ch 4 underwriting policy and practice

Chapter 4

UNDERWRITING POLICY AND PRACTICE

PHYSICAL AND MORAL HAZARDS

Physical hazards – Physical aspects of a risk that directly impact on its insurability or terms,

conditions and exceptions at which insurance may be accepted – Hazards identification is the

basis of successful underwriting e.g.:

Material damage

• Construction of the premises / Nature of the contents

• Location of the premises:

Proximity of the fire services

Proximity of the sea or inland water

Earthquake zone including tsunami risk

• Sprinklers, alarm and other loss minimisation devices e.g. fire doors or fire breaks.

Business InterruptionAlternative back-up sites for revenue-generating sites

Alternative suppliers of key ingredients or components


Liability

Motor

Compliance with health and safety requirements Nature of the activities carried out

Condition of the premises Proximity of the third parties

Number of vehicles in a fleet and nature of the

vehicle

Compliance with driving hours

restrictions

Age and condition of the vehicle Driver training and experience


Moral hazards relates to the conduct and attitude of the proposer / insured

Three scenarios of moral hazards:

Pre-inception – Proposer is required to answer of proposal form & other

questions truthfully. So that underwriter could assess the risk properly.

Poor risk management depicts poor moral hazards e.g.:

Pre-inception Post-inception Post-loss

Poor maintenance of premises or vehicles Poor or inadequate training


Post-inception poor moral hazards e.g.:

• Attitude to surveyor’s recommendations for risk improvement

• Response to requests to visit premises / operations

• Delays in premium payments

Post-loss moral hazard is evident from e.g.:

• Delays in loss notification with full details of circumstances

• Lack of readiness to assist insurers in determining the value of the loss

• Exaggerating the value of the loss

RISK CLASSIFICATION AND CATEGORISATION

Classification of risk facilitates the underwriting process. Risks are classified by

account and class of business, e.g.:

Within the class of business, individual covers / perils will be classified separately

(e.g. fire, explosion, storm, flood, escape of water under a material damage policy).

Package policies designates their own class of business but the individual covers

underwriting is done through their appropriate account e.g. motor or property

Personal insurances Motor Property

Private car Commercial vehicle Material damage

Household Motor fleet B.I

Personal accident Motor trade Theft

Pet money


UK insurance industry also use insurance industry-wide code for

classification, usually based on trade / occupation e.g.:

• ABI coding

• Standard Industrial Classification (SIC)

• Own classifications e.g.:

Motor Property Liability

Vehicle type Occupation of building Occupation

Vehicle use

Driver’s age Construction material Product


Categorisation – Risks with similar features and characteristics (similar degree of

hazard & claim profiles) are also categorised by the insurers in comparable groups for

ease of analysis & rating. E.g. :

Car rating group

Insurers band models of cars with similar characteristics together as it would be

unworkable to assess each model of car individually. Factors considered are:

Theft rating areas

Risk categorised by allocating post codes to different rating areas based on claim

experience, crime statistics etc.

Insurers regularly review their categorisation criteria.

Damage & parts costs Repair times Car security

UNDERWRITING AND RISK IMPROVEMENT

CRITERIA

In underwriting process, after risk classifications and categorisations, insurer define the

risk acceptance criteria (degree of hazards for risk acceptance).

Underwriting criteria derived from underwriting strategy it includes:

Examples of Underwriting criteria:

Material damage

Physical hazards Classification Categorisation

Accepting a highly protecting risks e.g. risks with fire alarms & sprinkler

Restricting the trades i.e. prohibiting the risk acceptance of all risks falling into a particular trade

Restricting the geographical location for underwriting


CRITERIA

Liability

• Excluding trade using asbestos.

• Limiting the use of heating & welding equipment .

Motor

• Offer cover to young & inexperienced driver (e.g. below 23).

• No underwriting fleets of high performance or high value vehicles.

Underwriter can accept non-standard risks with imposition of some terms and

conditions.


CRITERIA

Risk improvement criteria is derived from the implementation of underwriting criteria

i.e. it is the part of the underwriting criteria e.g.:

Home insurance

• Final exit door (FED) from the home to be fitted with a 5-lever mortise (wood

working) deadlock which meet British standard

Motor insurance

• Car is kept overnight in a locked garage.

Risk improvement criteria for commercial lines and high risk personal lines:

• Make the risk acceptable to the insurer and reduce the probability of loss prior to any

claim events

• Counter the impact of claims resulting from a common cause


CRITERIA

Risk surveys

Two main purpose of risk surveys:

• Accurately describe or classify the risk

• Insurer propose ways for risk improvements

Two categories of Risk improvements:

• Necessary improvements for a risk to be acceptable

• Optional improvements – May result in wider cover or a reduced premium for the

insured if implemented.

Common claims trends – If insurer finds claim trends then discuss it with insurance

surveyor / risk engineer and take measures to address the issues of claim frequency

through risk control measures (Involve costs) which is the part of underwriting criteria.

POLICY COVER, TERMS, CONDITIONS AND

RESTRICTIONS

Policy wordings – Reflect the underwriting policy of the insurance company and so

insurer often use model policy wordings.

Standard policies are drafted:

• To provide the extent of cover the insurer is willing to give

• To meet the policyholders’ needs in the sector or niche market at which it is aimed

• To compare favourably with competitors

• To achieve a balance between the risk exposure and premium charged

• To satisfy all the legal requirements

• To provide clarity in the event of the claim for quick settlement


RESTRICTIONS

Pre-printed booklet is published for high volume, low premium risks

of personal lines and small commercial risks.

4 key elements of an insurance policy:

The Operative Clause – Tell about the insured event coverage.

Cover provided by the operative clause is derived from the

underwriting policy.

Operative clauses Exemptions or Exclusions

Conditions clauses Schedule


RESTRICTIONS

The exemptions or exclusions clause

2 types of exclusions:

Criteria for exclusions is determined by:

Specific exclusions – Apply to certain parts or sections of the policy e.g.

Theft exclusions in packaged policies

General exclusions – Apply to the whole policy

Underwriting policy AND Cost of providing cover

Reinsurance protection available to the insurer


RESTRICTIONS

The conditions clauses express the policyholders’ rights & obligations.

Generally Insurance policies include following conditions:

Ensure fairness e.g. policyholder must advise the insurer of any alteration in risk as

soon as reasonably practicable & insurer may amend the term as required

Ensure the policyholder take reasonable care & cooperates in mitigating or avoiding a loss

Follow market practice e.g. cancellation condition


RESTRICTIONS

The schedule described the subject matter of insurance (Insured address, name etc.),

sums insured or limit of indemnity and specific to each policy written.

Endorsement and Memoranda are used to amend the policy.

Warranties – A warranty is an undertaking by the insured that the something shall or

shall not be done or that a certain state of affairs does or does not exist.

It must be strictly complied by insured otherwise insurer can avoid the policy.

Insurers apply warranties to ensure:

• Insured complies the requirement to make the risk acceptable within underwriting policy

• Certain features of higher hazards are not introduces without the insurer’s knowledge


RESTRICTIONS

Excesses:

Compulsory excesses are applied by the insurer as an underwriting measure

with the aim of:

• Reducing claim costs

• Eliminating small ‘nuisance’ claims which are costly to administer

• Making the insured more cautious regarding the prevention of loss

• Excluding some or all claims of an unacceptably high frequency, so premium can be

kept at a competitive level e.g. windscreen claims.

Voluntary excesses are applied at the request of the insured to eliminate small

claims and provide a reduced claims costs for the insurer, a discount premium is given.


RESTRICTIONS

Criteria for using excess:

Deductibles – Common in commercial policies for insured’s self-

insurance and same operations as excesses.

Policy limits – are determined by insurer’s capacity & reinsurance

arrangements and may be variable depending upon the nature of

risk.

Suitability Accurate costing

RISK EXPOSURE AND CONTROL

Losses may arise either from a single event or a single risk.

Single risks – Senior management assessed & established the

maximum capacity (S.I or limits of indemnity representing a claim

potential) that can be provided by a single risk. Underwriter must

ensure that the maximum exposure to a risk is acceptable within

the parameter of underwriting policy.

Single event can triggered losses from a number of policies e.g.:

Tsunami in Japan 9 / 11 terrorist attack – WTC


Aggregation means an accumulation of insured risk to a single insurer which exposes

that insurer to a significant flow of claims arising from a single cause of loss. E.g.:

Class of Business What is insured Nature of potential aggregation of risk

Motor Loss / damage. Liability to

3rd parties, property &

injury

Multi vehicle accidents & severe injuries to

people e.g. a motor way pile up

Household Home & contents loss or

damage. Liability to 3rd

parties

Weather e.g. storm affects a large multi

domestic dwellings

Comm. property All risk cover Multiple insureds affected by catas. loss

Travel People & their belonging.

Liability to 3rd parties

Pandemics or other natural disasters at

holiday resorts e.g. H1N1

RISK EXPOSURE AND CONTROL (IDENTIFICATION

AND CONTROL OF EXPOSURE)

Property insurance

Single risks – Maximum capacity of an insurer will laid be down in

the underwriting policy and it vary according to the nature and

quality of the risk such as plastic factory and spinning mill.

Maximum exposure on a single risk is calculated:

1. Total of the full value sums insured relating to a single location.

2. Estimated maximum loss (EML) is used to measure the exposure at a single

location.



Surveyors / Risk engineers establish correct EML by considering:

Underestimation of EML – Risk accepted over the maximum capacity – Less

reserves for loss – reduced profits.

Overestimation of EML – Risk not written because of insurer’s capacity or

unnecessary purchase of reinsurance.

Material used in the construction of the premises

Fire and sprinkler protection

Contents of the premises – Nature, distribution and combustibility

Use of location – hazardous processes & substances

Proximity to water course

Standard of management and house keeping



Accumulation logging – The insurer identifying & monitoring

accumulations at a single risk by recording of location of each risk

(usually via post code) and the maximum exposure at that location

(either via total S.I or EMLs).

Single events – Underwriting policy specifies the amount of capacity

available in specific geographical areas so the risk to natural perils can

be controlled.

Risk exposure aggregation is also being identified through

sophisticated computer programme, such as, risk zoning and a system

used for this purpose is the CRESTA (Catastrophic Risk Evaluation and

Standardising Target Accumulation).



Controlling exposure:

Liability insurance

Single risks – Maximum capacity of an insurer in respect of any policyholder

depends upon quality and nature of the risk.

Single events – Multiple policies can be triggered by 1.

Aggregation of liability insurance can be identified & controlled e.g. by:

• Examining exposure to similar trades.

• Examining proximity of insureds.

Purchase of reinsurance Co-insurance with other insurers


Approaches to issues of aggregation across a class of

business

Different insurers have different approaches but prudent risk selection is often

the key and the risk acceptance criteria will direct underwriter to:

Approaches to risk selection:

• Private Motor insurer not accepting business from young drivers.

• Insurer may set up a special unit to attract & handle high risk and then

reinsured it.

Positively specialise in some risks Avoid some risks altogether

Allow moderate exposure to others

DELEGATED AUTHORITIES & LINE SLIPS

Delegated authority can be restricted to e.g.:

• Issuing motor cover only

• Management of all or part of an insurer’s business in a particular territory.

Delegated authority holder is called cover holder.

Insurers / Underwriters are the risk carriers.

Agreement is known as binding authority.

Delegated authorities enable a business and underwriter to:

Gain access to business and Have the

local expertise and knowledge

Write in a sector in which it has little

expertise

Acquire income with low or without costs and risks of establishing branches or

employing underwriters


Delegated authority benefits intermediaries:

They incur fewer costs in placing business

Offer clients a quick turnaround on underwriting decisions

In many cases, can give cover immediately

Received enhanced levels of commissions to reflect the additional

work taken on

Participate in any profits from the risks written under the scheme


Operations of delegated authority

The binding authority details:

What risks can & cannot be covered e.g. class of business & trades

Rates of premium charged including any minimum levels

Limits, e.g. limits of indemnity, any minimum excess to apply etc. with maximum limit of

liability cover-holder can accept in aggregate.

Cover that may be granted and the wording to be used

Period of binding authority and geographical limit

If claim settlement authority is included then parameters are also identified


Importance of records and reporting

Delegated authority records is kept in bordereaux containing detailed information including:

Auditing and review – Risk carriers review not only parameters but also:

S.I & , in relation to major portfolio, the potential maximum amount of any 1 loss

A breakdown of income by section as well as details of individual premiums written

Identity of the client , The risk location and Retention rates of the business transacted

Adherence to the terms & conditions of the binding authority

Financial shape of the cover holder

Compliance with the legal & regulatory matters

Any other material development


Problems with delegated authority

• Conflict of interest – Acting for insured / proposer and insurer.

• Poor performance of the cover holder – Poor cash flow or a high level of losses

• Ambiguous terms – Liabilities remains with insurer

Line slips is an agreement between an individual broker and a group of 2 or more

insurers or underwriters whereby each insurer or underwriter agrees to accept a pre-

agreed proportion of a specified type of risk. Intermediary select the insurer or

underwriter as a lead underwriters.

LIAISON BETWEEN UNDERWRITING & CLAIMS

FUNCTIONS

Policy wordings

Claim department provide claim history and so wording is decided accordingly.

Recording of statistical data - Claim function allocate specific coding to each new

claims recorded on the claims data basis for analysis purposes. Generic coding for:

Type / cause of loss:

Type of vehicle involved in loss:

• Private car, commercial vehicle, special type.

Fire or storm for property insurance Fall from height or stress for EL

Hit in rear or windscreen breakage for motor fleet.

LIAISON BETWEEN UNDERWRITING & CLAIMS

FUNCTIONS

Individual claims – Queries on interpretation of the policy wording

will be directed to the underwriter so the original intent of the cover

to be provided can be established. For un-settled claims an

underwriter approaches the claim handler for back ground

information.

Backlogs – Underwriter should be updated with any backlogs of

claims department

Fraud – Claim personnel should notify to underwriters.

Emerging trends – Claims department should observe the claims

reported and advise underwriters of unusual pattern

COUNTER FRAUD INITIATIVES

Fraud (Crime) offence can be committed:

Opportunistic fraud-Examples of opportunistic fraud at underwriting stage:

• Fronting of private car policies.

• Omitting to disclose previous claims.

Examples of claims fraud:

• For theft claims, adding items to inventory which was never stolen

• Exaggerating the effect of insured event

• Inventing an insured event that can never took place

False representation Failing to disclose information Abuse of position


Pre-mediated fraud deliberate crime and engineered events of fraud e.g.

money laundering.

Fraud detection – Examples of fraud detection techniques:

Expert staff – Insurers built in-house fraud unit with expert staff to oversee the

implementation of fraud awareness policy. A claim handler must observe:

Claims for items where insured can’t produce any documentation

Claims made shortly after inception

Where several claims are made for similar loss or damage over a short period of time

Expert staff Covert surveillance

Investigative interviewing Photography and mapping


Market groups and associations - Formed for combatting fraud:

The Insurance fraud investigator’s group (IFIG) – has a membership

consisting of insurers, investigators, loss adjusters, and lawyers with the aim to

raise the profile of insurance fraud as a crime and discuss anti-fraud initiatives

and techniques and shares intelligence among its members to highlight potential

fraudulent activity.

Insurance Fraud Bureau (IFB) – establish to detect and prevent organised

insurance fraud and led by an operational steering group of insurance fraud risk

managers from various insurers and is funded by a levy on its members.


Aims of IFB :

• Analysing policy & claims records stored on industry data base for

suspicious activity

• Co-ordinating between insurers for investigation of potential fraud

• Working closely with police or other enforcement agencies.

Databases

Claims and Underwriting Exchange (CUE) – Central data base to prevent

multiple fraudulent claims and misrepresentation of claims history for motor,

home & personal injury and sickness incidents reported to insurance companies.

Details are held for 5 years.


Motor Insurance Anti-Fraud and Theft Register (MIAFTR) – Run by ABI and

enables motor insurers to share key information about motor claims.

MIAFTR assist insurers in identifying the most common form of fraud:

• Owner insuring their vehicle with several insurers and then claim total loss

from each

• Owners reporting a fictitious theft to the police and then storing the stolen

vehicle until insurer has paid out. Database automatically advise the insurer

when the police record that the vehicle has recovered.

Motor Insurance Database – Holds the insurance details of all vehicles

registered and insured in UK with the aim to combat uninsured drivers and

motor vehicle crime.

ch 4 underwriting policy and practice

Presentations & Public Speaking

moral hazardsmoral hazards

scenarios of moral hazards

loss risk classification

moral hazardsphysical

underwriting policy

hazards identification

risk improvementresponse

class of business