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 and to ensure that each insured pays a premium proportionate to their level of risk.

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 and rate adjustments.

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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Know this...

A signed application authorizes the insurer to obtain consumer or investigative reports under the Fair Credit Reporting Act (FCRA). There is no expiration date in the law. However, if the insurer needs to re-investigate after a significant period (typically 1–2 years), it may require a new authorization per company policy or to ensure data relevance.

Under the Fair Credit Reporting Act, if coverage is denied based on a consumer report, the insurer must send an adverse action notice identifying the consumer reporting agency (CRA).
The applicant may request a copy of the report from the CRA at any time after receiving notice; if the request is made within 60 days, the CRA must provide it for free.

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Note: Under FCRA, the insurer must identify the consumer reporting agency but is not required to provide the report itself. The applicant must request it directly from the CRA.

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. Rating services evaluate an insurer’s financial strength and its ability to meet policyholder obligations (claims-paying ability). Ratings services include Moody’s, Fitches, A.M. Best, and Standard & Poor’s, to name a few.

A.M. Best’s highest rating is A++ (Superior), followed by A+ (Superior), A (Excellent), and lower categories such as B, C, and D (Poor). D does not mean default. “E” indicates regulatory supervision, and “F” means the company is in liquidation.

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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, if an insurer consistently accepts late payments from the same insured without enforcing cancellation, the insured may reasonably rely on that behavior. The insurer may then be estopped from canceling for lateness because of that established course of conduct.

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Know this…

Waiver and estoppel generally apply after a policy is in force rather than during the initial underwriting process.

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 law that regulates how consumer information is collected and used. It requires insurers to notify applicants of adverse actions, provide the name of the consumer reporting agency, and allows consumers to obtain and dispute the information used in the report.
Insolvency: Insurer’s inability to pay debts.
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: The price charged per unit of insurance (for example, per $100 or per $1,000 of coverage).
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.