (endorsements), all co-insurers will pay 5% of their share of the premium to it.

The co-insurers are responsible for ensuring that policy terms and conditions and

premium levels accord with their own underwriting; policies and practices.

ALTERNATIVE FINANCIAL INVESTMENTSALTERNATIVE FINANCIAL INVESTMENTS

There are certain alternative instruments which allow risk transfer.

CAPTIVE INSURANCE COMPANIES.CAPTIVE INSURANCE COMPANIES.

DEFINITION;

A Captive insurance company is a limited purpose company, established and owned by a non-

insurance parent to transact, in the main, the insurances of its parent company or subsidiaries

thereof. It is not large enough to carry all the risk itself so a sizeable amount of reinsurance is



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usually required. The captive may retain a percentage of the risk or a fixed proportion. The

balance, usually the majority of the risk, is reinsured.

Captives may also write reinsurance themselves, possibly for other captives and usually on a

small scale. There are currently about 5,000 captive insurers globally.

TYPES OF CAPTIVE INSURERSTYPES OF CAPTIVE INSURERS

Single-parent captives; These companies benefits from;

1. lower operating costs than traditional insurers,

2. direct access to reinsurance;

3. full retention (by the parent company)of investment income and profits; and

4. freedom to outsource support services.

Potential disadvantages include;

1. additional administration costs for the parent company;

2. vulnerability exceptional losses;

3. the opportunity costs involved in setting up the operation; and

4. there may also be tax implications.

Group captives; Group captives, as the name shows, service a number of different

organizations and are jointly owned by them. They enjoy the benefit of single-parent

captives, but also a wider spread of exposure and the reduction in overheads that

(usually) accompanies larger volumes of business.

Disadvantages include;

1. poor loss experience as one or more of the participants can produce unwelcome

financial repercussions for all; and

2. there are also potential problems in managing the operation so that all participants

are satisfied.

Protected-cell captives (PCCs);

The funds (assets and liabilities) of each user are physically and legally held separately.

They seek to achieve the advantages of the single-parent captives and the operating cost

advantages of group captives, but without the cross-account exposure of the latter.



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ADVANTAGES FOR PARENT COS. & INSURERSADVANTAGES FOR PARENT COS. & INSURERS

Greater flexibility in arranging their insurance programs.

Insurance of deductibles carried under traditional covers;

Direct access to reinsurance;

Reduced premiums and potential to accumulate funds;

Availability of cover not found (or only in very restricted form) in the retail market;

First-hand involvement in claims settlements, with potential benefits in operating

processes and accident preventing;

Some insulation against the hard markets with their resultant high premiums; and

Greater risk control

For insurers the benefits can be;

Less pressure to accept accommodation business, which they would rather not write,

even for valued connections;

Potentially better risk management through greater policyholder involvement; and

Possible opportunities for reinsurance.

SOLVENT SCHEMES FOR ARRANGEMENT;SOLVENT SCHEMES FOR ARRANGEMENT;

These schemes are arrangements between insurers and their policyholders. Under the schemes

solvent insurers can exit from discontinued business with the consequent release of capital and

possibly, a saving in run-off costs. Policyholders benefit because they are immediately paid in

full the estimated value of their claims.

The basis of the arrangements is an aggregate assessment of all existing and future claims at a

given date, facilitating a final distribution.The schemes are legally binding on all policyholders (and creditors) or any class thereof, if the

necessary majority vote in favor of the proposed arrangement and the High Court grants

approval.

D AVAILABILITY OF REINSURANCED AVAILABILITY OF REINSURANCE

Insurers use reinsurance to limit their potential maximum exposure by ceding part to another

party (reinsurer).Main points are;



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In property insurance, insurer often use proportional and/or excess of loss treaties to

allow a higher gross exposure to be accepted as single fire risk.

Insurer also arrange catastrophe protection for the whole account against the risks of

accumulated loss following major events such as storms, floods, earthquakes, major fire

and explosions.

Reinsurance applies where an insurer willingly or unwillingly accepts more than its

normal capacity.

Treaty reinsurance will not require details of all individual risks written by the

reinsured.

Stop loss cover is a non-proportional reinsurance arrangement whereby annual losses

over an agreed amount for specified class of business are covered up to a fixed upper

limit.

Reinsurance serves a number of vulnerable functions; it enhances the capacity of

primary insurers, stabilizes the activities of the insurance industry by spreading risks

and provides insurers to obtain a greater return on capital employed.

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CHAPTER -5CHAPTER -5

IMPLEMENTATION OF OPERATIONAL CONTROLIMPLEMENTATION OF OPERATIONAL CONTROL


The main purpose of underwriting management is that high level objectives set forth by the

higher Management to get known to all working at front line for decision making and to apply

uniformity in all cases.

In practice there may be lot of difficulties which can be faced, as under;

It is not practically possible to grant one set level of authority to all underwriting staff,

because of their level of experience, e.g. senior underwriter at head office may have

more acceptance limit than a clerk.

There are number of distribution channels and have underwriting authority. Levels of

this authority vary as compared to in-house underwriters.

Even in well-managed insurance companies consistent and effective 1control through

several level management results substantial difficulties.

A AUTHORITY LIMITA AUTHORITY LIMIT

ESTABLISHING A CONTROL STRUCTUREESTABLISHING A CONTROL STRUCTURE

ELEMENTS OF UNDERWRITING CONTROL;ELEMENTS OF UNDERWRITING CONTROL;

The essential elements of the insurance underwriting process can be as under;

Identification or risk;

Measurement of risk by average and maximum size and frequency of occurrence;

Setting parameters for risk selection;

Limiting risk exposure by individual policyholders and in aggregate across the

portfolio;

Preparing a detailed legal contract (the insurance policy) which sets out clearly the

subject matter of each insurance and the risks insured, together with conditions and

exclusions; and



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Pricing risks and incorporating acquisition and operational expenses, together with a

profit margin, into the premium.

DIFFERENCE BETWEEN UNDERWRITING AUTHORITY ANDDIFFERENCE BETWEEN UNDERWRITING AUTHORITY AND

UNDERWRITING LIMIT;UNDERWRITING LIMIT;

Authority is extent of decision making given to individual underwriter or group of

underwriters.

Limits refer to exact parameters on type of business and gross and net acceptance

limits,

DETERMINING AN APPROPRIATE FRAMEWORK OF UNDERWRITINGDETERMINING AN APPROPRIATE FRAMEWORK OF UNDERWRITING

AUTHORITYAUTHORITY

Underwriting authorities are developed to support, the objectives and activities of other areas of

the insurer, including marketing, sales and claims. The customers in the market have

expectations about the speed of response and the extent of decision making authority by the

insurers staff. If the underwriting authority does not take needs of the market, e.g. (by

implementing unrealistic limitations) may harm the insurers ability to achieve business plans.

UNDERWRITING STAFF EXPECTATIONS;UNDERWRITING STAFF EXPECTATIONS;

Underwriting staff always expect that they shall be given underwriting authority to the extent

they can perform their functions successfully and efficiently. Low level of authority may de-

motivate them and conversely too much authority without proper training can cause de-

motivation and can result into acquisition of business which has not been properly priced or

underwritten.

Some managers may be reluctant to increase the underwriting authority due to fear of its

misuse. However, if the authority is increased it should be monitored by certain control

procedures, such as;

Understanding each individuals experience and knowledge;

Periodic review of their application of underwriting authority;

Appropriate training; and

Measurement of risks by the internal audit team.

Head office or Regional office underwriters, who are involved in more complex cases, have the

highest authorities. Similarly major branches underwriters have also the same aut

underwriting management (5th semester)

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