Insurers make money by accepting risk and promising to pay for covered financial losses. That doesn’t mean they must accept every application. If an insurer accepts too many poor risks, it can threaten the company’s ability to pay claims (insolvency).

An insurer’s underwriting department reviews each application to decide whether it’s an acceptable (standard) risk. Risk selection has two main goals:

• Provide equity among classes of risks
• Make sure each insured pays a premium that matches their level of risk

Premium rates depend on several factors, including:

• Loss experience
• Occupancy or operation involved
• Construction of the structure (for example, brick or frame)
• Overall exposures

Underwriters also review loss ratios, which help with future analysis and rate adjustments.

Underwriting is a legal form of discrimination based on risk profiles. Insurers separate applicants into high-risk (substandard) and low-risk (preferred) categories to set premiums and encourage safer behavior.

Discrimination based on statistical evidence can be acceptable in underwriting, but insurers must not make decisions based on unfair discrimination. Unfair discrimination targets protected classes such as race, national origin, sex, or religion.

How do underwriters decide whether an applicant is standard, substandard, preferred, or uninsurable? They rely on several information sources, including the following.

Application

The application is the most important source of underwriting information. It contains details that help the underwriter decide whether the risk is acceptable and what premium level is appropriate. The questions are designed to build a complete picture of the applicant, including any physical, moral, or morale hazards.

Producer’s report

Field underwriting is an initial risk assessment completed by insurance agents or producers during client interactions. It helps determine whether a client meets basic underwriting criteria before a formal application is submitted. Field underwriting may include:

• Gathering information
• Asking probing questions
• Observing client demeanor
• Identifying red flags
• Documenting observations

The producing agent or broker also provides the underwriter with an opinion and/or recommendation about the applicant and the proposed insured.

Inspections

With property insurance, the underwriter needs to confirm that the property exists and is in the condition described. A physical inspection is often required. The inspection may be completed by:

• The producing agent or broker
• A company representative

Consumer reports

Sometimes the underwriter needs more detail about the applicant. When the applicant signs the application, they authorize the insurer to obtain a consumer report. This report may include:

• A credit report
• An investigative consumer report (for example, interviews with current or previous employers or neighbors about the applicant and the exposure)

Sidenote

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 that identifies 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.

Sidenote

Know this...

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 consumers identify insurers that are financially sound. Many consumers check these ratings before choosing an insurer.

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

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.

Sidenote

Know this...

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

Waiver & estoppel

The legal concept of Waiver & Estoppel often comes up in insurance matters, especially in underwriting decisions and during the claims process. The idea is that the insurer can be held to “standards of established behavior.”

• Waiver occurs when an insurer gives up a right, such as the right to cancel a policy for nonpayment, by accepting a late payment and continuing coverage. Waivers can be express or implied.
• Estoppel prevents an insurer from changing its position when doing so would harm the insured. This supports 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 pattern. The insurer may then be estopped from canceling for lateness because of that established course of conduct.

Sidenote

Know this...

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

Lesson summary

Underwriting is how 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.