Professional Documents
Culture Documents
IC-45
The course covers the Principles and Practice of underwriting in all classes of
non- life insurance.
Although the course covers the syllabus prescribed for the examination, it is
desirable that candidates should read additional material such as text books,
office manuals and operating instructions and insurance magazines etc. This will
enrich their knowledge of the subject.
The candidates are also recommended to collect and study specimen forms used
in offices (e.g. Proposal, Policy, Claim forms and other forms relevant to the
subject). This will provide a practical basis for their studies.
The candidate may also avail of Oral Tuition Service wherever arranged by The
Associated Institutes and the Postal Tuition Service provided by the Institute.
These supplementary aids will help the student to improve their performance in
the examination.
The course should also prove useful to the general reader who desires to have
knowledge of the subject covered.
CONTENTS
CHAPTER 1
INTRODUCTION TO UNDERWRITING
Chapter Introduction
This chapter aims to provide you with an understanding of the concept of
underwriting. You will also learn about the process of underwriting and different
kinds of underwriting decisions.
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Based on the above definition, the main features of insurance can be summed up
as follows:
9 Risk transfer: Risk is transferred equitably among the group of individuals
who are exposed to similar kinds of risk, in exchange for a small contribution
called ‘premium’. The underlying principle is that, in a group, only few
individuals (and not all) would sustain losses due to the occurrence of an
uncertain event.
9 Pooling of Risk: Insurance is created when people pool their contributions
to create a large enough common fund so as to protect themselves from the
effects of a loss which may in turn randomly affect one or a few who have
contributed to the pool. Whether the loss they are attempting to protect
themselves from is loss of life, disability, assets, or whatever, the basic
concept remains the same.
9 Law of large numbers: If the risk of loss can be spread over a large enough
group (the law of large numbers), the financial loss resulting from the loss to
the members can be paid from the premium collected from the pool, if the
premium so collected reflects the risk affecting the group. This is in contrast
to one person bearing the full brunt of economic loss without any financial
backing. Thus, in insurance, a large and uncertain loss is reimbursed for a
small loss by way of premium.
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Features of underwriting
The main features of underwriting are as follows:
When viewed from the perspective of fairness, proper risk classification becomes
a central obligation of insurers to the policyholders who participate in their risk
pools. This is true regardless of whether the risk being insured is for life, assets
or earnings.
An individual who suffers from a serious illness (e.g., cancer, diabetes etc.) is at
a greater risk of premature death than an individual who does not have the
illness. Since all risks are not equal, it would be inequitable if all persons who are
to be insured are asked to contribute equal amounts.
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None of the insurance companies would wish to incur losses in excess of the
amount of premium that they are getting! Each underwriting decision involves
balancing the insurer’s desire to earn premium often in competitive conditions
with margins required to pay claims and expenses and also to ensure compliance
with regulatory requirements.
In some cases, the insurance company may refuse coverage to drivers with a
history of accidents.
The underwriter may offer discounts for vehicles fitted with anti-theft devices.
Rajiv Saxena had purchased motor insurance at the time of purchasing a car from
ABC insurance company. As per the terms and conditions of the insurance
policy, the insurance company would pay for the repairs if the car is damaged in
an accident.
Hence, by having an insurance policy, the financial losses that might arise due to
accidents are reduced or eliminated.
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The insurance company assumes the risk it takes on by charging premiums and
setting deductibles.
Hence, underwriters have the challenge to ensure that they correctly assess the
risk and accordingly charge the appropriate premium.
An insurer may lose business to competitors if the underwriter appraises risks too
conservatively, or it may have to pay excessive claims if the underwriting
decisions are too liberal.
Profile of underwriters
a) Underwriters have to
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With these systems, underwriters are better equipped to make sound decisions
and avoid excessive losses.
c) Role of internet
The internet also plays an increasingly important role in the work being done by
underwriters. Many insurers’ computer systems may now be linked to various
databases on the Internet that allow immediate access to information - such as
driving records in some countries, so that information necessary for determining
a potential client’s risk can be accessed instantly and utilised effectively. Such
access to real time information reduces the amount of time and paperwork
necessary for an underwriter to complete a risk assessment.
a) Insurers
b) Insured
Underwriting also helps the insured to appreciate the magnitude of risk that is
being proposed to be covered and the suggestions given to reduce the risk, which
if implemented, helps to improve insurability and reduce various hazards.
The underwriter’s opinion may determine how much the proposer has to pay for
insurance, the terms of coverage, exclusions, discounts, and deductions.
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d) Society
Efficient underwriting by insurers paves the way for organized and sustained
growth of risk taking in the country which significantly contributes to and
supports the growth of the economy and provides social cushions in case of
losses and catastrophes. It helps to improve the standards of safety and care and
achievement of the economic and social goals of a country.
Logically, therefore, insurers may not find it possible to accept every proposal.
An insurer has to ensure that the underwriting process needs to be carried out
meticulously.
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An insurer with a profit motive may want to charge very high rates for risks that
do not warrant such high rates. Such practices would result in loss to the
policyholders on their investments in the long term.
c) Regulation
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a) Selection of risks
In this step, the underwriter decides whether or not to accept a particular risk. It
involves
9 securing factual information from the Proposer via the proposal form,
9 evaluating that information, and
9 deciding on a course of action
Once the risk has been accepted, the underwriter then classifies and rates the
risks.
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Classification of risk
Insurers may have their own classification and rating system compliant with the
guidelines of the Regulator.
Rating
Rate making is the process of calculating a price to cover the future cost of
insurance claims and expenses, including a margin for profit.
To establish rates
9 Insurers look at past trends and changes in the current environment that may
affect potential losses in the future.
9 Insurers utilise the expertise and skills of actuaries, who use the data
collected by the insurer as per the actuary’s requirement and then use the
findings to validate the rates and suggest the right rating practices.
9 Underwriters also use experts such as engineers and surveyors to make site
inspection reports and evaluate the risks through their findings.
9 Upon a thorough examination of all the data, underwriters then decide the
final rates and terms under which a proposal can be accepted.
It should be remembered that ‘Rates’ are not the same as premiums. A rate is the
price of a given unit of insurance. Rates vary according to the likelihood and
potential size of loss.
In earthquake insurance, rates would be higher near a fault line and for a brick
house, which is more susceptible to damage, than for a concrete structure.
Objective of rating
The basic objective of rate makers is simply that the rates should be adequate and
reasonable, both from the point of view of the insurer and the insured.
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For insurer
Fire rates can be considered reasonable if they take into account all major factors
which affect the risk but ignore minor factors which would not result in more
than a small variation in the estimated rate.
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c) Policy forms
The underwriter must be familiar with different types of policies available as well
as be able to modify the form with additional necessary warranties, clauses, and
special conditions as may be needed to fit the underwriting requirements so that
the policy is issued correctly.
Reinsurance
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An insurance company may issue policies for many different types of insurance.
However, most underwriters perform their responsibilities as specialists. An
underwriter may underwrite only property policies, or only liability policies, or in
another case, only motor or retail insurance and so on.
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When evaluating risks, underwriters can take any of the following decisions:
a) Policy to be issued on a preferred basis,
b) Policy to be issued on a standard basis,
c) Policy to be issued on a substandard basis or
d) Proposal to be declined.
Preferred rate represents the lowest rates offered by an insurer for its coverage.
Rates offered on a preferred basis must adhere to the insurance regulations
applicable to them, just as rates offered on a substandard and standard basis must.
Insurance regulators do not want insurers to offer rates that are so low that the
insurer cannot meet its contractual obligations to pay covered claims.
Proposers who are issued policies with standard rates fall within the normal
boundaries of underwriting standards for that type of policy.
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The decision to issue a policy on a substandard basis occurs when a risk is not
deemed to be outside underwriting standards, but is considered to be of high risk
within those standards. The insurer generally has the following three basic
options when it offers a substandard policy to a Proposer.
9 Issue the policy with a higher premium than would be required for a
standard policy: The insurer may charge a higher premium to Proposers
who are considered to be of higher risk than those who would be considered
a standard risk as long as those higher rates fall within certain parameters.
The rate cannot be discriminatory. The insurer must charge the same rate to
every insured having similar characteristics.
9 Issue the policy with limited benefits: Insurers may respond to substandard
proposers by offering a policy with limited policy benefits or lower policy
limits. Again, the insurer may limit benefits as approved through the ‘file and
use’ guidelines of the Regulator.
9 Issue the policy with certain exclusions: Another option an insurer may
have is to offer a substandard Proposer a policy that excludes coverage for
certain property and insured or operations that are deemed too high a risk for
the insurer to cover. As with the other options discussed, such exclusions
must be allowable under the regulations.
An insurer may offer to provide liability coverage for all business operations
except for that portion that has potential pollution liability that is too high for
the insurer to cover.
d) Proposal to be declined
Insurers decline proposals for insurance when they find that the proposal
represents a risk that falls outside of their established underwriting standards.
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Proposals which are against public good and violate the laws of the country
would also be not insurable.
Depending upon the type of policy and its provisions, rates & terms of cover
may be varied at renewal; or in extreme cases, the insurer may make the decision
not to renew the policy.
Changes in rates or the decision not to renew are only made if allowed by policy
provisions and applicable regulations, if any, made by the Regulator.
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Summary
¾ Insurance is created when people pool their contributions to create a large
enough common fund so as to protect themselves from the effects of a loss
which may randomly affect one or a few who have contributed to the pool.
¾ As per IRDA, “Insurance other than ‘life insurance’ falls under the category
of general insurance”.
¾ Underwriting is the process of determining the level of risk presented by a
proposer and deciding whether to accept the risk and, if so, at what terms and
at what price.
¾ The main purpose and objective of underwriting is Risk Transfer. By
purchasing an insurance policy, the policyholder transfers his risk to the
insurance company against which he needs to pay a certain amount as
premium.
¾ Underwriting is a key differentiator enabling the insurer to stay competitive,
and at the same time be solvent and profitable.
¾ Underwriting is important to Brokers and Agents as it will match the needs
of consumers with the standards set by insurers.
¾ The three underwriting functions—risk selection, classification and rating,
and policy selection—are interdependent. That is, the underwriter determines
that a certain risk is acceptable upon which the underwriter proceeds to
classify and rate the risk and issues the relevant policy.
¾ The purpose of using classifications is to separate risks into homogeneous
groups to which rates can be assigned.
¾ ‘Rates’ are not the same as premiums. A rate is the price of a given unit of
insurance. Rates vary according to the likelihood and potential size of loss.
¾ Reinsurance ensures that no one insurer is overburdened while offering
covers to policyholders.
The underlying principle of risk transfer is that in a group, only a few individuals
(and not all) would sustain losses due to the occurrence of an uncertain event.
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Answer to TY 2
Answer to TY 3
Self-Examination Questions
Question 1
Question 2
A Risk pooling
B Risk sharing
C Underwriting
D Reinsurance
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Question 3
Question 4
A The RBI
B The IRDA
C The Government of India
D The Department of ministry and finance
Question 5
A Risk transfer
B Risk sharing
C Pooling of risk
D Law of large numbers
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The insurance company could become insolvent when large claims, whether by
frequency or severity, are filed.
Answer to SEQ 2
Answer to SEQ 3
Answer to SEQ 4
Answer to SEQ 5
According to the law of large numbers, if the risk of loss can be spread over a
large enough group, the financial loss resulting from the loss to the members can
be paid from the premium collected in the pool, if the premium so collected
reflected the risk affecting the group.
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CHAPTER 2
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The underwriter can then decide on whether to accept the risk or otherwise. If the
underwriter decides to accept the risk, then the next step would be to decide the
rates, terms and conditions. Here the skills of the underwriter play a vital role. It
is a quality that can be acquired through a continuous learning process, adequate
training, field exposure and deep insights.
The knowledge of causes of fire in fire insurance and the geography, climatic
conditions, port/road conditions, types of risks etc. encountered by goods in
transit or storage in marine insurance and so on.
Once the risk is accepted, the policy, which is a legal document, is to be drafted
without any ambiguity. It would be worthwhile to remember that any ambiguity
in an insurance policy will always be viewed against the insurer, since it is
drafted by him.
Broadly the underwriting of risks can be classified into the following broad
categories based on the subject matter that is being covered under the policy:
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d) Liability risks like motor third party liability, public liability, product
liability etc.
e) Risks of Householders, Shopkeepers etc. which are covered under Package
policies.
Considering the nature of risks, different methods are followed for underwriting
of new business and renewal business.
Broadly speaking, these instructions and guidelines may cover the following:
a) acceptance of simple risks irrespective of sum insured;
b) acceptance of certain specified risks up to specified sums insured;
c) acceptance of certain classes of business with prior approval of the
controlling office;
d) acceptance of risks subject to specific underwriting safeguards;
e) acceptance / rejection of sub-standard risks;
f) rejection of risks
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The insurer also may arrange for pre-acceptance survey of the risk depending on
the nature and value of the risk. Based on the information available in the
proposal and in the risk inspection report, additional questionnaire and other
documents which may be obtained, the insurer takes underwriting decisions.
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The limit of acceptance is basically the limit of sum insured up to which the
operating office can underwrite the risk without referring to the Controlling
Office. As a matter of precaution, the companies allow their operating offices to
underwrite the class rated products whereas the controlling office may prefer to
underwrite the individually rated and exposure rated products.
Proposals relating to certain risks that are found to be more claims prone owing
to physical hazard may have to be referred to the Controlling Office before
acceptance together with the following particulars:
a) Completed proposal form
b) Risk inspection report, additional questionnaires
c) Other premium income received from the same client and agent separately
for fire, marine and miscellaneous classes
d) Past loss experience
e) Reasons as to why the proposal is required to be accepted
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There are risks which may be regarded as extra-hazardous. Normally such risks
are to be declined. These risks are commonly referred to as Declined Risks.
Nevertheless, some of these risks are accepted subject to fixing of appropriate
rate of premium and imposing loss minimising restrictive conditions, clauses and
warranties in the policies.
a) Fire
9 Ammunition works
9 Camphor boiling works
9 Celluloid and celluloid articles factories
9 Explosive factories and premises
9 Fire wood / bamboos in the open
9 Fireworks factories and premises
9 Match factories and matches in transit
b) Marine
9 Bullion (gold), currency notes over specified limits
9 Bulk cargo on terms wider than I.C.C.(C)
9 Cement in bags on terms wider than I.C.C.(C)
9 Deck cargo on terms wider than I.C.C.(C)
9 Galvanised iron sheets on terms wider than I.C.C.(C)
9 Second-hand machinery against breakage
9 Oil in second hand drums against leakage and contamination
9 Perishable goods and sea foods etc.
9 Salt on terms wider than I.C.C.(C)
9 Sugar against 'all risks' terms
c) Miscellaneous
9 Burglary: Jewelers, dealers in precious stones, curios and antiques, gold
and silver smiths
9 Cash-in-transit: Proposals involving large carrying without adequate
escort arrangement
9 Fidelity guarantee: Employees remunerated on commission basis
9 Workmen’s compensation insurance: Fireworks / gun powder /
explosives manufacturers, collieries and mines of all descriptions,
quarries of all descriptions
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Certain risks are allowed to be accepted by the operating offices provided certain
loss minimising measures are taken.
9 Special perils (flood etc.) under fire insurance policy may be accepted
subject to inspection of the risk and satisfactory flood prevention measures.
9 Consequential loss (fire) policy may be granted only to clients, whose books
of accounts are regularly audited by a reputed firm of auditors.
9 In motor insurance, acceptance of 'Own Damage' risks is subject to the
specified year of manufacture of the vehicle being acceptable. This
specification varies from one class of vehicle to another. Older vehicles may
be accepted subject to inspection of the vehicle and imposition of excess.
9 Certain types of vehicles may be covered only for 'Act only' risks.
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The procedure dealing with acceptance of business and issue of documents such
as cover notes, policies etc. in all classes of insurance have certain common
features. These features may be considered under the following headings:
Provisional Acceptance
9 Declined risks: The proposals are examined in the light of the standards
adopted for the acceptance of risks by the insurer. Risks which are regarded
as extra hazardous are declined. Each company in their Corporate
Underwriting Policy spells out the list of declined risks.
9 Inspection report: At this stage, the question of inspecting the risk is often
considered. If the risk is large or involves complicated features, acceptance is
decided on the basis of an inspection report. Pre-acceptance inspection of
risks is common in fire, burglary, public liability and engineering insurances
etc.
9 Issue of cover note / policy: If the risk is acceptable, the premium is quoted
and, on receipt of the premium, cover notes/policies are issued.
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Issue of policies
9 Recording details: The policies are numbered in serial order and entered in
the premium register. The policy number is also entered in the cover note
register against the relevant cover note number, if a cover note has been
issued.
Annual cover: Most non-life insurance covers are granted on an annual basis.
The period of insurance (i.e. date of commencement of insurance and the date of
expiry) is clearly stated in the policy. The insurance contract, unless otherwise
stated, expires at midnight, of the date of expiry.
Renewal is not automatic: The preamble of a policy usually states that the
indemnity thereunder applies during the period of insurance named in the
schedule or any subsequent period in respect of which the insured shall have paid
and the insurer shall have accepted the premium required for renewal of this
policy. From this it is clear that renewal of the policy is not automatic. It depends
upon the consent of the insurers to renew the policy and the payment of
premium.
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Renewal methods
Renewal of policies can also be utilised to review underwriting results and take
corrective steps.
Many insurance products such as health for instance, are matters relating to the
life and dignity of human beings and hence renewals need to be handled with
great sensitivity. Courts can take an adverse view of practices that appear
detrimental to the protection of the consumer. Weighty reasons, such as those
based on grounds of fraud or misrepresentation and not merely on the basis of
random individualised claim experiences may need to be cited in case of a legal
dispute. Regulations have also come into force in some countries where refusal
of renewal is regulated.
Renewal is normally deemed to constitute a fresh contract and the duty of utmost
good faith is revived, although in many insurance cases a fresh proposal form is
not required to be completed by the insured. Renewal, of course, is effected
subject to payment of premium. A fresh policy is issued specifying the terms and
conditions of the further period insurance.
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A Frequency of losses
B Severity of losses
C Both frequency and severity of losses
D None of the above
Summary
¾ Before accepting the risk the underwriter is expected to visualise potential
risks, estimate the probability of peril operation and estimate the extent of
liability.
¾ The underwriting of risks can be classified into the following broad
categories: property risks, business interruption risk, personnel risks, liability
risks, package policies.
¾ The underwriter scrutinises the proposal and may arrange for pre-acceptance
survey of the risk depending on the nature and value of the risk.
¾ The limit of acceptance is basically the limit of sum insured (SI) up to which
the operating office can underwrite the risk without referring to the
Controlling Office.
¾ Generally speaking, approval of the Controlling Office is necessary before
acceptance of certain classes of business based on the size or complexity of
the business or both.
¾ Risks regarded as extra-hazardous are normally declined. These risks are
commonly referred to as Declined Risks.
¾ Certain risks are allowed to be accepted by the operating offices provided
certain loss minimising measures are taken.
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Self-Examination Questions
Question 1
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Question 2
Approval of the _________ is necessary before acceptance of certain classes of
business based on the size or complexity of the business or both.
A Branch manager
B Controlling office
C Regional office
D Corporate office
Question 3
Extra hazardous risks that are normally not accepted by the insurer are commonly
referred to as ________.
A Rejected risks
B Forbidden risks
C Declined risks
D Prohibited risks
Answer to SEQ 2
Answer to SEQ 3
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CHAPTER 3
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1.1 Underwriting
General insurance is a complex subject. To make it relevant to customers and to
make it profitable for their insurers, underwriters need to examine thoroughly all
the risk factors affecting the subject matter offered for insurance.
1.2 Ratemaking
The purpose of ratemaking is to set the prices of insurance products sold in such
a manner that it will provide sufficient income to pay for
9 the projected claims based on both experience and exposures,
9 all expenses that the insurer will incur in the selling and administration of the
product
In addition insurers would like to build a margin for adverse deviation and a
reasonable return on the capital employed.
There is also another requirement for ensuring proper ratemaking. The rates of
insurers are subject to regulatory review. The regulatory standards in India are set
in the “File and Use” guidelines and other regulatory directions given from time
to time by the insurance regulator i.e. IRDA.
The standard for the regulator is that the rate shall not be inadequate, excessive or
unfairly discriminatory as between risks of similar type and quality.
There are subsidiary objectives while developing a premium rating system apart
from the above mentioned. These are:
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Both objectives appear contradictory but are desirable and can be reconciled
if the price normally remains within predictable bands; and should not swing
too far owing to an unlikely extreme severe event.
Rating can be
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Though ratemaking for risks as per in-company manuals, involves the use of
mathematical and statistical data and tools, it also requires
9 understanding of risks and their behaviour
9 the use of sound judgement acquired through experience and knowledge,
9 the economic, technological, social, political and other factors which had an
impact in the past on the underwriting results and may also influence
possible losses in the future.
Rate makers necessarily need to appreciate that rates which have been adequate
in the past need not be so in the future.
Review of rates
Formulation of rates will need to be subjected to review both from within the
insurer and from outside.
9 Externally the review will be done by the regulator. In some cases the
government also may intervene to make the rates acceptable to the public.
All rates are based on various risk exposures that the subject matter of insurance
may be faced with. However the rate for use through a manual begins with the
basic exposure unit, e.g. a residential house.
Rating Factors
9 The relevant elements that are used to add up the rates make the rating plan
and the various specific elements in it are referred to as rating factors.
9 These rating factors can help to reflect the identified differences in loss
propensity.
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9 By ensuring that all the relevant rating factors are taken into consideration, it
can be ensured that the rates are not inadequate, excessive or unfairly
discriminatory as between risks of similar type and quality.
9 If there is failure to consider the adverse features of a risk, the rate will be too
low. If the competing insurance company’s factor in the negatives and the
insurer’s underwriter does not, then the insurer falls prey to adverse
selection.
While assessing the risk characteristics, the rating plan broadly looks at risks on
two sides of a matrix which has
9 on one side the frequency of losses and
9 on the other the severity of losses
For example, the frequency of losses to buildings may be noted where more
combustible materials are stored or where the building construction and
maintenance is of low standard. Similarly, in case of floods it is related to houses
in low lying areas. In respect of severity persons having high value contents tend
to have larger losses than those residences that have fewer contents and so on.
The regulatory standards in India are set in the ______ guidelines and other
regulatory directions given from time to time by the insurance regulator.
The basic method of forming rates generally follows one of the two basic
approaches:
a) pure premium method
b) loss ratio method
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In a small town loss experience of 1000 insured cars each valued at Rs. 5 lacs by
theft shows that over a period of say 10 years, on average 5 cars are stolen.
L
x 100
V
Where,
L is losses
V is value of all the cars
25,00,000
x 100 = 0.5%
50,00,00,0 00
The pure premium (i.e. the premium which is sufficient only to pay losses) is Rs
2500/- (0.5% of the value per car)
In arriving at the final rate of premium the pure premium is loaded to provide for
the following
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Mathematical Equation
P+F
R=
1−V −Q
Where,
R= Rate per unit of exposure
P = Pure premium
F = Fixed expense per exposure
V = Variable expense factor
Q = Profit and contingencies factor
The loss ratio method is used to indicate rate changes rather than rates per se. The
formula for this is
R = A X Ro
Where,
R = Indicated rate
Ro = Current rate
A = Adjustment factor which is equal to W/T
Where W = Experience loss ratio
T = Target loss ratio
1−V −Q
T=
1+G
Where,
G = Ratio for non-premium related expenses to losses
Q = Profit and contingencies factor
V = Premium related expense factor
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L
W=
ERo
Where,
L = Experience losses
E = Experience period earned exposure
Ro = Current rate
If the data is based on consistent assumptions, the results produced by both
methods should normally be comparable. There are, however, differences
between the two methods:
It is important that the data and assumptions used are based on logical and
consistent factors. Thus:
a) Selection of the experience period: The most recent loss experience period
must be used. The loss experience period must contain sufficient loss
experience so that the results have the necessary statistical significance or
credibility. Finally where the business is subject to catastrophic losses, the
experience period must be representative of the average catastrophic
incidence.
b) Difference in coverage should be treated separately e.g. in motor vehicle
insurance – private car, three wheelers, taxis, goods vehicles, passenger
vehicles etc.
c) Wherever there are basic limits, the premium needs to be adjusted for the
increased limits, if any, based on the change factors.
d) Where the experience period extends over several years the rate may change
often. However the earned premium underlying the loss ratio calculations
must be on a current level rate basis. Thus past premium must be brought
to the current rating level. This may be done by using good rating software.
e) In general the internal guideline rates should be based on direct premium
that is before reflection of reinsurance commission and loss data.
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The loss development method is based on the assumption that claims move from
the unreported to the reported and from unpaid to paid in a pattern which is
sufficiently uniform so that past experience can be used to predict future
development. Losses are arranged by accident year and accident year age. The
resulting data form a triangle of known values.
In the triangle
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Link ratio
The next step is to make the development history arithmetically. The resulting
ratio is known as age to age development factor or link ratio. The age to age
factors are then multiplied to generate age to ultimate factors which can then be
applied to the latest diagonal to yield projected ultimate values.
Trend in severity
Frequency factors can change due to court interpretations and can also reduce
owing to legislation such as the mandatory use of seat belts in motor vehicles.
Where sufficient internal claims experience is not available, external data can be
used. Various sources of statistical data are available from the industry as well as
from outside.
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Where individual risks are large enough so that their experience is to some extent
‘credible’, individual rating of such risks can be considered.
a) Prospective Systems
b) Retrospective Systems
Retrospective systems use the actual experience of the period to determine the
final cost of that period. Retrospective systems are more responsive to experience
changes than prospective systems. It is less stable as the experience can be more
volatile, but it can motivate the insured to implement additional risk control
programs.
All individual rating systems consider both experience and change in exposure, if
any, when the rating is done. Experience is relevant only when the credibility
factor exits, and where necessary experience is lacking, exposure indicators need
to be used.
All large individual risk rating is a form of experience rating as they need to
reflect the entity’s actual experience or the features that may affect the
experience. Experience rating is ideal when, with appropriate adjustments, the
past experience is predictive of the future.
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Social inflation means changes in the attitude of society whereby such items as
change in litigation mentality, the change in judicial activism and trend of awards
and legislation by the various Government arms directly or indirectly affect the
frequency and cost of claims.
The experience component must be related to the exposures affecting the entity
rated.
The length of the experience would ideally be 5 years. To reduce the effect of
unusual ranges due to catastrophic losses, experience rating plans limit per
occurrence limits on such losses.
Composite rating is a tool to rate large complex risks and where detailed
inspection and audit is carried out. Instead of rating different coverages using
different exposure bases, all applicable coverages are rated using one, composite
exposure base. The composite rate is based on historical exposures. Estimated
exposures are used if exact exposures are not available. The composite rate is
used to determine the deposit premium based on the estimated composite
exposure base and the final premium is based on the inspected/audited composite
exposure base.
Conclusion
Regulators have important concerns relating to rate making which may include
the following:
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e) As to rating criteria due credit must be given for past and prospective loss
and expense experience, to catastrophe hazards and contingencies, to events
and trends, to loadings for leveling rates over a period of time etc.
g) The expense provision included in the rates must reflect the operating
methods of the insurer and its actual or anticipated expense experience.
h) The rates may contain provisions for contingencies and reasonable profit.
In a city loss experience of 1000 bikes each valued at Rs. 75,000 by theft shows
that over a period of say 10 years, on average 2 bikes are stolen.
A Rs 15
B Rs 150
C Rs 1500
D Rs 500
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Summary
¾ Underwriting is the process of classifying the subject matter according to
their degree of insurability, based on the evaluation of risks to which they are
exposed, to decide on their acceptance and to charge appropriate rates of
premium.
¾ Objectives of a premium rating system include stability of rates,
responsiveness of rates to changes in loss exposures, should provide for
contingencies, should offer necessary incentive to the insured etc.
¾ Rating can be generic or individual
¾ Formulation of rates will not end with the rate makers themselves but need to
be subjected to review both from within the insurer and from outside.
¾ While assessing the risk characteristics, the rating plan broadly looks at risks
on two sides of a matrix which has
9 on one side the frequency of losses and
9 on the other the severity of losses
¾ The basic internal tariff or manual method of forming rates generally follows
one of the two basic approaches: pure premium method or loss ratio method.
¾ Pure premium is loaded to provide for the following: procurement costs,
expenses of management, margin for unexpected heavy losses and margin for
reasonable profit for insurers.
¾ The loss ratio method is used to indicate rate changes rather than rates per se.
¾ An important trend affecting ratemaking data is the trend in severity.
¾ There are two risk elements in ratemaking known as: parameter risk and
process risk.
¾ There are two types of individual risk rating systems: Prospective and
Retrospective.
¾ Composite rating is a tool to rate large complex risks and where detailed
inspection and audit is carried out.
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The regulatory standards in India are set in the File and Use guidelines and other
regulatory directions given from time to time by the insurance regulator.
Answer to TY 2
1,50,000
X 100
7,50,00,00 0
0.2%
Self-Examination Questions
Question 1
While assessing the risk characteristics, the rating plan broadly looks at risks
based on ___________
A Frequency of losses
B Severity of losses
C Both of the above
D None of the above
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Question 2
In a small town loss experience of 1000 cars each valued at Rs. 5 lacs by theft
shows that over a period of say 10 years, on average 5 cars are stolen. Calculate
the pure premium per car.
A Rs 250
B Rs 2500
C Rs 500
D Rs 5000
Question 3
The _________ is used to indicate rate changes rather than rates per se.
Question 4
A Prospective systems
B Retrospective systems
C Both the above
D Neither of the above
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Answer to SEQ 1
While assessing the risk characteristics, the rating plan broadly looks at risks
based on frequency of losses and severity of losses.
Answer to SEQ 2
Answer to SEQ 3
The loss ratio method is used to indicate rate changes rather than rates per se.
Answer to SEQ 4
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CHAPTER 4
Chapter Introduction
This chapter aims to provide you with an understanding of the rating approaches
in pricing of insurance products. You will learn about the different premium
methods that are used by insurance companies.
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1.1 Introduction
The insurance sector is different from other commercial sectors as it does not
offer any tangible physical product.
9 Insurance companies merely make a contractual promise with the customer
for future payment if a certain event occurs and is covered under the policy
term.
9 In terms of pricing a product, the industrial sector bases it’s pricing on
production and manufacturing costs, whereas in the insurance industry, the
price for insurance products results from the estimate of future obligations.
9 The insurance industry estimates any future payments it may have to make
based on actuarial methods.
Insurance pricing or rate making refers to the process of determining the rate that
can be charged by an insurance company for providing insurance cover to
policyholders.
Rate
Rate can be defined as the price per unit of insurance against each exposure unit.
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Hence, there is a need to devise ways and methods for arriving at the most
appropriate premium rate corresponding to the expected losses.
If the insurer fails to achieve the targeted number or volume of business and if
the actual claim costs, especially for catastrophic losses, are more than
statistically projected, the price (premium) received may not be sufficient to pay
all claims and expenses during the policy period.
The rating pattern for general insurance products can vary across products or
portfolios for insurance companies due to:
9 The peculiarities of the individual products themselves,
9 The availability of historical data concerning premium and claims statistics,
9 The nature and characteristics of exposure units that produced these statistics.
1.4 General insurance products as per ‘file and use’ IRDA guidelines
There are different premium methods that have been devised and used in general
insurance. The methods for determining the rate can be quite different for
liability insurance as against property and other insurance due to the peculiarities
of these businesses.
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Liability insurance: In Motor third party insurance in India, the claim settlement
duration can extend anywhere from 3-10 years. These claims are further exposed
to court award inflation.
Property and other insurance: In insurance like property, Motor Own damage,
Marine Cargo, Personal lines of insurance etc., the loss settlement periods will be
shorter, and at the worst, may not be expected to exceed 12 months.
Hence the benchmark rating principle for arriving at the premium rate cannot be
the same for liability insurance as for normal property insurance.
The file and use guidelines of IRDA classify all general insurance products into
two major categories based on the rating plan that is used in rate making for these
products. These are:
9 Class rated products- include all such insurance products of the insurer, for
which premium is determined via grouping, classifying and loss making
factors that can be easily identified and quantified.
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These two major categories of products are further sub-divided under file and use
guidelines as follows:
All such general insurance products that can be sold by an insurance company
with rates, terms and conditions as per the internal tariff guide of the insurance
company.
These include products where rates, terms and conditions, are determined
depending on the actual past experience of the insurance company relating to
claims.
These include general insurance products where rates, terms and conditions are
determined after evaluating the exposure to loss relating to certain risk,
independent of the actual claim experience with that risk in the past.
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These include general insurance products that are specifically designed for
individual large clients. The rates, terms and conditions for these policies are
driven by prevalent international market standards. As prescribed by IRDA large
risk includes:
9 Insurance worth a total sum insured of Rs 2500 crore or more at one location
for property insurance, material damage and business interruption combined
9 Rs 100 crore or more per event for liability insurance
The premium rating methods used by insurers can be classified on the basis of
the approach used for products classified under file and use guidelines of IRDA.
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In class rating method, risks with similar characteristics are placed in the same
class and charged the same rate, in line with a pre-defined tariff.
All industries manufacturing textiles are grouped together and will be charged
the same rate, in line with a pre-defined tariff.
9 Factors that might cause losses can be easily identified and quantified
9 Statistics on these factors is available and is accurate
The accuracy on the estimate of future losses depends upon the accuracy of the
statistics available. If the past data is not reliable, then an estimate on the future
losses would also not be realistic.
Class rating method can be effectively applied for determining the premium for
general insurance products that are sold to individuals, as:
9 Statistical data is easily available for such products.
9 Also, the customer base for such products is large; hence, owing to large
numbers, statistical data will also be more reliable.
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In India, Motor and fire tariff are the best examples of class rating method where
all the risks are classified into particular categories or classes and rated
accordingly.
9 Motor tariff: All Honda City vehicles in Mumbai will be assigned a single
rate
9 Fire tariff: All cement manufacturing units will be rated as a single unit.
The methodology of the class rating method is easy to apply but can be quite
difficult to calculate. Following 2 methods can be used to calculate the premium
under the class rating method:
All the factors that might affect the insurance product are selected and their loss
making effect is studied.
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Collect data for all rating factors over a suitable time period. The time period
should be long enough to ensure that there is adequate data for credible analysis
but it should not be so long that past data is no longer relevant to the future.
The pure risk premium is the product of claim frequency and claim severity per
unit of exposure. Hence, pure premium can be calculated as follows:
Pure risk premium is then loaded for expenses, inflation, commission, etc. to
arrive at the gross premium that is charged to the customer.
As against pure risk premium method, in loss ratio method, premium is adjusted
on the basis of actual loss experience of the insurance company. Hence, loss
ratio can be calculated as follows:
Loss Ratio = (Losses + Loss adjustment expenses) over the premium charged
However, it can be seen in real time situations that risks within the same
classification have widely varying loss experiences. Within a class, there may be
sub-classes or favourable or adverse features based on the risk differences.
Hence, the class rating approach for all categories of risk may not be appropriate
to fully describe the characteristics of risks in terms of premium rate. Hence to
overcome shortcomings of the class rating method, insurers popularly use the
Individual rating method.
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In which of the following methods is the premium adjusted on the basis of actual
loss experience of the insurance company?
Individual rating is also based on the class rating method, but the difference is
that the premiums are adjusted according to the actual losses of the individual
customers.
For an insurer, the primary goal of individual risk rating is to price the coverage
provided more accurately than if the rates were based only on manual or class
rates.
a) Individual risk rating supplements class rates by modifying the group rates in
whole or in part to reflect an individual entity’s experience.
b) An individual risk rating system should appropriately balance risk sharing
and risk bearing
9 The costs for small entities whose experience is not credible should be
determined solely based on risk sharing.
9 Very large entities whose experience is credible might have their
premium costs solely based on risk bearing.
9 Entities in between these extremes should base their costs on a weighting
of risk sharing and risk bearing.
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c) Individual or merit rating approach was devised to identify and recognize the
individual risk differences in the determination of premium rates.
d) In individual rating, the discovery of the appropriate rate depends on the
claim experience of the specific business applicant. In other words, it
measures the extent to which a particular risk deviates from the average of its
class.
e) Individual rating approach tries to identify the characteristics peculiar to the
risk and modifies the average rate for that particular class based on identified
characteristics like past claims experience.
3.3 Methods of determining individual or merit rating
Individual or merit rating can be determined using the following 3 methods
9 Schedule rating method
9 Experience rating method
9 Exposure rating method
3.4 Schedule rating method
In schedule rating method, the class rate is increased or decreased in the form of
percentage debits and credits, depending on exposure to loss making factors for a
certain individual. These credits and debits are sometimes applied before and
sometimes after experience rating. There may be a limit to the total debit or
credit that an entity can receive. The premium rate that is communicated to the
policyholder is derived only after adding these debits and credits to the premium
for the class.
Schedule rating method can be applied in case of property insurance where each
exposure is individually rated or class rate is modified in view of desirable or
undesirable physical features such as:
9 Location of the property
9 Size
9 Present condition of the property
9 Construction
9 Occupancy
9 Operating Methods
9 Protection or safety measures
9 Other exposures
9 Housekeeping & Maintenance
9 Loss Prevention or control Measures
9 Management outlook and attitude towards Loss prevention / control
measures
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a) Schedule rating method is the only individual risk rating system that does not
directly reflect an entity’s claim experience.
b) In theory, schedule rating method recognizes characteristics that are expected
to have a material effect on an entity’s experience which may not have
actually reflected in that experience. These characteristics could result from:
9 recent changes in exposure such as the addition of a swimming pool in an
apartment complex or
9 risk control programmes such as the recent implementation of a new
programme
c) Schedule rating is also used for entities that are too small to qualify for
experience rating.
d) Schedule rating systems usually take the form of percentage credits and
debits.
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In this method:
9 If the insured’s loss experience is better than average for the particular class
of clients, the class rate is further reduced.
9 If the loss experience is worse than the class average, the rate is increased.
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Experience rating takes both claim size and claim frequency into account for
arriving at the appropriate rate. In determining the quantum of the rate change,
the actual loss experience may be modified for considering exposure changes not
reflected by earlier experience.
Following factors are taken into account for arriving at the premium rate:
a) rate for a particular insured is first calculated using class rates
b) the class rate is then adjusted up or down based on either:
9 past loss experience of that particular insured; or
9 new exposure characteristics (e.g., loss control measures adopted) of that
insured
It is recognised that individual risks within a classification are not alike and that
there exist inherent differences such as variations in:
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These differences are of such nature that it is difficult to label them definitely and
they cannot be associated with conditions measurable in advance. It is known,
however, that variations in experience do exist in a way that definitely precludes
ascribing all of them to chance.
Experience rating method is considered by many as the most practical method yet
devised, or even suggested, for giving recognition to variations produced by such
factors.
The following example may be used for understanding the basic mechanics of
working out an experience rating plan:
In a group health insurance policy, the premium rating at the time of renewal is
modified in the sense that it is either loaded or discounted based on the claims
experience of the expiring year.
Here, a tolerance limit is set, up to which the premium will remain unchanged.
9 Beyond the limit, the premium is loaded by stipulated percentages, so that
the overall premium-claims ratio is kept at an acceptable level.
9 Similarly, if the claims experience is favourable then a stipulated percentage
of discounts are given.
9 Similarly, while quoting the premium under miscellaneous classes of
business, it is common to modify the base premium depending on the claims
experience over a period of time say, 3 or 5 years.
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This type of premium rating approach is used in Group Mediclaim and Group
Personal accident policies.
In a different approach under this rating plan, in the US and some Western
countries, a provisional premium is paid at the beginning of the policy period and
at the end of the period, a final premium is computed based on the actual loss
experience during the period.
Many factors enter into the risk's experience in different combinations and affect
the quality in different degrees. These cannot be classified and recognized so that
they may be given individual consideration in rating. They may, however, be
reflected to some extent by making use of the effect produced by them as shown
in the experience.
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The adjusted risk rate or experience rate may be looked upon as a weighted
average of the rate indicated as necessary by losses of the risk and the manual
rate, that is, the rate indicated by the classification experience. A comparison
may be made of different plans on the basis of indicated losses, pure premiums,
or premiums.
9 "Modify" the actual experience of the risk to bring it to the level of current
industrial conditions as reflected in the current manual rate level.
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9 In determining the adjusted losses, the hazard is divided into "normal losses"
hazard and "excess losses" hazard.
Large losses occur less frequently than normal losses and cost much more
individually. The volume of large losses in a given risk's experience is less
indicative of the real degree of hazard, which is inherent in the risk than the
volume of normal losses.
Some problems in Experience rating method are related to the availability of data
required to perform experience rating, and some problems are related to the
methodology. The disadvantages can be summed up as follows:
a) A biased loss trend: Often insurers tend to record individual loss details for
large losses only, i.e. incurred losses that are greater than a certain value
below the attachment point. This portrays a lesser loss trend leading to a
biased loss trend and ultimately a low premium rate obtained from this
projection.
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Exposure rating method considers the insured risks, i.e. the portfolio
composition, and the premium distribution commensurate to the risk.
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9 Sometimes, the exposure rating is derived from rates for similar risks in other
markets or are based on hazard evaluation done for other reasons such as for
risk management.
All specialty and liability products and property damage covers beyond certain
sums-insured use this rating approach to arrive at the premium rate.
Objective of the exposure rating method is to estimate proportion of the loss for
the underlying policy that is expected in the entire portfolio.
The primary reason for going for this type of rating approach is the general lack
of credible risk data of exposures, premiums and claims with the insurer or in the
entire market. To circumvent this limitation on a logical and systematic basis, the
rating approach tries to correlate and extrapolate the data of similar risks for
arriving at the rate.
Exposure rating and experience rating may be applied while rating renewals by
adding weights to each using credibility rating.
9 The insurer identifies the most important identifiable risk factors which can
produce a loss, and the premium rating is done by giving different
weightages to each of the identified risk factor.
9 Then a basic rate is arrived at by taking the premium rate for similar risks in
other developed markets, and each of the identified factors is superimposed
on this basic rate by giving a discount or applying loading based on the
nature of the risk factor being rated.
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This means that the claims experience we are missing can be derived from a
reference portfolio whose claims experience is sufficiently well supported
statistically. However, care should be taken to ensure that while comparing
portfolios, the portfolio which is similar and the nearest possible to the portfolio
under study should be selected.
Exposure curve
Insurers use this method to arrive at the appropriate premium using these curves.
These curves determine the premium that the insurer ought to charge, to cover
expected losses.
The exposure curves are built using factors like loss degree vs. deductible of
sum-insured or total premium under the portfolio vs. expected losses.
Case Introduction
A general insurer wishes to launch a health insurance policy targeted towards the
general population between the age groups of 3 and 60 years. However, as a new
company, it does not have any statistical data or supportive evidence towards the
likely losses for arriving at the premium to be charged.
In such a scenario:
9 The insurer’s consultant has come out with a World Health Organisation
report of India on the incidence of Stroke (cerebral vascular accident).
9 Similarly, the consultant has come out with incidence rates of Cancer,
Blindness, and Liver & Kidney transplants.
9 The consultant further adds that these are the diseases which result in
maximum hospitalization expenses on account of a single disease to
individuals in general in the Indian scenario.
The insurer, using this data, has prepared premium rating for the proposed health
cover in the following manner which is a good example of Exposure rating.
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The following are the important facts that are used in the rating process:
9 As per the WHO report, in India 73 persons per 1,00,000 populations per
year suffer from Stroke (cerebral vascular accident).
However, it has come to the notice of the insurer through the consultant that
as per an independent study conducted in India, the occurrence is between
100 and 268.
The insurer has taken a figure of 200 as justified taking the least and the
highest between the two studies and rounding off to the nearest hundred
conservatively.
9 According to another study, the rate of cancer incidence for all types and of
all organs in India is 631 per million i.e. 10,00,000 people. This gives a
figure of 60 cases per 1,00,000 persons approximately.
9 In case of blindness, the studies reveal that 20 members per 1,00,000 suffer
blindness either from accidents or disease.
9 There is no reliable data for age wise occurrence; a general impression from
one of the leading consultant doctors is that these diseases are rare at young
ages and the incidence goes up as age advances.
Hence, for arriving at the appropriate level of premium to suffice the likely
claims and in order to avoid adverse selection, the premium based on the above
factors is taken by the insurer as applicable to the youngest age bracket and the
same premium is gradually loaded for increase of age in bands. He chooses a
limit of Rs 1,00,000/- as the minimum sum-insured and feels that the premium so
arrived at can be applied to the higher levels of sum-insured without any
modification in a proportionate manner.
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Premium Workout
The insurer works out the premium per Rs.100000/- and taking it as the
premium for the entry level i.e. 3-35 years age, as below:
To this the insurer has to provide expenses towards his Marketing cost,
margin for profit, Administrative costs and overheads and he estimates them
as:
Marketing @25%
Margin for profit @ 10%
Administration & overheads @20%
This illustration shows how the exposure rating is arrived at based on the facts
related to the loss experience of general population, applying it to the likely
incidence of claims and the cost of premium thereof. However, there are several
methodologies and techniques in exposure rating for calculation of premium rates
but the example helps to understand as to how this operates.
3.12 Conclusion
Overall, whatever may be the method of arriving at the appropriate premium rate,
the main aim and objective in the whole process is to ensure that all losses are
paid out from the premium collected, leaving at least a minimum amount towards
profit margin.
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In order to achieve this and to choose the appropriate method of rating for the
risk(s) covered it is imperative to involve the Appointed Actuary right from
beginning of the exercise of deciding rates, terms and conditions.
Which of the following individual risk rating systems does not directly reflect an
entity’s claim experience?
Summary
¾ Insurance pricing or rate making refers to the process of determining rate that
can be charged by an insurance company for providing insurance cover to
policyholders.
¾ Insurance companies need to ensure that the rates that are charged by them
are able to cover all losses and expenses and help them earn some profit.
¾ In insurance business, rate adequacy measurement is quite complicated
because the insurer cannot foresee the actual costs at the time of selling the
policy.
¾ If the insurer fails to achieve the targeted number or volume of business and
if the actual claim costs, especially catastrophic losses, are more than the
statistically projected, the premium received may not be sufficient to pay all
claims and expenses during the policy period.
¾ The file and use guidelines of IRDA classify all general insurance products
into two major categories based on the rating plan that is used in rate making.
These are:
9 Class rated products: includes all such insurance products of the
insurer, for which premium is determined via grouping, classifying and
rating loss making factors that can be easily identified and quantified.
9 Individual rated products: includes all such insurance products, where
premium is determined based on an individual’s exposure to loss.
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Answer to TY 2
In loss ratio method, premium is adjusted on the basis of actual loss experience
of the insurance company.
Answer to TY 3
In Schedule rating method, the individual risk rating system does not directly
reflect an entity’s claim experience.
Self-Examination Questions
Question 1
_____________ includes non-life products that are specially designed to suit the
specific needs of clients.
Question 2
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Question 3
Which type of premium rating approach is used in Group Mediclaim and Group
Personal Accident Policies?
Question 4
Answer to SEQ 1
Customised products include on-life products that are specially designed to suit
the specific needs of clients.
Answer to SEQ 2
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Answer to SEQ 3
Answer to SEQ 4
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CHAPTER 5
Chapter Introduction
This chapter aims to provide you with an introduction to the File and Use
Regulations of IRDA, in relation to global insurance regulations.
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Which of the following are the goals of market conduct supervision for insurance
business?
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Filing of rates and policy forms for the regulator’s review ensures protection of
both the consumer and the insurer.
While it is essential to ascertain that the policy wordings are sufficiently sound to
protect the insurer from excessive liabilities that may lead to solvency failure,
there should be equity and fairness towards the interests of the policyholders.
Similarly, the pricing should not be very high or very low, but be commensurate
with the risks, leaving a reasonable profit margin for the insurer.
Some of the international practices that are being adopted in this regard are
briefly stated below:
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2. Prior approval: Under prior approval systems, policy forms and rates must
be filed and approval obtained by the state insurance department before they
can be used in the market. The regulators assess the reasonableness of the
documents filed against the standard benchmarks. In case there are any
policy provisions which do not comply with the regulatory requirements, or
other regulations in force, or the product does not appear to be creating the
desired value to meet the specific needs of each entity in the value chain, the
regulator returns the documents and advises the insurers to modify it.
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It is essential for insurers to receive approval for their rates and forms before
they go into effect.
3. File & Use (F&U): Under the F&U system, the insurers are required to file
their rates with the regulator before they go into effect; prior approval is not
required. However, the regulator has the authority to comment on the rates
before they are used, or can disapprove the rates.
“Deemed Approval” : both under Prior Approval system and File &Use system,
a prescribed period of time is stipulated for the regulator to take a decision either
for approval or disapproval which may vary from regulator to regulator
(normally it would be in the range of 30-90 days). The product would be deemed
to be approved if the regulator does not respond to the insurer within the set time
limit.
4. Use and File: In the Use & File system, there is no need to file rates in
advance and the system allows the companies to use the rates before they are
filed. But, the rates must be filed within a specific period after they have
been put to use. However, this system also allows the regulator to
subsequently disapprove the rates/ policy forms in case they fail to comply
with the statutory/standard requirements.
The same logic exists between Use & File, Flex Rating or No-file requirement,
where insurers are not required to obtain prior approval for rates before
implementing them. However, they are subjected to stringent Financial
Regulation, which monitors insurers’ financial condition or solvency.
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Filing of rates and policy forms for the regulator’s review ensures the protection
of ___________.
1. Definition of product
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2. Product design
3. Pricing
Pricing is the process by which the insurers determine the premium to be charged
from the insured for accepting a particular risk under the insurance contract.
4. Rate
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1. Prudent underwriting
The product design and rating must always be on sound and prudent underwriting
basis.
Prudent underwriting means that the insurer should only offer insurance of risks
that are quantifiable and manageable and where the premium can be properly
assessed.
The cover should be clearly defined and should be of value to the person insured.
2. Simplified language
All literature relating to the product should be in simple language and easily
understandable by the public at large. As far as possible, a similar sequence of
presentation may be followed. All technical terms should be stated in simple
language for the benefit of the insured.
There should be no effort to mislead the policyholder to assume that the product
is offering protection that it really does not, or that it offers such protection
subject to limitations and conditions that are not easily apparent. The limitations
and conditions should be easily capable of compliance.
3. Consistency of terminology
As far as possible, similar wordings for describing the same cover or the same
requirement should be used by insurers across all the products.
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The policy should provide simple dispute resolution procedures and also state in
simple language the process of arbitration of disputes.
The insurance product should comply with all the requirements of the IRDA
Protection of Policyholders’ Interests Regulations 2002. (See also Chapter 10).
Policies which are normally expected to be renewed e.g. Health Insurance &
Motor Insurance should not be cancelled or refused to be renewed unless there
are valid reasons such as fraud.
In case of adverse claim experience, the insurance company can renew the policy
with higher premium or higher deductible within the range filed and approved by
IRDA. However, when a renewal is refused, there is always a duty to inform the
insured in writing of the reasons for refusal well in advance of the expiry to
enable the insured to find an alternative.
6. Justification of price
The rates filed by every insurer will be reviewed by IRDA based on supporting
evidence. The pricing of products should be based on appropriate data and with
technical justification.
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9 If the rates proposed are based on reinsurance market level of rates: the
insurer should be able to demonstrate that the rates of the reinsurance
markets have been properly ascertained and represent rates quoted by
reinsurers of repute.
9 In case the rates are based on non-insurance technical data: the insurer
should be able to defend the logic underlying the establishment of the
estimated claims costs from which the rates are derived.
7. Reasonableness
The terms and conditions of cover shall be fair between the insurer and the
insured. The conditions and warranties should be reasonable and capable of
compliance. The exclusions should not limit cover to an extent that the value of
insurance is lost. The time allowed for reporting of claims should be reasonable.
The policyholder should not be required to do things that are onerous after a
claim to maintain his eligibility for protection nor should the policyholder be
prevented from resuming his business expeditiously by the claims process.
Margins built into rates shall be consistent with the experience of the insurer in
respect of commission, management expenses, contingencies and profit.
Insurers will not be arbitrarily allowed to design products at very low margins
merely to beat competition. The margin for commission built into the rates
should be at a level at which commission or brokerage will be paid. The
commission margin should not be unreasonably low because it will distort the
sales process and there will be an incentive to hide payments to agents and
brokers under different heads.
Expenses of management will generally reflect the overall expense ratio of the
insurer in the recent past. However, it is possible to design products at a different
margin for expenses where the insurer can demonstrate that the expenses of
management for that particular product will be different either because of the
characteristics of the potential market or the sales mechanism or administration
of that type of insurance.
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Necessary steps should be taken by insurers to ensure that competition will not
lead to unprincipled rate cutting and other improper underwriting practices.
Although this is a statement of the obvious, the fact that an insurer has to provide
such a confirmation should act as an indirect deterrent to improper practices.
If the rates are based on the generally prevailing market level of premium rates:
(i) The insurer should be able to demonstrate the reasonableness of the variation
from the currently prevailing level of rates
(ii) The insurer should be able to defend the logic underlying the establishment
of the estimated claims costs from which the rates are derived
A Only (i)
B Only (ii)
C Both (i) and (ii)
D Neither (i) nor (ii)
According to File & Use guidelines of IRDA, all products are classified into two
broad classifications, namely class rated products and individual rated
products.
There is a possibility of one product falling under two categories – class rated or
individual experience rated /exposure rated etc.
In such a case, the insurers can explore the possibility of filing sum insured bands
as basis of rating between an individually rated product and a class rated product.
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All rule based underwriting products fall into this category. These are standard
products that can be sold by any offices of the insurer with the rates, terms and
conditions of cover, including choice of deductible where applicable, as set out in
an internal guide tariff designed by the insurance company.
These are products specially designed for an individual client or class of clients,
in terms of scope of cover, basis of insurance, deductibles, rates, terms and
conditions of cover. Sometimes, these products are also described as ‘Special
Contingency Policies’.
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These will include Cargo insurance, group insurance for PA or Health, Motor
fleets, Hull insurance and so on.
These are products where the rates, terms and conditions of cover are determined
by an evaluation of the exposure to loss in respect of the risk concerned,
independent of the actual claims experience of that risk.
Some examples are insurance for earthquake risk, Public Liability insurance for
high hazard occupancies and so on.
These are typically insurance that is designed for individual, large clients and
where the rates, terms and conditions of cover may be determined by reference to
the international markets.
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1. Insurance for a total sum insured of Rs. 2,500 crores or more at one location
for property insurance, material damage and business interruption combined;
It is expected that in respect of such products, the insurer will quote terms in line
with the terms quoted by reinsurers including the extent of cover and deductibles
or claims conditions. If the insurer varies the terms quoted by the reinsurers while
quoting the terms to the proposer, such variation of terms and any increased
retention that results from it shall be consistent with the underwriting policy and
reinsurance policy approved by the Board for underwriting of business and also
for retention and reinsurance. The insurer shall charge an additional premium
over the rates secured from the international market that is commensurate with
the additional risk carried by it. Such additional premium charged should have
the concurrence of the officer designated by the Board for this purpose.
6.2 Conclusion
The underwriter has to ensure that all aspects of the regulations are implemented
in letter and spirit. This is important as the Indian market is gradually getting
adjusted to competition and the freeing of rates and terms. Once the market
learns to work with competition in prices, variation in the terms and conditions
can follow and thereafter, competition would be in terms of servicing parameters.
This will nevertheless mean that any widening in scope of cover should be
adequately priced. Violations of the regulatory guidelines can lead to market
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failure and harm public interest. Regulatory intervention is thus felt needed in all
markets to avoid market failures, to correct deviations in time and if not, to
minimise the negative effects and improve efficiency of the market.
Within the Class rated Products, which of the following will be considered a
package policy?
Summary
¾ Regulation of the insurance industry is necessary to maintain insurer’s
solvency, to protect consumers who have inadequate knowledge of insurers
and insurance practices, to ensure reasonable rates, and to make insurance
available.
¾ The various types of rating laws include: prior-approval laws, modified prior
approval laws, file-and-use laws, use-and-file laws, flex-rating laws, state-
made rates, and no filing required.
Framework Description
State Mandated Rates determined by the insurance regulator. Insurers
Rates must use the rate or may file a deviation to charge a
rate below the published rate.
Prior Approval Rates must be filed with and approved by the
insurance regulator before they can be used.
Flex Rating Prior approval of rates required only if they exceed a
certain percentage above (and sometimes below) the
previously filed rates, otherwise a file and use
provision applies.
File and Use Rates must be filed with the insurance regulator prior
(Waiting Period) to their use. A waiting period applies before the rates
can be used. Specific approval is not required but the
regulator retains the right of subsequent disapproval.
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Framework Description
File and Use Rates must be filed with the insurance regulator prior
(No Waiting to their use. The rates may be used immediately.
Period) Specific approval is not required but the regulator
retains the right of subsequent disapproval.
Use and File Rates must be filed with the insurance regulator
within a specified period after they have been placed
in use.
Informational Rates must be filed with the insurance regulator for
File informational purposes. No formal review of the rates
occurs and no supporting documentation is required.
No File Rates are not required to be filed with or approved by
the insurance regulator. However, the company must
maintain records of experience and other information
used in developing the rates and make these available
to the commissioner upon request.
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All the given statements are the goals of market conduct supervision for
insurance business.
Answer to TY 2
Filing of rates and policy forms for the regulator’s review ensures the protection
of both the consumer and the insurer.
Answer to TY 3
File and Use laws represent a compromise between the prior approval system and
no-file system.
Answer to TY 4
Answer to TY 5
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Answer to TY 6
Answer to TY 7
Under which of the following systems is a range established for insurance rates?
Question 2
In a certain state, all insurance rates must be approved by the state insurance
department before the rates can be used. This type of rating law is called:
A File-and-use
B No-filing required
C Flex-rating
D Prior-approval
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Question 3
Insurance companies are subject to many laws and regulations. The principal
areas regulated include all the following EXCEPT:
Question 4
Question 5
Question 6
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CHAPTER 6
Chapter Introduction
This chapter aims to provide you with an introduction to the applications of the
file & use regulations within the Indian market, examination of the regulations
and relevant forms that need to be submitted to IRDA.
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The insurer is not permitted to offer any product for sale until all queries
pertaining to the product have been satisfactorily resolved after filing and IRDA
confirms in writing that it has no further queries in respect of that product.
This requirement will also apply to cases where the underwriting policy under
which the products are designed needs to be filed instead of filing of particulars
of individual product.
However, the authority has the right to question terms and/or issue directions,
suspend a product or withdraw from the market if, at any time, it appears to
IRDA that a product being sold by an insurer is not appropriate for any reason or
does not carry rates, terms and conditions that are fair between the parties or the
documents used with the product are in any way unsatisfactory, notwithstanding
the fact that IRDA may have had no subsisting queries in respect of that product
when it was originally filed.
The insurer needs to justify the rates, terms and conditions of insurance offered to
a particular client or to a class of clients or for a particular product while filing
the product with IRDA.
The insurer is not permitted to offer any product for sale until:
A All queries pertaining to the product have been satisfactorily resolved after
filing
B IRDA confirms in writing that it has no further queries in respect of that
product
C Both A and B
D Neither A nor B
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In case of any subsequent changes made from time to time with the approval of
the Board, the same should be filed with the IRDA without delay. In case the
Board delegates the authority to define and execute the underwriting policy to the
management, it should only be done on the basis of a clearly defined statement of
underwriting policy approved by the Board and the management should work
within the scope of such policy.
Design and filing of products should only be done in conformity with the
underwriting policy approved by the Board.
It is necessary that the Underwriting Policy is placed before the whole Board and
not just a Committee of the Board. The policy should not give unfettered
discretion to the management to quote untenable rates or make inadequate
reinsurance arrangements in respect of large accounts.
All important decisions must require at least two senior executives who are not
directly one above the other in the line of authority, to approve the decision.
Underwriting policy
The underwriting policy placed before the Board should cover the following:
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Even where an insurer delegates the authority to design products and set the
rates, terms and conditions of cover to any subordinate office of that insurer, the
Chief Executive Officer will still be responsible for complying with the ‘F&U’
guidelines in respect of filing of products.
The Appointed Actuary or the Chief Financial Officer or the Financial Adviser is
brought in as a moderator to ensure that the insurer does not act improperly under
the pressure of competition.
The Board in this regard can consider the appointment of the Appointed Actuary
or Financial Adviser or the Chief Financial Officer or any other top management
executive who does not have any responsibility for business development, to act
as the moderator of rates and terms that are quoted on individually rated risks that
fall under large risks as defined in the guidelines.
The insurer needs to demonstrate to the regulator that the rates and terms in any
particular case are determined in conformity with the guidelines and underwriting
philosophy. Moreover, in respect of insurance of reinsurance-driven large risks
where the insurer quotes terms to the client that are different from those obtained
from the international markets, the rates, terms and conditions of cover quoted to
the insured needs to have the concurrence of the Moderator which should state
that the rate is based on sound technical reasons.
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In such cases, the role of moderator is to ensure that the terms are determined on
a sound technical basis and not merely to meet competition in pricing regardless
of logic.
3.2 Role of compliance officer
The Compliance Officer shall not be an officer who also holds responsibility for
underwriting. The Compliance Officer should be sufficiently senior in the
organisation to be able to enforce cooperation of the heads of underwriting in all
classes of business.
The Compliance Officer shall be responsible:
(a) to monitor the business activities of the insurer and ensure that all products
being sold by the insurer are in compliance with the underwriting policy as
approved by the Board and also with these guidelines;
(b) to file a complete list of all products falling under categories as defined in the
‘F&U’ guidelines,
(c) to file with IRDA at the end of every calendar quarter, a list of all new
products falling in categories viz. class rated risks and individually rated risks
as defined under the guidelines introduced by the insurer during the quarter
just ended and dates on which the rates, terms and conditions of those
products were filed with IRDA and the dates of confirmation by IRDA that it
has no subsisting queries in respect of those products; and also
(d) file a list of risks underwritten as Large Risks, etc.
3.3 Role of appointed actuary
The Appointed Actuary, in consultation with the underwriters of the insurer, shall
determine the requirements for compilation and analysis of data of sums insured,
premiums and claims at the stage of product design itself and ensures that such
data is captured at the stage of effecting insurance, on claims intimation and on
all claims payments.
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Analysis of data should enable review of rates, loadings and discounts for every
rating factor used in the determination of premium rates and for rating risks on
first loss basis.
The Appointed Actuary, in consultation with the underwriters of the insurer,
should compile various first loss rating schedules and schedules of discounts for
higher deductibles or franchise, for different products based on statistical data.
Such schedules shall form the basis for rating risks on first loss basis or without
condition of average in respect of those classes of business that are normally
underwritten on full sum insured basis and where condition of average applies
and also for allowing discounts for higher deductibles or franchise. This is to
ensure that when the insurer moves on to a different basis of insurance it does so
on a sound mathematical basis.
While filing the product, a certificate by the Appointed Actuary should
accompany every product stating the rating factors for which data will be
captured and that adequate capabilities have been put in place for collection,
compilation and analysis of such data.
In such cases, the Appointed Actuary can act as a moderator and review the
product design, rates and terms from the point of view of logic and
reasonableness.
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The advocate plays an important role in ensuring that the product documents are
written in clear unambiguous language that properly explains the nature and
scope of cover, the exceptions and limitations, the duties and obligations of the
insured and the effect of non-disclosure of material facts.
For example while certifying the proposal form, the advocate should ensure that
the proposal form secures information on all matters that are material to the
contract and that it highlights the importance of the proposer providing all
information relevant to the contract and the consequences of suppression or non-
disclosure of material facts.
Further, he has to state in his certificate viz. Form D that the filed documents are
in compliance with the Policyholders’ Protection Regulations and Insurance
Advertisements and Disclosure Regulations etc.
In order to ensure that all underwriting is done in compliance with the ‘F&U’
guidelines, it is essential to constitute a Technical Audit Department by every
insurer.
The role of ________ is to ensure that the insurer does not act improperly under
the pressure of competition.
A Compliance officer
B Appointed actuary
C Moderator
D Advocate
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A Compliance officer
B Appointed actuary
C Moderator
D Advocate
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In respect of products classified under individually rated risks, the insurer should
file a statement of underwriting policy that was approved by the Board and
should provide the information in Form A.
4.1 Form A
1. Product details
9 Name of Product: the name should not be misleading with regard to the
scope of cover offered under the policy. Except for generic names such as
homeowner’s comprehensive, shopkeeper’s comprehensive, banker’s blanket
etc. the name should not be closely similar to names of products of other
companies.
9 Nature of Revision Made: the revisions should make a real difference to the
cover offered. If the changes are insignificant, the reason for making the
revision should be enquired into.
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2. Product features
9 Basis of Cover:
“New For Old” Basis in Respect of Repair Expenses: the meaning for
“New for Old” as stated in Form ‘A’ is in respect of repair claims on partial
losses where no deduction is made for depreciation should be clearly stated
in the product.
Reinstatement Value Basis for the Property Insured: the policy should
clearly set out the expectation with regard to the proper sum insured for the
risk.
9 Excluded Perils: whether any peril that is normally covered under such
products is excluded in this product; if so it should be clearly brought out in
product documents.
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3. Marketing
9 Target Market: the appropriateness of the product for the market and the
scope for business should be considered.
9 Sales Channels Planned to Sell the Product: the sales channels should be
appropriate to access the target market and should be cost efficient.
9 Plans and Budget for Sales Promotion: the insurer should make an
assessment of the business expectation for the product, the profit expectation
on the sales and then examine whether the sales promotion costs are
reasonable in terms of profit expectation in the short-term of say, 3 years.
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5. Actuarial support
9 Risk Factors Used For Rating: all relevant rating factors should be listed
and no rating factor should be discriminatory in nature or impractical of
implementation or could lead to problems if used in underwriting.
9 Margins built into the Rates and Terms for Acquisition Cost, Expenses
of Management, Catastrophe Reserve, Other Contingencies and Profit
Margin: these margins should be realizable and adequate. Where the
insurer’s current expenditure exceeds the margins being built in, the actuary
should evaluate the strain that will result from underwriting the business at
inadequate margins and the expected deficits based on business volume
expected to be underwritten. This evaluation needs to be reported to the
Board and such rating on “planned underwriting loss basis” is to be
sanctioned by the Board. The insurer should also have sufficient solvency
margin to absorb such strain.
9 Whether the IT System will provide Data on Each of the Risk Factors in
Respect of Sums Insured, Premiums and Claims: the IT system should
provide data on each of the risk factors in respect of sums insured, premiums
and claims. If not, the insurer must state how the data to validate the
premium loadings or discounts related to those risk factors will be generated
and how the experience by those risk factors should be monitored.
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9 Where the Rates and Terms are in the Form of an Internal Tariff for
Class Rated Risks: if the class of business was based on previous
manual/tariff, the insurer can compare the extent of the variation from tariff
for both rating factors and level of premium rates. If new rating factors are to
be introduced, their relevance should be demonstrated. If some of the rating
factors are to be dropped, the rates should sufficiently reward favorable
hazard features. Where the variation in rates compared to the manual/tariff is
more than 20%, the justification will need to be evaluated critically. It is
possible that the insurer may follow a different categorization of risks for
rating other than the one adopted in the earlier manual/tariff. For the purpose
of checking variation in rates proposed, comparison should be made with
rates as per earlier classification and the proposed rates for those categories.
9 Where the Rates and Terms Quoted to Individual Clients can Vary from
the Internal Tariff Rates and Terms: the details of the criteria and extent
of such variations are required to be provided. This is intended to prevent
arbitrary changes in rates especially to meet competition. The variations in
rates for inclusion or exclusion should be reasonable.
9 Where the Tariff is Used Only as a Guide and the Underwriter has
Authority to Depart from the Tariff: the level of management at which
such departure can be made and the permitted extent of such variation and
the circumstances in which such variation is permitted is to be specified. This
is the discretionary part of the rating formula. The authority to vary the rates
should rest with persons responsible for underwriting and not with persons
responsible for business development. Changes in rates should be for
objective criteria and not merely to match the rates of a competitor.
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9 What are the Elements of Insurance put together in the Package: the
elements of insurance put together in the package should be clearly defined.
9 The Package Rate Should be Derived by Adding Together the Rates for
Individual Elements of Insurance; If not, it is Essential to State How it is
Rated: one can accept the package rate to be an aggregation of individual
rates with some allowance for saving in administration cost arising from the
packaging. Any other basis need to be properly justified with technical
support.
9 In the Former Case how is Each Element of Insurance Rated? The levels
of rates for each of the insurance elements in the package should be taken
into consideration. There should be adequate premium for the risks covered.
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9 What is the Target Claims Ratio? The target claim ratio is considered and
fixed by the Board of the insurer. However, whenever the target claims ratio
exceeds 80%, there is need to examine the risk at a budgeted level of
underwriting loss and satisfy the regulator on sustainability of the
underwriting model adopted by the insurer.
9 How are the Statistics Used for Experience Collected and Analysed? The
system should automatically capture underwriting and claims information
and the analysis should be annual or more frequent. Data should also include
sums insured.
9 How is the Exposure Data Converted into Rating Factors? This can be a
mathematical basis using probabilities of loss occurrence and expected
values of loss amounts. Whatever the basis, it should be clearly defined.
9 If the Rates are derived by Comparison with Other Risks: In such a case,
the basis of comparison should be stated. Here, use can also be made of rates
quoted in other cases of risks of similar hazard or rates used by reputed
reinsurers or foreign underwriters. Adaptation of such rates should be on a
technically sound basis.
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7. Documents
The following documents and certificates are needed to be attached while filing a
product with the IRDA.
b) Certificates
(i) Certificate by the Principal Officer or the Designated Officer in Form B
(ii) Certificate by the Appointed Actuary in Form C
(iii) Certificate by the lawyer of the insurer n Form D
8. Supplementary information
If there is any information other than that provided, it can be filled in this form
and with enclosures as required, so that this supplementary information also can
be taken into account in examining the filing of the product.
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4.2 Form B
1. The rates, terms and conditions of the product filed with this certificate have
been determined in compliance with the IRDA Act, 1999, Insurance Act,
1938, and the Regulations and guidelines issued there under, including the
File and Use guidelines.
2. The prospectus, sales literature, policy and endorsement documents, and the
rates, terms and conditions of the product have been prepared on a
technically sound basis and on terms that are fair to both the insurer and the
client and are set out in a language that is clear and unambiguous.
3. These documents are also fully in compliance with the underwriting and
rating policy approved by the Board of Directors of the insurer.
4. The statements made in the filed Form A are true and correct.
5. The requirements of the revised File and Use guidelines have been fully
complied with in respect of this product.
Further, if any alterations are made in the wording, the implications of such
alterations should be explained.
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4.3 Form C
He has to certify that the rates, terms and conditions of the filed product are
determined on a technically sound basis and are sustainable on the basis of
information and claims experience available in the records of the insurer and that
an adequate system has been put in place by insurer for collection of data on sum
insured, premiums and claims based on every rating factor that will enable
review of the rates and terms of cover from time to time.
He should state the periodicity planned for reviewing of the rates, terms and
conditions of cover and confirm that the requirements of the revised File and Use
guidelines have been fully complied with, in respect of the filed product.
4.4 Form D
This is the certificate to be given by the Lawyer of the insurer confirming that he
has carefully studied the prospectus, sales literature, policy wordings and
endorsement wordings relating to the above-mentioned product in the light of the
IRDA (Protection of Policyholders’ Interests) Regulations 2002, and the File and
Use Guidelines and that these above mentioned documents are written in clear
unambiguous language, and properly explain the nature and scope of cover, the
exceptions and limitations, the duties and obligations of the insured and the effect
of non-disclosure of material facts.
Further, he has to state in his certificate that the filed documents are in
compliance with the Policyholders’ Protection Regulations and Insurance
Advertisements, Disclosure Regulations etc.
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Chapter summary
¾ The Regulator can take certain actions even when a policy has been
previously approved. These could include questioning terms, issue directions,
suspend a product, withdraw it from market etc.
¾ The insured must have an underwriting philosophy and policy approved and
agreed at board level.
¾ Overall responsibility lies with the CEO.
¾ There are a number of roles with specific responsibilities including
moderator, compliance officer, actuary, board, lawyer and auditor.
¾ Regulations refer to two Categories of Product – Class rated and Individual
rated.
¾ There are four forms to be completed for Product approval – Form A and
Form B (Principal Officer), Form C (Actuary) and Form D (Lawyer).
The insurer is not permitted to offer any product for sale until all queries
pertaining to the product have been satisfactorily resolved after filing and IRDA
confirms in writing that it has no further queries in respect of that product.
Answer to TY 2
Answer to TY 3
The role of moderator is to ensure that the insurer does not act improperly under
the pressure of competition.
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Answer to TY 4
For certain reasons, the regulator can withdraw products – which of the following
is NOT one of these reasons?
Question 2
While filing an insurance product with the IRDA, the insurer needs to justify:
Question 3
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Question 4
Question 5
Question 6
Question 7
A Form A
B Form B
C Form C
D Form D
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Answer to SEQ 2
The insurer needs to justify the rates, terms and conditions of insurance offered to
a particular client or to a class of clients or for a particular product while filing
the product with IRDA.
Answer to SEQ 3
The underwriting policy placed before the Board should cover all of the above
mentioned points.
Answer to SEQ 4
Option A is incorrect as the Compliance Officer shall not be an officer who also
holds responsibility for underwriting.
Option D is incorrect as the role of Moderator is to ensure that the insurer does
not act improperly under the pressure of competition.
Answer to SEQ 5
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Answer to SEQ 6
Answer to SEQ 7
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CHAPTER 7
TOOLS OF UNDERWRITING
Chapter Introduction
This chapter aims to provide you with an understanding about the elements of
risk management framework. The chapter also discusses some important tools
used by insurers for effective and results oriented underwriting.
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Weaknesses in the underwriting process and in the types and levels of controls
and systems can expose an insurer to the risk of operational losses which may
threaten the long-term viability of the insurer.
An effective underwriter is one, who knows when to say “No” to a risk that is not
insurable under the parameters the underwriter has established, despite the
attractiveness in terms of quantum of premium involved.
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d) The process for nominating the appropriate approval authorities and the
definitive limits to those authorities (including controls surrounding
delegation of power to intermediaries of the insurer).
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In order to understand these tools and their utility in the process of imparting
effectiveness to the whole underwriting process, let us examine each one of them
for a better understanding of the implications.
This comprises all documents that evidence the contract of insurance and all
other related matters pertaining to that contract. They consist of the following
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While the basic information on the risk about identification, hazard profile,
identifiable risk features, history of previous insurance/s and loss profile histories
is collected from the proposer in the proposal form, other documents are prepared
by the insurer. However, some of them like reinsurance slip, cover notes,
insurance certificates and renewal notices are provided separately to fulfill
certain obligations incumbent upon the insurer.
i) Proposal Form
Similarly, if the insurer has not obtained full information at the time of
acceptance of the risk, then the insurer cannot at a later date claim that the
insured has suppressed material information relevant to the risk. Hence, it is a
very important document both from the point of view of the insurer and proposer.
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The policy document becomes a legally binding contract between the proposer
and the insurer specifying each others obligations under the contract. Any error
in the policy document can have an adverse impact on both the parties to the
contract, more so on the insurer.
Contra Preferentum
Insurance policies are also called contracts of adhesion, because of the unequal
knowledge and lack of bargaining power that the insured may have vis-à-vis the
advantages of knowledge and power enjoyed by the insurer and therefore any
ambiguity will be construed against the insurer. The legal phrase ‘contra
preferentum’ is used in this regard, which means that any ambiguous provision in
the policy is construed against the person who drafted the contract.
Every insurance policy is issued subject to certain terms, which limit the
operation of insurance or levels of indemnification that the proposer can avail.
All insurers have standard policy wordings for each class of business they
transact. These wordings have evolved after a process of development. The
advantage of such wordings is that they are tried and tested as policy drafters
have responded to claims experience and court decisions over many years.
Conditions
Conditions are the specific requirements imposed under the contract, the
violation of which can lead to adverse effect on the policy liability for a loss.
These are terms to be followed compulsorily for the performance of the contract.
Warranties
Warranties are special conditions based on the statements made by the insured.
These are imposed under the policy, which are to be adhered to by the proposer
for performance of the contract.
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However, in case of violation of these warranties, the insurer has the right either
to accept or reject the claim.
The cumulative effect of terms, conditions and warranties that form part of the
contract of insurance is that the performance of the insurance contract to
indemnify a loss depends on their compliance.
Exclusions
A motor insurance policy typically states that it will pay for damage to the
automobile arising out of an accident to the vehicle.
Exclusion in the policy shall provide the following: There is no coverage if the
driver of the vehicle is found under the influence of intoxicating drugs or liquor
at the time of the happening of the accident.
The insurance policy can also have certain exclusions that could be removed if
additional premium is paid (e.g. spontaneous combustion).
iii) Endorsements
Any changes/amendments in the policy details like changes in the subject matter,
personal details, coverage details or cancellation of cover are carried with
endorsements under the policy.
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9 A change in the state of the subject matter may or may not adversely affect
the risk perception of the insurer. The insurer would always like to know of
any changes that have occurred in the risk, whether material or not for the
sake of better control and efficient risk coverage.
9 If the change in the risk profile alters the risk potential then the insurer might
charge additional premium and/or alter conditions and cover the risk.
9 If the change in the risk profile does not alter risk potential from what
existed, at the time of inception of the policy, the insurer may accept the
change simply by way of entering the change in his books without charging
any additional premium.
Under the contract of insurance if the insured fails to intimate about the changes
in the risk profile to the insurer, it may result in either repudiation of a claim
reported or reduction of eligible claim amount depending on the nature of
variation in risk profile.
What will happen in a fire insurance policy if the location of the stock covered is
changed and the same is not informed to the insurer?
When a claim is made for a loss at the new location, the insurer will decline the
claim
9 as the location is not the same as mentioned in the policy and further
9 as the insured has failed to intimate the change in location to the insurer
Hence, endorsements speak of changes in the risk either since inception or during
the period of the policy.
Apart from the above there are certain other endorsements which are used and
attached along with insurance policies specifically stipulating the restrictions
imposed on the coverage as given in the policy terms and conditions.
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In nature, these endorsements are akin to the warranties imposed under a fire
policy, whereby the insurer puts in an additional condition either restricting the
processes carried out at the workplace or avoiding risks altogether under certain
circumstances. However, the endorsements are an important part of insurers
operation for effectively dealing with risks and enforcing tests of admissibility of
claim.
Each of the reinsurers accepting the risk signs the slip indicating the percentage
of risk accepted by him. The lead reinsurer or the insurer accepting the maximum
percentage of the risk will issue the reinsurance document detailing
9 terms,
9 conditions,
9 deductibles,
9 premium rates and
9 names of the other reinsurers along with their percentage of acceptances of
the risk
v) Insurance Certificate
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Renewal notice also requires the insured to intimate any changes in the risk
covered under the original policy. Even though it is not mandatory and
compulsory to issue renewal notices, insurers issue renewal notices due to the
reasons of continuing relationship and for the sake of good order, and as a
healthy business practice.
2.4 Deductibles
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Benefits of deductibles
The reason for adopting the deductible as an underwriting tool by insurers is that
typically a large number of claims are small, and since the administrative costs of
settling a claim can be quite high, the ability to eliminate small claims as a result
of a deductible can lead to significant reductions in the cost of doing business for
the insurer. This, in turn, will generally lead to lower premiums for the insured
with a deductible clause than without the deductible clause.
Furthermore, since a deductible would require the insured to bear part of a loss,
this helps in elimination or minimising the possibility of moral hazard as the
insured finds it worthwhile to make an effort to prevent and/or control a loss.
Thus, a deductible is advantageous to both the insurer and the insured; the cost of
doing business is lowered for the insurer while the insured pays a lower
premium. The reduction in the premium, typically, would not be directly
proportional to the size of the deductible but would reflect the decreasing
probability of larger losses.
Types of deductibles
There are many types of deductibles that are prevalent in insurance contracts.
The following three types of deductibles are among the most common.
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2.5 Co-insurance
The term co-insurance has different meanings or practices in different parts of the
world.
In the original insurance contract there will be a lead insurer, who issues the
policy for the risk as proposed by the insured. The shares of the various other
insurers participating in the insurance as co-insurers will be given by way of a
co-insurance clause in the policy.
Thus co-insurance refers to the joint assumption of the risk between various
insurers.
This helps the insured to keep relations with various insurers and get the benefit
of their service. All the insurers in the transaction will share the premium and
claims, if any, in the same proportion of the premium.
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In the US and some other western countries co-insurance means the percentage
of the total risk that the proposer or insured is made to bear in case of a claim.
Under this arrangement, the insurers would like the insured to be insurer for a
part of the risk, so as to avoid moral hazard, if any. A majority of health
insurance policies in the western countries are issued with a co-insurance clause,
whereby the insured is made to bear stipulated percentage of the claims made.
Benefits of reinsurance
Reinsurance is often used to smooth out the peaks and valleys of a primary
insurer’s profits and losses. By reinsuring some of its risks, the primary insurer
can plan for a steady flow of profits.
A small insurance company that wishes to enter a new and unfamiliar category of
business may choose to supplement its own underwriting capabilities with those
of a reinsurer who already has experience in that area. Since the reinsurance
underwriter has to evaluate the underlying risk anyway, that expertise will be
shared with the underwriter of the primary policy. This benefit can be multiplied
by choosing multiple reinsurers with expertise in different areas.
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If the retention is too high, then the insurer may end up in losses due to the fact
that the losses are beyond the limit upto which the insurer can absorb. On the
contrary if the retention is too low, then the insurer will be ceding unnecessarily
to the reinsurer a premium which would have helped to maximise the profit of
the insurer. Hence, the retention limit should be judicious so that neither it is set
too high or too low.
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The amount of retention to be decided is not easy, but at the same time it is of
paramount importance for the survival and profitability of the company itself.
The retentions are fixed for each individual classes of insurances and will form
the basis for the reinsurance treaties to be entered with the reinsurers.
The amount of retention a company can have for any risk depends on factors like
9 paid up capital and free reserve,
9 expected gross premium,
9 class of business,
9 spread of risk,
9 composition and size of the portfolio,
9 past experience in a portfolio,
9 classification of risk,
9 geographical location and concentration of risks,
9 cost of reinsurance and type of reinsurance,
9 foreign exchange regulations and
9 inflation in the country etc.
Treaty Slips
Once, the necessary premium modalities are complied with, the reinsurer binds
the agreement by issuance called as treaty slips indicating the
9 terms,
9 conditions,
9 deductibles,
9 commissions payable,
9 various warranties that are applicable and
9 method of settlement of accounts
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Later the treaty slips are replaced with fully worded reinsurance treaties or
policies by the reinsurer.
Bordereaux
This is the technique and process of effectively protecting the insurer’s balance
sheet and financial stability by managing each of the portfolio of risk that the
insurance company underwrites. In practice, no insurer would like to have steep
peaks and slopes in the profitability of the portfolio which he underwrites.
Instead, the insurer would like to have more stable profitability with averaging
out of peaks and slopes in the overall portfolio.
Concept of Portfolio
9 Motor Portfolio: The term portfolio means in the case of motor vehicles
insurance of any kind as part of the motor portfolio.
9 Fire Portfolio: All the risks falling under the basic fire insurance comes
under fire portfolio.
9 As mentioned above the same goes for other categories such as the marine
cargo portfolio, marine hull portfolio, engineering portfolio and
miscellaneous portfolio.
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One of the ways in which the insurance company manages its portfolio is through
effective reinsurance. Even though reinsurance plays a vital role in portfolio
management, the primary insurers have the responsibility of managing the
portfolio as any adverse results in the portfolio might have disastrous effect on
the profitability or even on the very survival of the company itself.
Portfolio management primarily depends on the value at risk, portfolio mix and
finally the overall approach of the insurer on profitability, for each portfolio.
Hence, a good, efficient and well managed portfolio is the cornerstone for
success and survival of any insurance company. The documentation associated
with it will be in the form of board approved policy for underwriting, risk
management and financial stability.
Conclusion
These tools have been traditionally used by underwriters for decades and have
been found to be effective and result oriented. However, these tools are not
exhaustive but are the more important ones among those commonly used by
insurers. These tools help us in ensuring that the underwriting policy as
determined by the company is carried out effectively for generating an
underwriting surplus.
Before opting for reinsurance, insurance companies decide on keeping some risks
underwritten with them. This business portion which is kept by the insurance
company is known as _________
A Withholding Limit
B Retention Limit
C Detention Limit
D Preservation Limit
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Summary
¾ Underwriting is the process by which an insurer determines: whether or not
to accept a risk and, if to be accepted, the terms and conditions to be applied
and the level of premium to be charged.
¾ Commercial considerations can increase the risks for the insurer and create a
premium deficiency situation which can have undesirable consequences.
¾ The risk management framework typically consists of the following
elements:
9 Willingness and capacity to accept risk
9 Nature of business to underwrite
9 Details of formal risk assessment process
9 Nominating the appropriate approval authorities and their definitive
limits
9 Monitoring compliance with underwriting policies and procedures
¾ Approaches that can serve as tools for underwriting
9 Underwriting philosophy
9 Underwriting policy
9 Use of reporting forms on trends emerging on the claims front
9 Stated methods of taking the emerging claims experience
¾ Insurance documentation comprises all documents that evidence the contract
of insurance and all other related matters pertaining to the insurance contract.
¾ The proposal form is very important from the point of view of both, insurer
as well as the insured.
¾ Conditions are the specific requirements imposed under the contract, the
violation of which can lead to adverse effect on the policy, the liability for a
loss.
¾ Warranties are special conditions based on the statements made by the
insured. These are imposed under the policy, which are to be adhered to by
the proposer for performance of the contract.
¾ Exclusion is a clause contained in an insurance policy which describes the
condition or type of loss that is not covered by the policy. A policy can have
multiple exclusions.
¾ Changes or amendments in the policy are carried out by the insurer by
issuing endorsements under the policy.
¾ Reinsurance placement slip is a very important document pertaining to risks
which are reinsured.
¾ Cover note is a temporary document evidencing the receipt of premium and
acceptance of the risk by the insurer, pending preparation and issuance of
fully worded insurance policy.
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Answer to TY 2
Before opting for reinsurance, insurance companies decide on keeping some risks
underwritten with them. This business portion which is kept by the insurance
company is known as retention limit.
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Self-Examination Questions
Question 1
Warranties are special conditions based on the statements made by the ________.
A Insurer
B Insured
C Underwriter
D Broker
Question 2
A Exception
B Exemption
C Exclusion
D Omission
Question 3
Changes in the state of the subject matter that are accepted and incorporated by
the insurer in his book are called __________ under the policy.
A Endorsements
B Modifications
C Variations
D Amendments
Question 4
A 15 days
B 30 days
C 45 days
D 60 days
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Question 5
Answer to SEQ 1
Warranties are special conditions based on the statements made by the insured.
Answer to SEQ 2
Answer to SEQ 3
Changes in the state of the subject matter that are accepted and incorporated by
the insurer in his book are called endorsements under the policy.
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Answer to SEQ 4
Answer to SEQ 5
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CHAPTER 8
TYPES OF POLICIES
Chapter Introduction
This chapter aims to provide you with an introduction to different types of
policies offered by insurance companies.
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3. Insurance of Liability: Liability arises from the law of tort and may arise
owing to the insured’s negligence, causing personal injury and damage to
property of others. Liability also may be without negligence i.e. ‘no fault’
basis in regards to handling of hazardous substances under Public Liability
Insurance Act 1991.
Broadly speaking, property insurance policies are on indemnity basis and all
policies on human life are benefit ones.
The Insurance Act 1938 classifies non-life insurance business into Fire, Marine
and Miscellaneous classes. Thus the financial statements of general insurers are
drawn into 3 classes of business. As general insurance began to cover specialized
risks, the need for further classification was necessary for insurers to develop
prudent underwriting practice for each class of risk.
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No matter what the basis of classification, the insurance policy covers a peril or
combination of peril. A peril can be the cause of injury, damages or loss.
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A Damages
B Injury
C Loss
D All of the above
Named peril policy provides only coverage on losses incurred to property from
perils or events named in the policy. It contains conditions which cover what the
insurer thinks is the most likely perils.
9 It provides coverage for all direct loss or damage caused by specific perils
mentioned in the policy.
9 Under the named peril policy, if the damage or loss occurs by a peril not
mentioned in the policy, then there is no coverage for it. The policy has
standard terms, exclusions, conditions and deductibles.
9 Standard Fire & Special perils policy, Motor Comprehensive insurance etc.
can be examples of named perils policy.
9 Named perils policies can be further classified as those with basic covers and
those with add-ons.
A basic Standard Fire and Allied perils policy excludes perils of earthquake; an
insured may decide to cover delete such exclusions on payment of additional
premium, in order to obtain earthquake cover.
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Exclusions of riot and strike perils in Standard Fire and Allied Perils policy gives
benefits for discount in premium.
9 However, there are some type of exclusions such as war, nuclear risk etc.
which cannot be deleted even upon payment of additional premium. Such
exclusions are called ‘absolute exclusions’.
9 The burden of proving that the loss is due to the covered peril is on the
insured. If the loss is on account of the specified exclusion relating to the
covered peril, the burden shifts to the insurer.
Named peril policy providing coverage for direct loss can be either a ________
or a ______.
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2. In “All Risks” insurance policy, it is not necessary to name or list the insured
perils since the intent is to cover all risks of damage or loss due to accidental
circumstances.
3. One of the common perils responsible for property damage is the accidental
fall of the property or some other object falling upon the property. This peril
is usually not covered in the Named-perils policies.
5. The burden of proof is mostly upon the insurer. This means that the insured
need not demonstrate the precise cause of loss but has the burden of proving
that some loss or damage has occurred and that the loss was not excluded by
the policy.
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7. Though the terminology “All Risks” is catchy and used by insurers from a
marketing angle, it may confuse the buyer of insurance into thinking that
there are no exclusions. The distinguishing characteristic of ‘All Risks’
policies is a comprehensive set of exclusions, which need to be elaborate as
otherwise the underwriter will be faced with a loss which was not intended to
be covered. There may be different set of exclusions for each type of policy
depending upon the risks covered.
8. Some interesting exclusions and their relevance under “All Risks” policy for
jewellery, cameras, works of art etc. are discussed below:
9 Unlike the traditional named perils policy, where the covered perils are
listed in the policy, an “All Risks” cover is open-ended, in the sense that
the covered perils are not specifically listed. Hence, insurers may
exclude certain specific perils in addition to the standard exclusions, if
they do not intend to cover such perils based on the risk factors.
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9 Absolute exclusions like war and allied perils, nuclear risks can not be
deleted.
9 Another confusion the word “All Risk” denotes is that all of the property
concerned is covered. In case the intention of the policy is to cover only
specific items, the list of such items has to be collected along with the
proposal form; otherwise, the insurer becomes liable for all or any of the
property up to the value of the sum insured. If such a list is not possible,
a per article limit may be imposed in the policy to take care of high
valued items.
10. Since there are now various types of All Risk policies, underwriters would
have to understand them in their separate contexts. There could also be
apparent contradictions between what is available in the all risk policy, and
something wider could be apparently available in a named perils policy. The
pricing of an All Risks cover presents its own details for the underwriter in
view of the unknown perils not specifically excluded.
11. More importantly, All Risks insurance policies in the personal lines of
insurance may involve high degree of moral hazard and hence acceptance
limits of the lower level underwriters are normally kept low.
The policy that covers any risk which the contract does not specifically exclude
is called:
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A policy which combines two or more types of insurance covers into one policy
is called ‘Package Policy’.
Commercial insurers also sell insurance covers separately and offer policies that
combine protection for major property and liability risks in one package.
Generally, package policies are created for businesses that face same kind and
degree of risk. Package policy could be applicable to various segments of
customers and include home package (Householder’s Comprehensive policy),
shop package, office protection shield policy etc.
9 Various ‘individual policies’ that are already available with the insurer are
bundled into various sections and underwritten as one policy document.
9 Basic premium of the individual section usually would be the same as the
premium applicable for ‘individual policy’. But some discounts are offered
on the number of sections chosen by the insured, since the costs involved for
the insurers in issuing & servicing multiple policies is reduced. Thus the
benefit of having a package policy is that it reduces the cost.
9 Advantage for the insured is that there is no need to deal with various
insurers and different renewal dates.
9 Some package policies provide for extra covers that may not be available in
an individual policy marketed by the insurer.
9 The package policy lists out all the terms and conditions for each individual
section either in a common set or individually as may be required.
One of the disadvantages is that a package policy may include covers whether
they are needed or not. Sometimes, the insured may end up paying premium for
certain covers that may not be strictly desired by him. Most insurers may,
therefore, offer choice of sections to be covered for the insured.
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When the insurer makes a policy according to the needs of the policy holders by
developing a policy tailor made to the risk exposed is called _________
5. Special Covers.
[Learning Outcome e]
5.1 First Loss Policy
A first loss policy is a property insurance cover in which the policy holder
arranges cover for an amount below the full value of items insured and for this,
the insurer agrees not to penalise him for under insurance.
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9 The insured is required to take the policy for the highest sum insured
that he predicts during the year and pay a provisional premium.
1. Fire floating policy is issued when the insured is not able to declare separate
value of stock in each godown but is able to declare the total value of all his
stocks in various specified godowns. The policy, therefore, covers in one sum
insured, stocks stored in different specified godowns.
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4. Along the same lines, Declaration and floating policies can also be granted
in burglary insurance.
5. For Marine cargo insurance, merchants who are involved in regular import
and export trade or who are sending consignments regularly by inland
transportation can avail of a declaration policy (also known as open policy or
floating policy).
6. This policy is valid for one year and all shipments and consignments as the
case may be, declared during the policy period are automatically covered
under the policy. There is no need for issuing specific policies for each
shipment or consignment.
9. Recently, such floating policies have come into vogue to cover all the
members of a family under one sum insured in Medical insurance.
11. In case of jewellery, it would be prudent that the sum insured is fixed after
valuation of the property by a professional jeweller. Such a valuation reckons
wear and tear element towards usage up to the point of valuation.
12. It still does not mean that the sum insured would be automatically paid in the
event of a loss.
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3. In Motor insurance,' agreed value' policies are issued on vintage cars which
are over a specified age and certified to be in good working condition by an
Automobile Engineer/Inspector. It is not easy to determine their current
market value.
4. In the event of a total loss, the motor insurance policy pays a specified sum
as the value of the vehicle, and no depreciation is deducted.
A 25%
B 65%
C 50%
D 75%
Summary
¾ Liability arises from the law of tort and may arise owing to insured
negligence, causing personal injury and damage to property of others.
¾ The unique characteristic of ‘All Risks’ policies is that the scope of cover is
determined by exclusions, which need to be elaborate as otherwise the
underwriter will be faced with a loss which was not intended to be covered.
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¾ A policy which combines two or more types of insurance covers into one
policy is called ‘Package Policy’.
¾ First Loss Policy is mainly used when total loss is virtually impossible to
occur.
A peril can be the cause of injury, damages or loss. No matter what the
classification is, the insurance policy covers a peril or combination of perils.
Answer to TY 2
A named perils policy can cover either one or more than one specified perils
Answer to TY 3
Answer to TY 4
The needs of the policyholders keep changing and are different from each other;
thus special measures are taken to understand the insurance needs of the
policyholders and give them custom made insurance policies.
Answer to TY 5
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Self-Examination Questions
Question 1
A ii, iii
B i, iv
C iii
D iii, iv
Question 2
When the insured is unable to declare separate value of stock in each godown but
is able to declare the total value of all his stocks in various godowns, he can take
insurance cover of:
Question 3
When the total value of stocks is greater at the time of loss than the total value
declared for insurance purpose, this additional condition is called:
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Answer to SEQ 2
Fire Floating policy covers in one sum insured stocks stored in different specified
godowns.
Answer to SEQ 3
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CHAPTER 9
Chapter Introduction
This chapter aims to provide you with an understanding of the concept of
underwriting profit and loss. The chapter also explains what should be the
underwriting philosophy, underwriting profitability ratios used by insurers, areas
where adverse results can appear. The chapter also focuses on the concept of
reunderwriting, loss cause analysis and the corrective actions that can be taken,
underwriting audits and recommendations.
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Underwriting profit
Owners of the capital who have invested in the company would also be looking
forward to returns on the capital invested. In simple terms profit can be measured
as follows
Underwriting loss
However making easy profit is not that simple for the underwriter. There can be
number of reasons for the insurer not making desired profits. Some of these
reasons include:
a) there is a need for rate approval from the regulator,
b) the rate war among competing insurers is to be factored in at the time of
pricing,
c) the sales force of the insurer may not be as effective as desired / expected,
d) the underwriting cycle may be indicating very soft rates etc.
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9 Earned premium is that part of the premium in a policy which is being earned
as the risk period progresses and therefore can be measured on any given
date within the policy period in proportion to the total period of the policy.
Example: A policy starting on January 1st for a period of one year and
expiring on 31st December is taken as a reference. The earned premium on 1st
July will be 50% of the written premium and on 31st December it will be
100%.
9 A comparison of the written premium and earned premium can indicate the
dynamism of the insurer in premium growth.
9 In periods of rapid growth the earned premium will be low. In times of poor
or no growth, the earned premium in comparison with written premium will
be high.
After having analysed the earned premium in comparison with written premium,
the losses need to be analysed. Losses can be computed by looking at the three
elements that constitute incurred losses, namely
a) paid losses
b) change in loss reserves to reflect unpaid but incurred losses and
c) loss expenses
There are a number of ratios that insurers use to measure profitability of their
underwriting operations. There are three ratios that are commonly used.
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If the loss ratio of an insurer is 75%, it indicates that for every Rs. 100 the insurer
earns, it pays a loss of Rs. 75.
b) Expense ratio: The second ratio is the expense ratio. The formula for
calculating the expense ratio is as follows
This ratio takes into account the expenses incurred by the insurance company for
business purpose.
c) Combined ratio: The third ratio is the combined ratio. The formula for
calculating the combined ratio is as follows
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Insurers can also move to segments where there is less competition and rate
cutting, segments which are less price sensitive or where the moral and physical
hazards are proven to be less and so on.
The method of coverage may also need to be re-examined for instance, if the
focus is on certain types of group policies, such policies may show more
volatility than individual policies or sales through a particular type of
intermediary may show more losses than through other intermediaries.
Increasing premiums
Playing with rates is another option. Rates can be raised to get additional
premium or can be lowered to get more volume. Rate increase can be through
slow increases in stages or a sudden large increase, with various consequences
among customers. Another option is without touching the rates, reconfigure the
policy terms and conditions so that effective coverage is reduced. All such
actions relating to rates, terms and conditions need approval of the regulator.
The loss ratio can be decreased by a more careful examination of claims and
claim assessments. Claims can also be reduced by placing more restrictions in the
policies underwritten. The underwriting guidelines could be enforced more
strictly and if they are found ineffective, they should be reviewed and
strengthened.
The expense ratio can be reduced by looking at the outflow of expenses, whether
they are creating necessary value and whether any of the costs incurred are due to
historical needs not relevant now and so on. Costs once analysed can be
rationalised appropriately. Thus all the three factors singly or in combination can
help to turn underwriting losses into profits.
To ensure that premium and loss exposures match in the proportion desired,
underwriting guidelines are prepared, underwriters suitably trained and given
necessary experience. Whenever unacceptable loss ratios emerge the compliance
of underwriting policies and guidelines needs to be checked through an
underwriting audit. The audit should be carried out regularly. Special
underwriting audits also can be carried out for more focused study of
underwriting results.
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1. Rating
Premiums are inadequate to cover the loss exposures. The needed response is
to increase rates, but the same is fraught with difficulties. The new rates need
to be filed with the regulator for their nod and has to compete in the market
with other insurers. Moreover the premiums are to be earned and therefore
the profitability will only emerge in the future.
2. Underwriting
3. Policy wording
If the interpretations in the policy wording are open to larger risk coverages
than anticipated, more claims or larger claims will get paid resulting into
underwriting losses. Therefore the policy wording will need to be revised.
There are two ways of doing this:
9 by way of endorsements in the policy and
9 by revising the entire policy wording
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The latter can be onerous, time consuming and costly as all old unused policy
copies need to be withdrawn, new ones printed. Even after these, it cannot be
certain that policy interpretations will be benign.
4. Reserving
Loss reserves are not correctly computed. The reserving guidelines need to
be revised and the employees concerned have to be trained to assess these
accurately.
5. Claim processing
6. High Exposures
7. High Expenses
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Each insurance portfolio has goals and these are monitored for variances against
the planned goals and corrective action is initiated as may be necessary.
The insurer has a significant amount of data in its books, but this data needs to be
organised so that the patterns that are likely to emerge indicating deterioration in
the underwriting process can be identified. The computer systems available today
enable insurer to sort the data and obtain various reports. The report may indicate
9 unusual frequency: more number of claims than were estimated or
9 more severity: more amounts to be paid out than was the expected norm
9 Reports culled from claims data can indicate useful patterns from analysis of
the cause of loss in conjunction with the location where loss has taken place.
9 Losses also can be examined under various other heads such as the category
of the insured, the type of physical risk covered (whether class I, II or III as
may have been classified by the insurer), or intermediary wise loss analysis
and so on. In Motor insurance, for instance, there could be a spurt of theft
claims and the manner, time and location of the loss may indicate a pattern in
the theft of vehicles.
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The loss experience can be viewed month wise to see whether the loss numbers
are accelerating or decreasing. The loss profile can be viewed on year to year
basis to see changes in the pattern of claims. Causewise analysis of claims can
reveal major losses that arise in the portfolio and what action needs to be taken
for those losses which are the most frequent. When these losses are compared
with the location of loss or the workshop where these repairs take place or the
type of intermediary that sold these policies etc. clear patterns may emerge that
can be considered for corrective action. Similar analysis can be made for severity
of losses as well.
After the losses have been analysed it is possible to review the claim files
themselves to go deeper into the cause of loss and to find out whether
9 the loss was preventable or
9 took place because of negligence or carelessness of the insured or
9 whether the loss arose owing to poor maintenance or housekeeping or
due to larger issues like a downturn in the local economy or country or social
unrest etc.
Once the causes of losses have been duly identified, it is possible to look at
possible corrective actions. The corrective approach to be implemented
effectively can vary from simple to complex and easy to hard. Some issues may
have to deal with physical hazards, others with moral or morale (carelessness
owing to having taken a policy) hazards. There can also be situations where
adverse selection may be unknowingly permitted by the insurer owing to certain
laxness in analysing claim patterns in the earlier review of underwriting norms.
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5. Upgradation of assets and revaluation may not have been informed to the
insurer by the insured and market trends in these aspects can be discovered
by proper discussions with loss assessors, based on the trends seen in the
claim files and revision may be required in sum insured and collection of
additional premium.
6. Modify risk profile of the portfolio as a whole. Thus, for example, if the
underwriting guidelines allow coverage in areas where buildings are situated
in congested markets, such a concentration of coverage may have an adverse
result during times of social unrest, then such risks may be discouraged for
acceptance in future. The selection of the insured for underwriting can thus
be made more stringent even though the guidelines may be silent on such
strictness, so that the underwriting experience is made to fall within the claim
ratios planned for.
9. Legislation and court verdicts can have dramatic effects on claim outcome
and suitable remedial measures need to be taken so that the claim ratios
come back to planned level.
10. Modifying the pricing: This decision can be fraught with many unforeseen
consequences. Insureds with very favourable claim ratios may leave if the
rate increase is perceived to be against their interests.
They may either stop insuring or go to competitors. This will have disastrous
consequences on profitability. One method to modify rates that may be more
acceptable is to consider tiered rating, where insureds can be divided into
segments within the portfolio.
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Rates are then applied based on tiers of risk exposure as elucidated in the
revised underwriting manual based on claim experience and the analysis by
the insurer’s experts.
9 Lower than standard rates are offered to better class of insureds
9 Average rates offered to median class and
9 Loaded rates offered to ‘less than standard’ segment of insureds
These tiers will apply to insured on the basis of risk profile and will be
modified later on with the insured’s claims experience or further disclosures
made at the time of renewal.
11. Discontinue the portfolio: This is a very drastic action, which requires
approval of the regulator, can generate consumer objection particularly if all
insurers redline such policy or class of insureds. Therefore all efforts should
be consciously made to improve the portfolio before approaching the
regulator to discontinue the product or portfolio.
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After all the corrective actions have been analysed, selection of the corrective
actions has to be made. Such actions should normally begin with implementation
of the easiest and for those policies that will generate the highest desired
improvement. This is necessary as otherwise there could be mounting expenses
9 in changing the rates, terms
9 in training the underwriters and sales wings
9 to obtain necessary approvals and
9 communicate changes to the customers
The changes can also anger or confuse customers and may therefore require
skillful communication to reassure the insureds.
The insurer also will need to reconcile to the fact that there are possibly long lead
times before the underwriting changes can show necessary effect on profitability.
This is owing to the need to comply with various regulatory requirements, the
full year time required for the renewal cycle to be completed and so on. Thus
changing direction of the results in a portfolio can be a lengthy process.
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Audit recommendations
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Catastrophe
Similarly in the event of a large catastrophe like a severe flood in a metro city,
many lessons can be learnt on how to manage the underwriting to take care of
flood risks in general and for concentrations in a metro city in particular. Since
such catastrophes can happen owing to various rare events like tsunami, super
cyclones, earthquakes, breach of canals and dams; insurers need to take adequate
safeguards in taking care of risk concentrations and risk mapping to offer special
guidelines for vulnerable areas.
Conclusion
a) Underwriting profitability: The profitability of underwriting is a basic
requirement for sustenance of insurance business on sound lines and insurer
has to take this task with utmost seriousness in view of competitive scenario
and regulatory requirements. While the focus is on increase of premium
income, easy underwriting can generate volumes but not profits and
therefore, the focus has to be on very scientific approaches to appreciate the
risk exposures across locations, customer and asset segments and in the
context of competitor’s rates / policy terms for comparison.
b) Frequency and severity of claims: The second area of focus is to see that
claim outgo both on counts of frequency and severity are within the planned
limits. Claim reports on various parameters can help to bring out the patterns
of claims and help to stem losses quickly by better claims control as well as
by bringing necessary corrective action in underwriting.
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Summary
¾ Underwriting profit or loss is the amount of money that an insurance
company gains or loses owing to its operations excluding investment
earnings.
¾ The profitability of an insurance company is measured as follows
Profit = Premium Amount – Losses (Claims) – Expenses incurred
¾ Some reasons for the insurer not making desired profits can be: regulator not
giving the rate approval, rate war among competing insurers, sales force not
being effective& soft underwriting cycle.
¾ Steps towards planning for underwriting profitability include: Have a proper
underwriting philosophy developed, get it duly vetted by the top management
and actuary and get it formally approved by the Board.
¾ Earned premium is that part of the premium in a policy which is being earned
as the risk period progresses.
¾ Losses can be computed by looking at incurred losses, namely: paid losses,
change in loss reserves to reflect unpaid but incurred losses and loss
expenses.
¾ Common ratios that insurers use to measure profitability of the underwriting
operations are: Loss ratio, expense ratio and combined ratio.
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¾ The loss ratio can be decreased by a more careful examination of claims and
claim assessments.
¾ Whenever unacceptable loss ratios emerge the compliance of underwriting
policies and guidelines needs to be checked through an underwriting audit.
¾ Areas where adverse results can appear include: rating, underwriting, policy
wordings, reserving, claim processing, high exposures, high expenses
¾ Reunderwriting is the process by which profitability of a portfolio is
managed and claims are duly examined for identifying loss exposures and
taking necessary correction for implementation.
¾ The corrective actions can be implemented by one or more of the following
steps: non-renewal, cancellation of policies with material misrepresentation,
modification of coverage, examination of adequacy of sum assured, modify
risk profile of the portfolio, modify underwriting guidelines, modifications
based on changes in the environment, modifying the pricing, discontinue the
portfolio.
¾ Corrective actions should begin with implementation of the easiest for those
policies which will generate the desired improvement.
¾ The purpose of underwriting audit is to give feedback to the underwriter and
to the management on correctness of implementation of the underwriting
policy and interpretation and use of underwriting /rating manuals.
¾ Based on the audit report, auditors may advise the department to review and
begin to re-underwrite the portfolio or portions of the portfolio that has
deviated from planned results.
Answer to TY 2
The correct answer is C.
Policy wording can be revised by way of endorsements in the policy or by
revising the entire policy wording
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Self-Examination Questions
Question 1
The underwriting philosophy developed by senior underwriter needs approval
from which of the following?
Question 2
A Earned premium
B Written premium
C Both are one and the same
D None of the above
Question 3
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Answer to SEQ 1
Answer to SEQ 2
Answer to SEQ 3
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CHAPTER 10
PROTECTION OF POLICYHOLDERS’
INTERESTS
Chapter Introduction
This chapter aims to provide you with an understanding about the provisions of
IRDA (Protection of Policyholders’ Interests) Regulations, 2002.
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Introduction
Insurers have the duty of protecting interests of policyholders. Such a duty is also
cast on the underwriter whilst underwriting. Apart from the File & Use and
related guidelines from the regulator, an important regulation to be complied with
particularly by technical wing of the insurer is the Protection of Policyholders’
Interests Regulations, 2002.
The above regulations are applicable to life and general insurance companies. In
this chapter we will restrict the discussion to regulations applicable to general
insurance companies
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a) Complete disclosure
b) Dispassionate advice
Where the prospect depends upon advice of the insurer or his agent or an
insurance intermediary, such a person must advise the prospect dispassionately.
c) Declaration
Where, for any reason, the proposal and other connected papers are not filled by
the prospect, a certificate from the prospect may be incorporated at the end of the
proposal form to state that the contents of the form and documents have been
fully explained to him and that he has fully understood significance of the
proposed contract.
a) Proposal form
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Where a proposal form is not used, the insurer shall record information obtained
orally or in writing and confirm it within a period of 15 days thereof with the
proposer and incorporate this information in its cover note or policy.
The onus of proof shall rest with the insurer in respect of any information not so
recorded, where the insurer claims that the proposer suppressed any material
information or provided misleading or false information on any matter material
to grant of a cover.
c) Processing of proposals
Proposals shall be processed by insurer with speed and efficiency and all
decisions thereof shall be communicated in writing to the proposer within a
reasonable period not exceeding 15 days from receipt of proposals by the insurer.
The regulations stipulate that every insurer shall have in place proper procedures
and effective mechanism to address complaints and grievances of policyholders.
The grievances shall be addressed efficiently and with speed.
b) Insurance Ombudsman
a) Insured details: A general insurance policy shall clearly state the name and
address/es of the insured and financiers, where applicable.
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d) Sum insured and premium details: The details of sum(s) insured ought to
be given. So also whether there is any deductible / franchise. The policy must
contain details of premium payable and where the premium is provisional,
whether it is subject to adjustment and if so, the basis of adjustment.
f) It must also contain details of obligations of the insured under the policy
etc.
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The IRDA stipulates various disclosures - financial and others, which have to be
complied with by insurers. There are regulations for advertising that have to be
complied with by insurers as well as intermediaries.
The 'File & Use' procedure of the IRDA requires products to be filed with the
regulator as per procedure laid down, before they are launched / sold. The
prospectus which becomes a primary source of information about the product for
the policyholder has to be transparent and complete. Hence it is necessary for the
insurer to file this with the regulator along with other relevant document.
The insurer shall communicate all decisions to the proposer within a reasonable
period not exceeding _______ from receipt of proposals by the insurer.
A 3 days
B 7 days
C 15 days
D 30 days
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Summary
¾ IRDA has issued the Insurance Regulatory and Development Authority
(Protection of Policyholders’ Interests) Regulations in 2002.
¾ Prospectus of any insurance product shall clearly state the scope of benefits
and extent of insurance cover, explain the warranties, exceptions and
conditions of insurance cover and clearly spell out allowable rider or riders
on the product with regard to their scope of benefits.
¾ Where the prospect depends upon advice of the insurer or his agent or an
insurance intermediary, such a person must advise the prospect
dispassionately.
¾ Proposals received shall be processed by the insurer with speed and
efficiency and all decisions thereof shall be communicated by it to the
proposer in writing within a reasonable period not exceeding 15 days from
receipt of proposals.
¾ Every insurer needs to have in place proper procedures and effective
mechanism to address complaints and grievances of policyholders.
¾ Insurance Ombudsman details shall be communicated to the insured along
with policy document and as may be found necessary.
¾ A general insurance policy document shall contain details of insured,
property, period of insurance, sum insured, premium, policy terms and
conditions and obligations of the insured under the policy.
¾ On receipt of a claim communication, a general insurer shall respond
immediately and give clear indication to the insured on procedures that he
should follow.
¾ An insurer shall dispose of the claim within 30 days of receipt of the survey
report.
¾ Any communication received from a policyholder shall be responded to
within 10 days of its receipt.
¾ The IRDA stipulates various disclosures - financial and others, which have to
be complied with by the insurers.
¾ On the pricing front, it is necessary for insurers, in the interest of the
policyholders, to strike a balance between reasonable and equitable pricing
without jeopardising their solvency margins.
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The insurer shall communicate all decisions to the proposer within a reasonable
period not exceeding 15 days from receipt of proposals.
Self-Examination Questions
Question 1
In claims where a surveyor has to be appointed, it shall be so done within _____
of the receipt of intimation from the insured.
A 24 hours
B 48 hours
C 72 hours
D 96 hours
Question 2
Any delay in discharging the claim once the offer of settlement has been
accepted by the insured, shall attract interest at a rate which is ______ above the
prevailing bank rate.
A 1%
B 2%
C 3%
D 4%
Question 3
Where a proposal form is not used, the insurer shall record the information
obtained orally or in writing and confirm it within a period of ________ thereof
with the proposer and incorporate this information in its cover note or policy.
A 7 days
B 15 days
C 30 days
D 45 days
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Question 4
A 10 days
B 15 days
C 30 days
D 45 days
Answer to SEQ 2
Any delay in discharging the claim once the offer of settlement has been
accepted by the insured, shall attract interest at a rate which is 2% above the
prevailing bank rate.
Answer to SEQ 3
Where a proposal form is not used, the insurer shall record the information
obtained orally or in writing and confirm it within a period of 15 days thereof
with the proposer and incorporate this information in its cover note or policy.
Answer to SEQ 4
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CHAPTER 11
Chapter Introduction
This chapter aims to provide you with an understanding of new areas where
challenges are occurring in the field of insurance. The chapter also discusses
product innovation.
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a) New potential hazards: These are the unforeseen risks resulting from rapid
innovation and change. The world is changing on a continuous basis, with a
rate of scientific advance that is simply unparalleled. Many new products,
whether pharmaceuticals, consumer goods, automobiles or food products - to
name but a few - are coming to market faster in many innovative forms than
ever before.
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Risks arising from catastrophes like Hurricane Katrina of 2005 in the USA or
the earthquake and tsunami in Japan, floods in Thailand etc. have outdone
large catastrophes seen earlier. Insurance coverage is something that can no
longer be taken for granted and each peril has to be specifically insured – be
it flood, storm surge, tsunami, terrorism, earthquake or pandemics in respect
of health or life insurance and so on.
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It is because of these new types of risk solutions that the insurance industry has
to realise that the nature of the industry is changing. Underwriters would do well
to expand their imaginative capability while preserving their prudential approach
and conservative pricing skills. There is a need for underwriters to continuously
upgrade their skill and encourage innovation in the quest of consumer relevance
in the area of change and increasing perceptions of risk.
Rate Making
Underwriters and actuaries have begun to construct more complex risk classes by
considering various additional differentiating factors.
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Despite this, the basic model still remains the same - that customers sharing the
same risk features are categorised together into one rating group and then
separated out on the basis of their accident behaviour. One major implication of
this approach is the fact that among new customers without driving history, good
drivers will subsidise bad drivers for some time, until the premium reduction of
the good drivers takes effect, which may be a slow process extending over years.
Similarly, the rate increase for new bad drivers will lag their actual loss costs.
De-tariffing: While this may be socially desirable, the recent de-tariffing and
competition has made it possible for insurance providers to offer innovative rate
structures geared towards attracting and rewarding good customers while dealing
with bad customers individually on merits as much as possible. Detariffing
enables an insurer to shift from ‘rule based’ to ‘risk based’ underwriting and
rating. These rate structures differ from the traditional ones by considering many
more risk factors than before.
Data Mining: Data privacy and regulatory requirements may, however, prevent
widespread use of some of these data, but many more differentiators will begin to
be used in rate making than has traditionally been the case. Data mining is the
method of choice for managing the complexity introduced by using additional
variables. Using predictive modeling, major determinants for accident behavior
can be found, producing much smaller and more homogeneous subgroups of
drivers or insurance customers in general. Rate making will involve
determination of many niches of good and bad customers and result in rules that
can characterise these various groups.
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This shifts the emphasis of the industry from the problem of “determining
optimal premium” to the issue of “improving customer relationship” by:
Data mining is also the method of choice to monitor effectiveness of these goals
as well as performance of various rules developed for setting insurance
premiums.
Like for any other data mining task, the most fundamental requirement is
availability of appropriate and credible data.
The primary question to be addressed with data is setting of rates for new and
existing customers. Several of the variables may not be available for new
customers, in particular data on premiums, costs, and profitability. Data on
previous accident behavior may be incomplete or entirely missing, e.g. when
dealing with a newly licensed driver. In order to predict a rate in these cases, care
must be taken to exclude these variables from any rate-predicting model.
Rate Monitoring
In addition to rate setting, there is also the issue of "rate monitoring", i.e.
dynamically managing the rate structure for existing customers. This involves
analysing profitability of various risk classes and may result in taking corrective
action in case of under-performance or in the face of competitive pressures. It
may also involve a change in the "bonus malus" system.
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Pure Premium
The basic concepts, which are used in rate setting and rate monitoring, are the
"pure premium" and the "loss ratio".
Pure premium is the premium that would be sufficient to offset all accident claim
costs.
The pure premium is "rock bottom" of any premium structure: at that level an
insurance company would not generate a profit, but ideally, would not lose any
money either.
None of these costs are included in the pure premium - neither are underwriting
costs, such as commissions to agents and brokers included.
The actual premium therefore is always substantially higher than the pure
premium.
9 industry competition,
9 overcapacity,
9 customer pressure and
9 other relevant factors
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Without necessary capital or return on risk assumed, further volume build up will
not be permitted.
In case of Motor insurance, other things being common, which of the following
factors can lead to the prospect getting a lower rate compared to other prospects?
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9 The insured or the intermediary may not disclose information other than
asked for.
9 In a dynamic risk situation it would be essential for the underwriter to ensure
that real risk factors are fully exposed and that all relevant information is
called for.
9 Once relevant information is available, careless processing or understanding
of the information can also affect proper underwriting.
9 Research and development in insurer’s systems need to be strengthened and
underwriter needs to be kept updated on changes that need to be understood
so that correct information is sought for and obtained.
The cover that is to be structured must offer value to the customer and at the
same time must be correctly priced.
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Rating plans are normally designed to ensure that underwriting profit is obtained
on a portfolio of similar risks. Rating naturally follows the assumption that there
is a high degree of accuracy in exposure measurement and coverage structuring.
Pricing divergence from what is required can often happen if there is a false
belief in superiority of the underwriter’s personal judgment, as also to execution
errors and infatuation of meeting market pricing measures.
Poor underwriting and rating: These can set off a negative spiral. First of all
profitability begins to fall and then, on analysis, it is found that the information
contained in the proposals and policy folders is inaccurate and unreliable. As a
result, the actuaries and Head Office underwriters begin to build loadings on to
premium manuals due to prevalence of systemic under-pricing, poor data quality
and anticipated errors in underwriting execution.
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Product innovation
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Insurers identify the need for new products and services or for changes to
existing ones by collecting information from internal and external environments.
In addition, insurers monitor key indicators within a portfolio of policies. When
changes are identified in key indicators, the analysts will determine reasons and
make necessary changes to the products. New products and services or changes
to existing ones are undertaken only after significant research.
Insurers need to create an easy system for reporting of information from the
above sources as part of their regular activity. They should develop a system for
collecting and analysing the reported data. An efficient and meaningful analysis
will facilitate identification of potential need for development of new products /
changes to existing products.
The current customer trends can be studied from changes seen in the economy,
technology trends, consumer buying and so on. These will be reported in various
media.
Examples of this can be rapid rise of tourism and travel trade, steep penetration
seen in the sale of mobile phones, two wheelers etc.
c) Emerging trends
d) Market research
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The key indicators that can trigger need for changes in product are:
9 changes in number of new policies sold,
9 number of existing policies renewed,
9 loss ratio,
9 changes that can increase or decrease risk profile of the portfolio
3.4 Determining cost and benefits of new products & product changes
A study made by insurers that compares the likely costs of a product or service
with likely benefits, both:
9 to the customer (meeting the customers’ needs) and
9 to the insurer (meeting the profit and growth objectives)
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Once the proposals for new product / changes are approved by management of
the company, the new / revised product is filed with the Regulator (IRDA) as per
guidelines and marketed after completing regulatory formality.
A Frequency
B Severity
C Extent of concentration
D All of the above
Summary
¾ In the underwriting area, challenges for underwriter are considerable due to
continuous flux in the risk fields, new and emerging profile of losses and
unforeseen catastrophes that take place intermittently.
¾ New areas where underwriting challenges are occurring
9 New potential hazards
9 New vulnerabilities with hazards remaining the same
9 Untested insurance
9 Growing need for international insurance coverage
¾ Underwriters and actuaries have begun to construct more complex risk
classes by considering various additional differentiating factors.
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In case of Motor insurance, other things being the same, use of additional anti-
theft devices in a car can lead to a prospect getting lower rates compared to other
prospects.
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Answer to TY 2
The correct answer is D.
At the time of underwriting, exposure measurement is done on the basis of
following parameters:
9 frequency
9 severity
9 the extent of concentration and
9 similar other considerations
Self-Examination Questions
Question 1
Giving insurers the freedom to decide pricing of their products is known as
______.
A De-tariffing
B Re-tariffing
C Free-tariffing
D Market-tariffing
Question 2
The premium level at which an insurance company would not generate a profit,
but ideally would not lose any money either is known as _________.
A Net Premium
B Gross Premium
C Pure Premium
D Breakeven Premium
Question 3
________ the cover is an option that helps to secure a negotiated balance
between need for the widest cover desired by customer and obtaining a fair price
for the cover.
A Constructing
B Structuring
C Configuring
D Organising
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Answer to SEQ 1
Giving insurers the freedom to decide the pricing of their products is known as
de-tariffing.
Answer to SEQ 2
The premium level at which an insurance company would not generate a profit,
but ideally would not lose any money either is known as pure premium.
Answer to SEQ 3
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CHAPTER 12
Chapter Introduction
This chapter aims to provide you with an introduction to the relationships
between IT (information technology) and Underwriting.
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These include
9 development of real-time information access;
9 an electronic workspace for sales staff and underwriters to collaborate;
9 streamlined information and data collection with third-party providers;
9 reduced dependence on paper;
9 automation of simple underwriting decisions; and
9 analytical methods to reduce underwriting risk
A Impact of globalisation
B Challenging market conditions
C Slow and inefficient traditional methods of insurance process
D All of the above
In the process, different software applications / packages were built and deployed
on different platforms and languages by different business units; each one
catering to specific requirements of respective user departments.
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9 Underwriters,
9 Sales Teams,
9 Agents,
9 Channel partners like Bank assurance, corporate agents, Brokers, Reinsurers,
Co-insurers, T.P.A.s, Dealers, Corporate and individual clients,
9 Surveyors,
9 Advocates,
9 Banks,
9 Regulators and
9 Other stake holders
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The technology selected for automation of the insurance business process should
be state-of-the-art and next generation.
9 Underwriting
9 Policy administration
9 Premium collections and Financial Accounting
9 Claims administration
9 Client management - CRM
9 Brokerage & commissions
9 Banks – Bank Assurance & Finance
9 Work Flow management
9 Document and image management
9 Information ordering
9 Brokers, Agents, Loss Assessors Appraisal
9 T.P.A.
9 Business processor
9 Business intelligence
a) Data Mining
b) Risk Management
c) Rate Making
d) Product Development
e) Actuarial Issues
9 Co-insurers and Re-insurers Management
9 Compliance and Regulatory Issues
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1. The Internet not only provides customers direct access to the company, but
also now requires the company itself, and not just their agents, to directly
deal with customer regarding individual information requests, and the need to
manage prospects and customers effectively.
3. The result again is an increased focus on the customer, his needs, and
tailoring of insurance policies to fit those needs on a profitable basis for all
concerned.
Customer data do not consist any more of the data provided by the customer
when filling in an application form, but is enhanced with any data considered
relevant, limited by ingenuity, availability and legislation.
Common enhancements are data from other business transactions carried out
within the organisation, such as possible investment activities, or other life/non-
life insurance contracts, possibly including other companies, demographic
information, professional and personal information, and where permitted, general
financial, credit information, travel information, and conceivably anything left
behind as electronics trails (e.g. credit card transactions).
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In target marketing, the purpose is to identify group of prospects that are most
likely to be interested in a particular product. A common approach uses so-called
"predictive data mining".
Based on available data of customers who have or have not bought the product in
question, the most important characteristics distinguishing these groups are
determined using one of several modelling tools. These characteristics are then
used to score the likelihood that a prospect will acquire the product.
Often, the data are not already available, but need to be obtained in one or several
test campaigns. Also care needs to be taken, that only those data are used which
will be available for the prospects to be scored in cross-selling; the purpose is
similar, except we are attempting to sell an additional product to already
established customers. In the insurance industry, this turns out to be important for
bonding the customer: a customer is less likely to let a policy lapse if he owns
more than one product from the company.
In addition to predictive data mining, there are other techniques that can be
applied here, for example association analysis. In this type of analysis we could
determine which types of insurance products frequently "go together", e.g. occur
frequently in our customer database.
In addition to frequency, there are also other measures available that assess the
affinity among such products. In any case, we can look for such affinity product
groups that include our product we want to cross-sell. We then focus on all
customers who have all of the affinity products except for our cross-selling
product. These customers will then be the targets of our cross-selling effort.
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The techniques for fraud detection depend very much on the application
concerned. In areas such as mortgage fraud or health insurance fraud, the
emphasis might be on detecting suspicious relationships between the participants
involved.
For example, it might turn out that many accident victims are diagnosed by a
small set of doctors, or that high-cost producing referrals involve a small set of
doctors, or that a collection of property objects has frequently changed hands
recently, involving the same people, and increasing in price each time.
It not only involves various data mining business questions and techniques, but
also goes beyond data mining and may involve data management, warehousing
and customer interfacing issues at a minimum, often the entire organisational
structure and business processes as well.
In essence, data mining will allow to consider many more factors in the rate
making process than was possible before.
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An electronic workspace that stores all content and manages the end-to-end
process should be created for distributors and underwriting staff. The use of
middleware, application integration tools and XML will help insurers integrate
the workflow to agency management, point-of-sale and underwriting
workstations to support STP.
2. Rules Engines
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3.4 How best can insurers adapt their processes to leverage next-
generation underwriting systems?
Business rules engines remove people from generic processes and incorporate
their expertise into the system.
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Benefits can also be achieved in the financial bottom line, as well as throughout
the company.
For example, underwriting analytics and insight can be shared with other
departments, such as product development, claims and marketing, to help with
loss assessment, risk management and opportunity identification.
These benefits will provide strategic value to insurers and will drive dramatic
increases in operational efficiency in underwriting.
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Those companies that trust science have placed a premium on consistency in the
underwriting process, deeming regularity of the automated process to be more
important than human intervention. They recognise that only the most complex
risks or processing exceptions require direct intervention by underwriting staff.
They have been rewarded with higher profits and reduced losses.
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Wherever automated controls between the core processes are ad hoc, or at the
most, loosely coupled, these processes still require human intervention and time
for strategy changes and program enhancements. Creating a fully automated and
efficient underwriting process requires an insurer to determine which process can
be eliminated from the manual workflow. Each of the eliminations of a manual
routine underwriting process will lower costs and increase processing speed.
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Summary
¾ The insurance industry is moving from a product oriented industry to a
customer oriented service provider because of globalisation, deregulation and
technology.
¾ Insurers must develop new strategies and deploy technologies to automate
and manage the underwriting process better.
¾ Due to different aspects of computerisations, emphasis shifted from
traditional product portfolio to innovative products targeting selected
customer segments.
¾ The potentially vast collection of data on customers and prospects can be
analysed with data mining software for a variety of business concerns,
some of which are:
9 Target marketing
9 Cross-selling
9 Fraud detection
9 Customer Relationship Management
9 Rate making
9 Capital adequacy monitoring
9 Investment strategy
9 Reinsurance strategy
9 Allocation of capital
9 Strategy and business planning
¾ Predictive modelling, risk segmentation and product management are critical
components of underwriting.
¾ Benefits of technology based underwriting will provide strategic value to
insurers and will drive dramatic increases in operational efficiency in
underwriting.
¾ Underwriting has traditionally been viewed as both an art and a science.
However, it has long been said that life insurance underwriting is more an
art, than a science.
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All given causes are the reasons for need of IT application in insurance
underwriting.
Answer to TY 2
Answer to TY 3
Answer to TY 4
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Question 2
Which of the following has not been automated within the underwriting system?
Question 3
A Projected claims
B Selling and administration expenses
C Investment income
D Margin for a reasonable return on the capital employed
Question 4
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Question 5
Answer to SEQ 2
It is not usual to automate the client visit (although it could very occasionally be
done by video conferencing).
Answer to SEQ 3
Investment income is not part of rate making – income is a bonus, but globally
tends to be too volatile to be an effective part of rating – most insurers look to
ensure they make an underwriting profit excluding investment.
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Answer to SEQ 4
Answer to SEQ 5
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GLOSSARY
Enterprise wide Architecture: In the computer industry, the term is often used
to describe any large organization that utilizes computers. An intranet, for
example, is a good example of an enterprise computing system. The term
architecture can refer to either hardware or software, or to a combination of
hardware and software.
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Portal: a Web site or service that offers a broad array of resources and services,
such as e-mail, forums, search engines, and on-line shopping malls.
Rating Engine: A software application used for rating the products / proposals.
The rating engine analysing the existing data and application data and generates
the competitive rates.
Work Flow: Workflow at its simplest is the movement of projects and/or tasks
through a work process. More specifically, workflow is the operational aspect of
a work procedure: how tasks are structured, who performs them, what their
relative order is, how they are synchronized, how information flows to support
the tasks (workflow) and how tasks are being tracked. As the dimension of time
is considered in workflow, workflow considers "throughput" as a distinct
measure. A Workflow Application is where various applications, components
and people must be involved in the processing of data to complete an instance of
a process. For example, consider a purchase order that moves through various
departments for authorization and eventual purchase. The orders may be treated
as messages, which are put into various queues for processing. A workflow
process involves constant change and update. You can introduce new
components into the operation without changing any code.
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