Underwriting | Achievable Property & Casualty

Insurers are in the business of accepting risks and insuring against financial loss associated with those risks. This does not mean that they want to (or have to) accept every application for insurance. Accepting too many bad risks threatens an insurer with insolvency.

An insurer’s underwriting department will carefully review each application for insurance to determine whether or not it represents an acceptable (standard) risk. The objective of risk selection is to provide equity among all classes of risks.

There are many components involved in determining premium rates. Among these are loss experience, the occupancy or operation involved, construction of the structure (i.e. brick or frame) and the overall exposures. Underwriters also look at loss ratios which assist in future analysis.

Underwriting involves a legal form of discrimination based on risk profiles. They separate people into high-risk (substandard) and low-risk (Preferred) categories to determine premiums and encourage customers to reduce their risky behaviors.

While certain discrimination based on statistical fact is considered acceptable, insurers must not make underwriting decisions based on unfair discrimination. Unfair discrimination targets protected classes, such as race, national origin, sex, or religion.

How do underwriters determine if an applicant is standard, substandard, preferred, or uninsurable? There are several sources that an underwriter utilizes to reach his/her decision, including:

Application

The most important source of information is the application. The application contains a considerable amount of information, all of which helps the underwriter determine an adequate premium level. The questions on the application are intended to provide a complete picture of the applicant, revealing any physical, moral, or morale hazards.

Producer’s Report

Field underwriting is an initial risk assessment by insurance agents or producers during client interactions. It helps determine if a client meets basic underwriting criteria before formal application, saving time and resources, improving client experience, and reducing insurer risk. Field underwriting by producers may involve gathering information, asking probing questions, observing client demeanor, identifying red flags, and documenting observations.

The producing agent or broker provides information to an underwriter regarding his/her opinion and/or recommendation regarding the applicant and the proposed insured.

Inspections

With property insurance, the underwriter wants to make sure that the property to be covered actually exists and is in the condition claimed. Physical inspection of the property is usually required by the underwriter. Inspection may be conducted by the producing agent or broker or a company representative.

Consumer Reports

An underwriter may wish to investigate the applicant in more detail. When an applicant signs the application, they give the insurer the authorization to obtain a consumer report. This consumer report may include a credit report of the applicant or be of an investigative nature where an insurer representative interviews current or previous employers or neighbors regarding the applicant and the exposure.

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A signed application authorizes the insurer to collect information for 30 months. If they have not done so by then, a new authorization must be obtained.

If an applicant is denied coverage due to information collected, this regulation grants access to the information and reasons for the denial. After receiving notice that an adverse underwriting decision has been made, an individual has 90 business days within which to request a copy of the report.

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Note: This law does not allow the insured to require that the insurer send him/her a copy of the report. It allows them to request a copy of the report from the agency that provided the information.

Financial Status

Independent rating services help the consumer identify insurers who are financially sound. Consumers commonly look to ratings services prior to making a decision on which insurer to purchase coverage from. Ratings services gauge a corporation’s financial ability to make the interest and principal payments of the bonds they have issued. Ratings services include Moody’s, Fitches, A.M. Best, and Standard & Poor’s, to name a few.

It’s widely accepted that AAA is the highest financial rating, D being the lowest. A “D” rating indicates the insurer is in default and is unable to pay its claims.

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Note: Rating services are private corporations and are not regulated by the NAIC.

Waiver & Estoppel

The legal concept of Waiver & Estoppel is often used in matters relating to insurance, particularly with underwriting decisions and during the claims process. This concept holds an entity (the insurer) to “standards of established behavior”.

Waiver occurs when an insurer gives up a right, like the right to cancel a policy for nonpayment, by accepting a late payment and continuing coverage. Waivers can be express or implied.
Estoppel stops an insurer from changing its stance if it harms the insured, assuring policyholder protection. For example, an insurer can’t cancel a policy for a late payment if it has a history of accepting late payments from others, as this implies late payments are acceptable.

Lesson Summary

Underwriting insurers assess and insure risks. Here are some key points:

Accepting bad risks can lead to financial trouble for insurers.
Underwriters review applications to decide if the risk is acceptable.
Premium rates are based on various factors.
Loss experience, occupancy, construction, and exposure impact rates.
Loss ratios are crucial for future analysis.

Underwriters classify applicants as standard, substandard, preferred, or uninsurable using the following sources:

Application: Contains vital information for the underwriter.
Producer’s Report: Provides the agent’s input.
Inspections: Verifies the property condition.
Consumer Reports: May include credit or investigative reports.

Consumers can check an insurer’s financial status through rating services:

AAA is the highest rating, and D indicates default.
Ratings from Moody’s, Fitches, A. M. Best, and Standard & Poor’s help assess financial strength.
Rating services are not regulated by the NAIC.

Chapter Vocabulary

Definitions

Actuarial Report: A document or other presentation, prepared as a formal means of conveying to the state regulatory authority and the Board of Directors, or its equivalent, the actuary’s professional conclusions and recommendations, of recording and communicating the methods and procedures, of assuring that the parties addressed are aware of the significance of the actuary’s opinion or findings and that documents the analysis underlying the opinion. (In Life and Health) this document would be called an “Actuarial Memorandum.”
Actuary: An insurance professional skilled in the analysis, evaluation, and management of statistical information. Evaluates insurance firms’ reserves, determines rates and rating methods, and determines other business and financial risks.
Adverse Selection: The tendency of those exposed to a higher risk to seek more insurance coverage than those at a lower risk. Insurers react either by charging higher premiums or not insuring at all.
Class Rating: A method of determining rates for all applicants within a given set of characteristics such as personal demographic and geographic location.
Fair Credit Reporting Act: Federal laws that allow consumers who are denied insurance because of information contained in a credit report to be notified and allowed to obtain the information used in the report from the reporting agency.
Insolvency: Insurer’s inability to pay debts.
Law of Averages: A mathematical rule stating that as the number of exposure units increases, the closer the actual results will approach the predicted results of an event.
Law Of Large Numbers: The theory of probability on which the business of insurance is based. Simply put, this mathematical premise says that the larger the group of units insured, such as sport-utility vehicles, the more accurate the predictions of loss will be.
Preferred Risk: Insured, or applicant for insurance, who presents a likelihood of risk lower than that of the standard applicant.
Rate: Value of insured losses expressed as a cost per unit of insurance.
Representations: On an application, facts that the applicant represents as true and accurate to the best of his/her knowledge and belief.
Standard Risk: A person who, according to a company’s underwriting standards, is considered a normal risk and insurable at standard rates. High or low-risk candidates may qualify for extra or discounted rates based on their deviation from the standard.
Substandard Risk: Risks deemed undesirable due to medical condition or hazardous occupation requiring the use of a waiver, a special policy form, or a higher premium charge.
Underwriter: Person who identifies, examines and classifies the degree of risk represented by a proposed insured in order to determine whether or not coverage should be provided and, if so, at what rate.
Underwriting: The process by which an insurance company examines risk and determines whether the insurer will accept the risk or not, classifies those accepted, and determines the appropriate rate for coverage provided.