IC 45 Underwriting III ebook

IC-45

GENERAL INSURANCE UNDERWRITING Acknowledgement: This course has been prepared with the assistance of P. C. James B. V. Sastry A. K. Padhiari K. G. P. L. Rama Devi V. Peri R. Srinivasan Y. Priya Bharat B. V. Sastry A. S. Chaubal We also acknowledge Get Through Guides, Pune for their contribution in preparing the study material.

INSURANCE INSTITUTE OF INDIA G- Block, Plot No. C-46, Near Dhirubhai Ambani International School, Bandra Kurla Complex, Bandra (E), Mumbai – 400 051.

GENERAL INSURANCE UNDERWRITING

IC-45

First Edition: 2010

All Rights Reserved This course is the copyright of the Insurance Institute of India, Mumbai. In no circumstances may any part of the course be reproduced.

Published by Sharad Shrivastva, Secretary-General, Insurance Institute of India, G- Block, Plot C-46, Bandra Kurla Complex, Bandra (E) Mumbai – 400 051 and Printed at ……

PREFACE This course is designed for the use of candidates of the Associateship Examination (non-life) of the Insurance Institute of India. The course covers the Principles and Practice of underwriting in all classes of non- life insurance. Specifically, the course explains the meaning, objectives and process of underwriting, describes the tools of underwriting and different methods of rate making and examines the impact of IRDA Regulations on issues of rating, underwriting, policyholders' protection etc. Finally the course includes Research and Development and I.T. Applications in underwriting which reflect value additions to the course. 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 No.

Title

Page No.

1

Introduction to Underwriting

1

2

Methodology and procedures of underwriting

22

3

Principles of ratemaking

35

4

Rating approaches in Pricing

52

5

File & Use of Regulations

79

6

Applications of File & Use Regulations

101

7

Tools of Underwriting

125

8

Types of Policies

150

9

Underwriting Profitability & Re underwriting Strategies

168

10

Protection of Policyholders' Interest

187

11

Research and Development in Underwriting, Rating and Product Innovation – Challenges ahead

198

12

I.T. Applications in Underwriting

215

Glossary

236

IC - 45 General Insurance Underwriting

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.

a) Understand the concept of underwriting. b) Learn about the process of underwriting. c Learn about differe different nt kinds of underwritin underwritin decisions. decisions.

1


1. Understand the concept of underwriting. [Learning Outcome a] 1.1 Introduction to insurance Insurance products have gained popularity in recent times as they offer security to individuals against financial losses that might occur due to some uncertain or unplanned events.

Insurance is a contract between the insurer and a policyholder/insured, where the insured pays premium as consideration and insurer promises to pay a certain amount of money or provide a defined service if an uncertain event covered under the insurance policy occurs during the policy term. Let us first understand the various terms used in this definition: a) Insurer: refers to a company that designs, endorses and sells insurance policies to the individuals. b) Policyholder/insured: refers to an individual or an organisation who purchases an insurance policy from the insurer by paying premium. c) Premium: it is the amount that is calculated using actuarial techniques aimed at ensuring that the insurer earns profit even after payment of certain claims.. d) Uncertain event: the uncertain event has to be covered in the insurance policy that has been purchased by policyholder. Insurance can be taken against any of the following uncertain events:  Risk of death or disability due to natural or accidental causes  Risk of disability and sickness  Risk of loss of or damage to property due to natural or unforeseen events etc. Insurance can also be defined as follows:

Insurance refers to the risk transfer cum-sharing mechanism, where risk of an individual is transferred to another, by way of pooling of risks among a group of individuals who are exposed to similar kinds of risk, in exchange for a premium.

2


Based on the above definition, the main features of insurance can be summed up as follows: 

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.



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.



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 ris k affecting the group. This is i s 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.

1.2 Introduction to General Insurance As per IRDA, “Insurance other than ‘life insurance’ falls under category of general insurance”. General insurance business in India can be broadly categorised as follows:  Insurance of property against fire, theft, etc.  Insurance of loss of income such as Loss of Profits or Business Interruption insurance,  Personal insurance such as accident and health insurance  Liability insurance that includes legal liabilities

1.3 Introduction to underwriting Underwriting is a core insurance function which can be defined as follows.

Underwriting refers to the process by which insurability of the ‘risk’ is evaluated, which helps in taking decisions regarding acceptance or rejection of the risk.

3


Features of underwriting The main features of underwriting are as follows: a) To determine the level of risk presented by the proposer

Underwriting is the process of determining the level of risk presented by a proposer and deciding whether to accept it for insurance and, if so, at what terms and at what price. b) To classifty risk based upon the risk characteristics

Underwriting attempts to classify risks based upon their characteristics so that each insured in a specific class pays a premium in proportion to the likelihood that a covered loss may occur. Understanding the concept of risk sharing or pooling makes it easier to understand the role of underwriting and risk classification in insurance. The simple fact is that – ‘not all risks are equal’. 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.

In the field of property insurance, wooden structures are at a greater risk of burning than stone structures; hence, a higher premium is required to insure a wooden structure.

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. c) To ensure that the insurance business is conducted on sound lines

Underwriting is a methodological approach to ensure that the insurance business is conducted on sound lines and that risks offered for insurance are evaluated for loss potential on both frequency and severity over a period of time over which the liability may flow to the insurer.

4


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 case of vehicle insurance, an insurance company might charge higher premium in the case of:  young drivers,  old models of vehicles,  drivers with a history of accidents 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.

In case of property insurance, an insurance company may inspect propertieswith respect to their exposure to fire risk, theft risk etc. Accordingly, underwriters may offer reduced premiums for properties that have safety features such as sprinkler systems.

1.4 Purpose and Objectives of underwriting By purchasing an insurance policy, a policyholder transfers his risk to the insurance company against which he needs to pay a certain amount as premium. The main purpose and objective of underwriting is deciding level of acceptability, adequacy of premium & other terms for such a Risk Transfer.

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.

5


The insurance company assumes the risk it takes on by charging premiums and setting deductibles. 

If premium is kept low : If a company charges too little, it could become insolvent when large claims, whether by frequency or severity, are filed.  If premium is kept too high : If a company charges too much, it will lose business to its competition, and face regulatory hurdles as well.

Hence, underwriters have the challenge to ensure that they correctly assess the risk and accordingly charge the appropriate premium.

1.5 Profile of an underwriter The profile of an underwriter may be understood by what he does in the insurance organization. Insurance companies are in the business to protect individuals and organizations from financial loss by assuming risk—risks of motor accident, property damage, illness and other occurrences. 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         

Analyse proposal forms and do background check on proposer. Identify and Assess the level of risk Evaluate the risk of loss Establish who can be given coverage Decide on special terms and conditions that can be offered for accepting the risk Determine the appropriate premium, and the terms and conditions for providing insurance cover. Write policy wordings Negotiate with insurance brokers and the proposer Monitor account information

6


b) Underwriters use computer applications to manage the risks they underwrite more efficiently and accurately. These systems   

analyse and rate insurance proposals, recommend acceptance or rejection of the risk, and adjust the premium rate in accordance with the risk

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.

1.6 Importance of underwriting Underwriting is important to different entities from different perspectives. a) Insurers

For Insurance companies underwriting is a core activity. The underwriting capacity it has helps to offer value to consumers in terms of  Risk reduction,  Risk improvement and  Risk transfer. Underwriting is a key differentiator enabling the insurer to stay competitive, and at the same time, be solvent and profitable. 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.

7


c) Agents and brokers

Underwriting is important to Brokers and Agents as it will match the needs of consumers with the standards set by insurers. It helps the intermediary to appreciate the philosophy of the insurer, help clients to improve their loss profile, give customer satisfaction and also help in business growth. 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.

The underlying principle of _____________ is that in a group, only few individuals (and not all) would sustain losses due to the occurrence of an uncertain event. A B C D

Law of large numbers Underwriting Risk Transfer Broking

2. Learn about the process of underwriting. [Learning Outcome b] 2.1 Important factors in the process of underwriting As discussed earlier, underwriting is the process of determining whether a risk offered for insurance is an acceptable risk, and if so, at what rate the insurance cover will be accepted. 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.

8


Some important factors that need to be considered by an insurer in the underwriting process are: a) To maintain equity and sustainability

An insurer has a responsibility to its current policyholders to ensure that it will be able to meet all the contractual obligations of its existing policies. If the insurance company issues policies on risks that are uninsurable or risks that require premiums higher than what the insurer charges, the insurer’s ability to meet its contractual obligations is jeopardized. b) To protect consumer’s long term interest

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

Regulation is another important factor in the underwriting process. In order to protect consumer’s long term interests and to protect policyholders against insolvency or other malpractices, an insurer is regulated by an insurance regulator in many countries. In India, the insurance regulator is the Insurance Regulatory and Development Authority (IRDA). IRDA, in tune with the best practices of insurance tradition, expects the insurer to establish reasonable, nondiscriminatory standards for accepting risks. The premium rates for many types of insurance must be approved or should be within the framework of guidelines issued by the Regulator.

2.2 Process of underwriting The process of underwriting involves four basic functions: a) Selection of risks, b) Classification and rating, c) Policy forms, and d) Retention and reinsurance. The first 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 he proceeds to classify and rate the risk and issues the relevant policy.

9


The underwriter also performs a fourth, separate function before underwriting is complete: reinsurance. Diagram 1: Process of underwriting

The first three processes are interdependent. By performing these four functions, the underwriter increases the possibility of securing safe and profitable distribution of risks in his books. a) Selection of risks

In this step, the underwriter decides whether or not to accept a particular risk. It involves  securing factual information from the Proposer via the proposal form,  evaluating that information, and  deciding on a course of action Underwriting involves examining material disclosures in proposal forms, and supporting documents such as Inspection Reports, Valuation Reports/ appraisals or bills that certify the value of property, or medical reports that verify the health condition of an individual. b) Classification and rating

Once the risk has been accepted, the underwriter then classifies and rates the risks.

10


Classification of risk

The purpose of using classifications is to separate risks into homogeneous groups to which rates can be assigned. Several tentative classifications may be tried out before a final decision on classifying the risk is reached. 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 

Insurers look at past trends and changes in the current environment that may affect potential losses in the future.  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.  Underwriters also use experts such as engineers and surveyors to make site inspection reports and evaluate the risks through their findings.  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.

11


For insurer

From the point of view of the insurer, 

The rates in the aggregate must be sufficient to provide for the payment of claims, expenses and taxation and leave an adequate margin for catastrophes and profit.



It is also important that the rates in any class should not be excessive because the premium should be affordable and equitable to the consumer and the business should not be lost to a competitor making its own rates on a more reasonable basis.

Unless these requirements are met, it is impossible to survive and grow in a dynamic insurance market. For insured

From the point of view of the insured, reasonable rates imply that he should not be required to pay more than a sufficient sum to cover the hazards involved, together with a reasonable charge for expenses, catastrophes and profits. It is very difficult to determine an adequate amount of premium in principle, let alone on a case case to case basis. There can be numerous factors that might might affect the risk associated with an individual. Hence, it would be very difficult for an actuary to consider all those factors and accordingly rate them. Also it is interesting to note that in Life insurance, vast majority of lives are accepted at rates which involve only one factor, namely, ‘age’, although there are many other factors which are known to have some bearing on mortality. A rating structure should not be so complicated that it becomes difficult or expensive to apply. 

For classes involving small units, the application of the system must be as standardised as possible.  For a class involving large size of individual units, greater complexities can be reasonably built in to produce greater rating accuracy.

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.

12


c) Policy forms

After determining the acceptability of a risk and assigning proper classification and rating, the underwriter dealing with that particular class of risk, is ready to issue an insurance policy. 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. d) Retention and reinsurance Reinsurance

Reinsurance in simple terms is insurance of insurance. It is a mechanism used by insurers to spread risks in order to limit their exposure to claims which might arise on policies of insurance which they have issued. . Reinsurance ensures that no one insurer is overburdened while offering covers to policyholders. Catastrophes, large losses or a series of losses, new and unexpected liabilities, etc. can create risks & affect profitability of the insurer.Thus, a decision needs to be taken while underwriting on the amount that will be retained in the insurer’s books and on the method of appropriate reinsurance for the balance. Therefore, reinsurance becomes an essential part of underwriting as it is a tool to help the insurer to:  expand its underwriting capacity,  maintain earnings stability, and  reduce the requirements of creating large reserves

Which of the following is incorrect? A B C D

Rates are the same as premiums. A rate is the price of a given gi ven unit of insurance. Rates vary according to the likelihood and potential size of loss. Rate making is the process of calculating a price to cover the future cost of insurance claims and expenses.

13


3. Learn about decisions.

the

different

kinds

of

underwriting

[Learning Outcome c] 3.1 Types of underwriters 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. Diagram 2: Types of Underwriters

14


3.2 Underwriting decisions 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. Diagram 3: Underwriting decisions in Risk Evaluation

a) Policy to be issued on a preferred basis

If a proposal falls within the lowest risk boundaries of underwriting standards, the policy is issued on a preferred basis. 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. b) Policy to be issued on a standard basis

Proposers who are issued policies with standard rates fall within the normal boundaries of underwriting standards for that type of policy.

15


Underwriters base their determination that a policy should be issued on a standard basis on an analysis of the characteristics of the risk represented by the Proposer. c) Policy to be issued on sub-standard basis

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. 

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.



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.

Dealing with substandard Proposers by limiting policy benefits is common in commercial coverage. 

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.

16


These underwriting standards take into consideration many items, such as  regulations that require the insurer to establish adequate rates,  laws that mandate that certain factors cannot be used to decline a proposal, or  the proposal is contrary to various insurance principles and practices such as those of insurable interest, utmost good faith or indemnity Proposals which are against public good and violate the laws of the country would also be not insurable.

3.3 Monitoring of underwriting decisions Once a policy is issued, underwriters continue to monitor the policy from an underwriting perspective. Such monitoring is done at  policy renewal, or  at periodical intervals such as every six or twelve months, or  as and when a claim occurs. Depending upon the type type of policy and its provisions, rates & terms terms of cover 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.

If a proposal falls within the lowest risk boundaries of the underwriting standards, then which of the following decisions can be taken by an underwriter? A B C D

Policy to be issued on a preferred basis. Policy to be issued on a standard basis. Policy to be issued on a substandard basis. Proposal to be declined.

17


Summary 

 



  

  

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. As per IRDA, “Insurance other than ‘life insurance’ falls under the category of general insurance”. 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. 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. Underwriting is a key differentiator enabling the insurer to stay competitive, and at the same time be solvent and profitable. Underwriting is important to Brokers and Agents as it will match the needs of consumers with the standards set by insurers. 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. The purpose of using classifications is to separate risks into homogeneous groups to which rates can be assigned. ‘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. Reinsurance ensures that no one insurer is overburdened while offering covers to policyholders.

Answers to Test Yourself Answer to TY 1

The correct answer is C. 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.

18


Answer to TY 2

The correct answer is A. Rates are not the same as premiums. Answer to TY 3

The correct answer is A. If a proposal falls within the lowest risk boundaries of the underwriting standards, then the underwriter can issue the policy on a preferred basis.

Self-Examination Questions Question 1

ABC insurance company is a new entrant in the insurance market. As a marketing strategy, it has decided to accept the risk at lower premium rates as against the prevailing market rates. What could be the repercussions of this? The insurance company will lose business to competitors It will face regulatory hurdles The insurance company could become insolvent when large claims, whether by frequency or severity, are filed. D It will earn profit by maximizing sales. A B C

Question 2

___________ensures that no one insurer is overburdened while offering covers to policyholders. A B C D

Risk pooling Risk sharing Underwriting Reinsurance

19


Question 3

Which of the following decisions is incorrect when a risk is not deemed to be outside underwriting standards, but is considered to be of high risk within those standards? A B C D

Issue the policy with a higher premium Issue the policy with limited benefits Issue the policy on a preferred preferred basis Issue the policy with certain exclusions

Question 4

Which of the following is the insurance regulator in India? A B C D

The RBI The IRDA The Government of India The Department of ministry and finance

Question 5

According to ______________________, 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. A B C D

Risk transfer Risk sharing Pooling of risk Law of large numbers

20


Answers to Self-Examination Questions Answer to SEQ 1

The correct option is C. The insurance company could become insolvent when large claims, whether by frequency or severity, are filed. Answer to SEQ 2

The correct answer is D. Reinsurance ensures that no one insurer is overburdened while offering covers to policyholders. Answer to SEQ 3

The correct answer is C. If a proposal falls within the lowest risk boundaries of the underwriting standards, then only the underwriter can issue the policy on a preferred basis. Answer to SEQ 4

The correct answer is B. The IRDA is the insurance regulator in India. Answer to SEQ 5

The correct answer is D. 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.

21


CHAPTER 2

METHODOLOGY AND PROCEDURES OF UNDERWRITING Chapter Introduction This chapter aims to provide you with an understanding about the various steps involved in the underwriting process.

a) Understand the underwriting procedure.

22


1. Understand the underwriting procedure. [Learning Outcome a] 1.1 Underwriting skills Underwriting needs a combination of various skills. Before the underwriter accepts the risks, he would be expected to:  Visualise potential risks: Clearly visualise the property or interest to be insured and the variety of potential risks that can cause losses to them  Estimate probability of peril operation: Estimate the probability of operation of peril to be insured in relation to both ' frequency' and 'severity' of losses  Estimate liability: Estimate the extent of liability that may arise due to the operation of a peril and the claims processing implications 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.

1.2 Classification of underwriting of risks 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: a) Property risks such as a manufacturing plant, machinery and building b) Business interruption risk c) Personnel risks such as policies relating to personal accident insurance and health insurance

23


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. Diagram 1: Broad classification of underwriting of risks

1.3 Underwriting of new business Acceptance of new business is one of the main underwriting functions. This is done based on the knowledge and skills of the underwriter who is authorised to do so. Where the insurance is complex or is of high value, senior officer will either assist or underwrite such risks. Each insurer has its own manuals of underwriting instructions. 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

24


1.4 Scrutiny of the proposal A completed proposal form gives:  details of the insured,  details of the subject matter,  type of cover required,  details of the physical features both favourable and adverse including type and quality of construction, elevation, age, presence of firefighting equipments, the type of security etc.  previous insurance and  claims history Diagram 2: Proposal Form

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.

25


1.5 Limit of acceptance 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. Viewed in another perspective, insurers generally allow their operating offices to underwrite classes of business where the claims experience does not vary to a large extent unless affected by catastrophic losses. Examples of these classes are personal line insurances like motor policy, mediclaim policy and householder’s policy etc. Limits of acceptance could also be dependent on the type of assets or persons to be covered or geographical areas where the risks are not normal or standard. Thus depending on the underwriting standards adopted by each insurer the limits of acceptance can vary across various parameters.

1.6 Acceptance subject to controlling office approval 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. Some of these classes could be: a) Aviation b) Fire and Machinery Loss of Profit Insurance c) Industrial All Risk Policy d) Public Liability, Products Liability etc. e) Jeweler’s block beyond a specific sum insured f) Contractor's All Risk / Erection All Risk etc.

1.7 Acceptance of extra-hazardous risks 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

26


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. Some examples of such risks in different classes of business are: a) Fire  Ammunition works  Camphor boiling works  Celluloid and celluloid articles factories  Explosive factories and premises  Fire wood / bamboos in the open  Fireworks factories and premises  Match factories and matches in transit b) Marine  Bullion (gold), currency notes over specified limits  Bulk cargo on terms wider than I.C.C.(C)  Cement in bags on terms wider than I.C.C.(C)  Deck cargo on terms wider than I.C.C.(C)  Galvanised iron sheets on terms wider than I.C.C.(C)  Second-hand machinery against breakage  Oil in second hand drums against leakage and contamination  Perishable goods and sea foods etc.  Salt on terms wider than I.C.C.(C)  Sugar against 'all risks' terms c) Miscellaneous  Burglary: Jewelers, dealers in precious stones, curios and antiques, gold and silver smiths  Cash-in-transit: Proposals involving large carrying without adequate escort arrangement  Fidelity guarantee: Employees remunerated on commission basis  Workmen’s compensation insurance: Fireworks / gun powder / explosives manufacturers, collieries and mines of all descriptions, quarries of all descriptions

27


1.8 Acceptance of risks subject to underwriting safeguards Certain risks are allowed to be accepted by the operating offices provided certain loss minimising measures are taken.



Special perils (flood etc.) under fire insurance policy may be accepted subject to inspection of the risk and satisfactory flood prevention measures.  Consequential loss (fire) policy may be granted only to clients, whose books of accounts are regularly audited by a reputed firm of auditors.  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 may be accepted subject to inspection of the vehicle and imposition of excess.  Certain types of vehicles may be covered only for 'Act only' risks.

Imposition of exclusions in marine insurance

In marine insurance, acceptance of some types of proposals is subject to imposition of exclusions. Examples are: Proposal for Asbestos cement pipes and sheets Transformers

Refrigerators and air conditioners Cargo in paper bags Glass Sanitary ware Second hand machinery Oil in second hand drums Motor spare parts, ball bearing Motor vehicles

Exclusion Breakage is excluded

Breakage is excluded and excess imposed on leakages Denting and scratching are excluded Tearing and bursting of bags is excluded Breakage, scratching and chipping and denting is excluded Breakage, chipping and denting is excluded Breakage is excluded Leakage and contamination is excluded Theft, pilferage and non–delivery is excluded Denting and scratching excluded

28


In marine insurance, the cargo carrying vessel is an important underwriting factor. Whereas normal rates are charged for cargo carried on vessels which conform to standards prescribed (e.g. liner vessels not over certain years old), extra rates are charged if the vessel is over certain years of age (overage) or the tonnage is below the prescribed limit (under-tonnage).

1.9 New Business Procedure 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 

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.



Limits of acceptance: Reference is also made to the limits of acceptance to ensure that the sum insured accepted is within these limits. These limits vary according to the type of risks and are determined on the basis of reinsurance arrangements.



Reinsurance arrangement: If the sum insured exceeds these limits, it is necessary to arrange reinsurance before acceptance. This is done at the Corporate Office level.



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.



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.

29


Issue of policies 

Policy preparation and stamping: When complete particulars of the risk are available the policy is prepared and stamped in accordance with the Indian Stamp Act.



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.



In marine open policies , in addition to the policies, certificates serially numbered are issued which may be required in respect of specific consignments. The certificate incorporates such information as policy number, name of the insured, sum insured, terms of insurance and details of premium etc.



In motor insurance, in addition to the policy, a certificate of insurance is issued. This document is required to be issued under the provisions of the Motor Vehicles Act, 1988, as evidence of insurance cover in respect of legal liabilities to third parties compulsorily insurable under the Act.



Renewal: The policies are entered in a renewal register or an expiry register according to the date and month of renewal to facilitate the procedure of inviting renewal at the appropriate time.

1.10

Underwriting of renewal business

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 po licy is not automatic. It depends upon the consent of the insurers to renew the policy and the payment of premium.

30


Renewal notice: It is important to note that there may be no strict legal obligation on the part of insurers to renew the policy or even to invite renewal. However, as a matter of courtesy and good business policy, insurers issue a renewal notice to the insured, usually a month in advance of the date of expiry. If for any reason, they are not interested in the renewal of the policy, they give previous notice to the insured to that effect. Renewal methods

Renewal of policies can also be utilised to review underwriting results and take corrective steps.     

There are a number of renewal methods that can be incorporated in policy conditions such as: Non-cancelable renewals: Renewals are assured and without any changes Guaranteed renewals: Changes not usually made in the terms of the policy but premium rates can vary based on underwriting results Non-renewable for stated reasons such as on reaching a specified age Optionally renewable: Subject to re-evaluation of risk by the insurer which can include review of premium and modification of the terms and conditions.

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. Under certain types of insurances, adjustment of premium has to be made at renewal. For example, under money-in-transit insurance, the premium is calculated on basis of the actual amount of money in transit during the period of insurance. If premium so calculated differs from the provisional premium then premium shortfall is collected or excess premium refund is made, as the case may be. Similar practice is also followed in fire and marine declaration policies and workmen's compensation insurance.

31


Reinsurance programme: Insurers formulate their reinsurance programme well in advance for the new financial year and file it with Insurance Regulatory and Development Authority (IRDA).Within the broad framework of the reinsurance programme, the insurer operates its day to day reinsurance activities. (This topic is dealt with in Chapter 7)

(Note: The step by step procedure described above is based on manual operations. With the use of IT applications, the process is made automatic based on software design for the purpose).

At the time of underwriting a proposal, the underwriter has to estimate the probability of operation of peril to be insured in relation to ________. A Frequency of losses B Severity of losses C Both frequency and severity of losses D None of the above

Summary 



 



 

Before accepting the risk the underwriter is expected to visualise potential risks, estimate the probability of peril operation and estimate the extent of liability. The underwriting of risks can be classified into the following broad categories: property risks, business interruption risk, personnel risks, liability risks, package policies. The underwriter scrutinises the proposal and may arrange for pre-acceptance survey of the risk depending on the nature and value of the risk. 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. 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. Risks regarded as extra-hazardous are normally declined. These risks are commonly referred to as Declined Risks. Certain risks are allowed to be accepted by the operating offices provided certain loss minimising measures are taken.

32




If the sum insured exceeds limits of acceptance, it is necessary to arrange reinsurance before acceptance. This is done at the Corporate Office level.  Renewal of general insurance policies is not automatic. It depends upon the consent of the insurers to renew the policy and the payment of premium.  Renewal methods include: non-cancelable renewals, guaranteed renewals, non-renewable, optionally renewable.  Insurers formulate their reinsurance programme well in advance for the new financial year and file it with Insurance Regulatory and Development Authority (IRDA).


The correct answer is C. At the time of underwriting a proposal, the underwriter has to estimate the probability of operation of peril to be insured in relation relat ion to t o both bot h 'frequency' and 'severity' of losses.


Which of the following is true for reinsurance programme? The insurer needs to formulate their reinsurance programme well in advance for the new financial year. B The insurer needs to formulate their reinsurance programme on a half yearly basis C The insurer needs to formulate their reinsurance programme on a quarterly basis D The insurer needs to formulate their reinsurance programme on a monthly basis A

33


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 B C D

Branch manager Controlling office Regional office Corporate office

Question 3

Extra hazardous risks that are normally not accepted by the insurer are commonly referred to as ________. A B C D

Rejected risks Forbidden risks Declined risks Prohibited risks


The correct option is A. The insurer needs to formulate their reinsurance programme well in advance for the new financial year. Answer to SEQ 2

The correct answer is B. 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. Answer to SEQ 3

The correct answer is C. Extra hazardous risks that are normally not accepted by the insurer are commonly referred to as declined risks.

34


CHAPTER 3

PRINCIPLES OF RATE MAKING Chapter Introduction This chapter aims to provide you with an introduction to the basic principles of rate making and related issues.

a) Understand the concept of ratemaking. b) Learn about the process of ratemaking.

35


1. Understand the concept of ratemaking. [Learning Outcome a] 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. Underwriting is the process of  classifying the subject matter according to their degree of insurability  evaluation of risks to which they are exposed  to decide on their acceptance to decide on terms and conditions and  charge appropriate rates of premium

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  the projected claims based on both experience and exposures,  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.

1.3 Objectives of a premium rating system There are subsidiary objectives while developing a premium rating system apart from the above mentioned. These are: a) Stability: Rates should remain stable over a period of time

36


b) Responsiveness: Rates should respond to changes in loss exposures.

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. c) Contingencies:It should provide for contingencies, whereby some loadings are built in for the unknown and the unknowable; d) Incentive(s) to insured: It should offer necessary incentive to the insured, that is, incentives should be built into the rates to encourage the insured to avoid losses and in case of a loss to minimise the loss costs. Diagram 1: Objectives of Premium Rating System

1.4 Types of rating Rating can be 

Generic rating: it will be rated as per an internal manual or guidelines prepared by the insurer for risks of the same class or category, or



Individual rating: there can be individual experience based rates or where experience is not available, based on the analysis of exposure made by the underwriter.

37


Though ratemaking for risks as per in-company manuals, involves the use of mathematical and statistical data and tools, it also requires  understanding of risks and their behaviour  the use of sound judgement acquired through experience and knowledge,  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. 

Internally the review is required in the light of competitive forces at play in the market.



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.

1.5 Making the rating structure 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. In fire insurance, there can be various rating factors involved such as a) the type of construction, b) the age of construction, c) the height of the building, d) the proximity to other buildings, e) the nature of locality etc. Rating Factors 

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.  These rating factors can help to reflect the identified differences in loss propensity.

38




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.  If there is failure to consider the adverse features of a risk, the rate will be b e 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.

1.6 Frequency and severity of losses While assessing the risk characteristics, the rating plan broadly looks at risks on two sides of a matrix which has  on one side the frequency of losses and  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. A B C D

File and Use Fill and File File and Upload Download and File

2. Learn about the process of ratemaking. [Learning Outcome b] 2.1 Process of Ratemaking The basic method of forming rates generally follows one of the two basic approaches: a) pure premium method b) loss ratio method

39


a) Pure premium method

A simple illustrative example is given below to introduce the concept of pure premium, followed by mathematical equations in subsequent paragraphs.

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. The pure premium is expressed in the formula L V

x 100

Where, L is losses V is value of all the cars Losses = Rs. 5 lac x 5 = Rs. 25 lacs Values = Rs 5 lacs x 1000 = Rs. 50 lacs 25,00,000 50,00,00,0 00

x 100

=

0.5%

The pure premium (i.e. the premium which is sufficient only to pay losses) is Rs 2500/- (0.5% of the value per car) Pure premium is also known as the “Burning Cost”.

In arriving at the final rate of premium the pure premium is loaded to provide for the following   

Business Procurement costs e.g. agency commission, brokerage etc. Expenses of management Margin for unexpected heavy losses and  Margin for reasonable profit for insurers

40


Mathematical Equation

The formula for pure premium method is R =

P+F 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 b) Loss ratio method

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 The target loss ratio is obtained by the following ratio T=

1−V −Q 1+G

Where, G = Ratio for non-premium related expenses to losses Q = Profit and contingencies factor V = Premium related expense factor

41


Experience loss ratio is obtained by the formula W=

L 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: Pure Premium Method

Loss Ratio Method

Based on exposure Does not require existing rates

Based on premium Requires existing rates

Gives indicated rates

Gives indicated rate changes

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.

42


2.2 Trended, Projected Ultimate Losses Trended, projected ultimate losses are of paramount importance in the rate making exercise. The projection can be on a pure loss basis or on allocated loss adjustment basis. However, as often the unallocated loss adjustment data is not available, such costs are treated as part of the expenses loading. Of significant importance is the method and techniques for projecting unpaid and unreported losses to their ultimate settlement values. Usually this is done through what is known as the loss development method. 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. Diagram 2: Loss Development Method

In the triangle 

the horizontal movement to right represents the claims development over time  the vertical line downward represents change in exposure level and  the positive-sloped diagonal represent the evaluation data

43


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

An important trend affecting ratemaking data is the trend in severity. Inflation, court awards, medical inflation and such other costs are factors, which cause upward trends in loss severities. Frequency is also subject to trend. 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.

2.3 Loading Factors There are expenses such as commission, taxes (service tax) and expenses of management which are generally paid on the basis of direct written premium. Profit as an element of insurance pricing relates to the reward expected by the insurer for doing the business and is determined by  company’s profit objective,  rate of investment return and  regulatory approach to profits being made by insurers Contingency loading represents a provision for adverse deviation or a risk loading. There are two risk elements in ratemaking known as a) parameter risk and b) process risk a) Parameter risk is the risk associated with selection of the parameters underlying the applicable model of the process. Thus selecting the wrong development factor can lead to under-pricing. b) Process risk is the risk associated with the projection of future contingencies, which are inherently variable.

44


2.4 Individual Risk Rating Where individual risks are large enough so that their experience is to some extent ‘credible’, individual rating of such risks can be considered. Individual rating is normally done for various reasons such as  the price charged to the large risk is charged more realistically or  to encourage and motivate more risk control programs or  to reflect the modification, if any, in the design of cover specially provided Types of individual risk rating systems

There are two types of individual risk rating systems: a) Prospective and b) Retrospective a) Prospective Systems

Prospective systems use past experience so as to determine the costs of coverage for the future. 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.

2.5 Experience Rating 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.

45


Thus losses need to be adjusted to reflect  economic and social inflation  changes in the number, size and types of units  changes in policy limits, terms and conditions 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 following combinations are usually used: a) Actual paid losses to expected paid losses b) Reported losses and expected losses c) Projected ultimate losses d) Projected ultimate losses for the experience period adjusted to the current exposure and inflation levels 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.

2.6 Composite Rating 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: a) Rates shall not be excessive, inadequate or unfairly discriminatory.

46


b) Normally a rate will not be considered excessive in a competitive market. Rates will be considered excessive if they are likely to produce a profit that is unreasonably high in relation to past and prospective loss experience, or if expenses are high in relation to services rendered. c) A rate is inadequate if together with the investment income attributable to it, the insurer fails to satisfy that the rate will cover projected losses and expenses. d) A rate can considered unfairly discriminatory in relation to another in the same class if it inequitably reflects the differences in expected losses and expenses. Similarly for a risk or group of risks the discounts, credits or surcharge among the risks do not bear a reasonable relationship to the expected losses or expenses unfair discrimination may be held against the rates filed. 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. f)

Risks may be classified in reasonably traditional ways.

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. How much will be the pure premium? A B C D

Rs 15 Rs 150 Rs 1500 Rs 500

47


Summary 



  

 

    

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. 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. Rating can be generic or individual 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. While assessing the risk characteristics, the rating plan broadly looks at risks on two sides of a matrix which has  on one side the frequency of losses and  on the other the severity of losses 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. 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. The loss ratio method is used to indicate rate changes rather than rates per se. An important trend affecting ratemaking data is the trend in severity. There are two risk elements in ratemaking known as: parameter risk and process risk. There are two types of individual risk rating systems: Prospective and Retrospective. Composite rating is a tool to rate large complex risks and where detailed inspection and audit is carried out.

48



The correct answer is A. 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

The correct answer is B. The pure premium will be calculated as follows: Loss = 75,000 X 2 = Rs. 1,50,000 Value = 75000 X 1000 = Rs 7,50,00,000 1,50,000

X 100

7,50,00,00 0 0.2% 0.2% of Rs 75,000 will be Rs 150


While assessing the risk characteristics, the rating plan broadly looks at risks based on ___________ A B C D

Frequency of losses Severity of losses Both of the above None of the above

49


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 B C D

Rs 250 Rs 2500 Rs 500 Rs 5000

Question 3

The _________ is used to indicate rate changes rather than rates per se. A B C D

Loss ratio method Pure premium method Both the above Neither of the above

Question 4

____________ use past experience so as to determine the costs of coverage for the future. A B C D

Prospective systems Retrospective systems Both the above Neither of the above

50



The correct option is C. 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

The correct answer is B. The pure premium will be Rs 2500. Answer to SEQ 3

The correct answer is A. The loss ratio method is used to indicate rate changes rather than rates per se. Answer to SEQ 4

The correct answer is A. Prospective systems use past experience so as to determine the costs of coverage for the future.

51


CHAPTER 4

RATING APPROACHES IN PRICING 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.

a) Understand the concept of insurance pricing and its importance. b) Learn about premium rating methods - the class rating method. c) Learn about premium rating methods - the individual rating method.

52


1. Understand the concept of insurance pricing and its importance. [Learning Outcome a] 1.1 Introduction The insurance sector is different from other commercial sectors as it does not offer any tangible physical product.  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.  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.  The insurance industry estimates any future payments it may have to make based on actuarial methods.

1.2 Insurance pricing Insurance pricing is also known as rate making.

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.

Theoretically, the insurance pricing or premium rate should be determined mathematically and statistically with the principle of law of large numbers and by using a credible process of loss forecasting based on an analysis of the probability, frequency and severity of loss for the risk that is to be covered. Rate

Rate can be defined as the price per unit of insurance against each exposure unit.

53


The business of insurance presumes an exposure to loss. 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. There can be following 2 cases with respect to rate making: 

No possibility of loss: if there is no possibility of any future loss, then there will be no need for insurance.



Possibility of loss : If an entity does have an exposure to loss, it is desirable that the cost of transferring that loss, or the risk premium, to another party is proportional to the expected loss, which is assumed to vary with the exposure.

Hence, there is a need to devise ways and methods for arriving at the most appropriate premium rate corresponding to the expected losses.

1.3 Rate adequacy measurement In insurance business, rate adequacy measurement is quite complicated because the insurer cannot foresee the actual costs at the time of selling the policy. Price is estimated through loss forecasting methods based on a sound statistical framework. 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:  The peculiarities of the individual products themselves,  The availability of historical data concerning premium and claims statistics,  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.

54


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: 

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.



Individual rated products- include all such insurance products where premium is determined based on an individual’s exposure to loss.

Diagram 1: File and use guidelines of IRDA

55


These two major categories of products are further sub-divided under file and use guidelines as follows: 1. Class rated products: These are further classified as a) Internal Tariff rated products

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.

Examples of internal tarriff rated products are:  Motor insurance  Health insurance  Personal accident insurance b) Packaged or customised products

These general insurance products are specifically designed to suit the requirements of an individual customer. The terms, conditions, rates and scope of insurance cover etc. are specially customised to meet the t he individual’s needs. 2. Individual rated products. These are are further classified as a) Individual experience rated products

These include products where rates, terms and conditions, are determined depending on the actual past experience of the insurance company relating to claims.

Examples of individual experience rated products are:  Cargo insurace  Hull insurance  Health insurance b) Exposure rated products

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.

56


Natural disaster risk such as earthquake, flood, tsunami etc.

a) Insurance of large risks

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:  Insurance worth a total sum insured of Rs 2500 crore or more at one location for property insurance, material damage damage and business interruption combined  Rs 100 crore or more per event for liability insurance

Internal tariff rated products is an example of _____________ A Class rated products B Individual rated products C Exposure rated products D Insurance of large risk

2. Learn about premium rating methods - the class rating method. [Learning Outcome b] 2.1 Introduction to premium rating methods 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. Hence, different premium rating methods include: a) Class rating method  Pure premium method  Loss ratio method b) Individual or merit rating method  Schedule rating method  Experience rating method

57


Diagram 2: Premium rating methods

2.2 Class rating method 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.

Class rating method can be applied only when:  

Factors that might cause losses can be easily identified and quantified 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:  Statistical data is easily available for such products.  Also, the customer base for such products is large; hence, owing to large numbers, statistical data will also be more reliable.

58


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.  Motor tariff: All Honda City vehicles in Mumbai will be assigned a single rate  Fire tariff: All cement manufacturing units will be rated as a single unit. Methods of class rating

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: Diagram 3: Methods of Class Rating

a) Pure risk premium method

Process of determining premium under this method is as follows: 1. Determine the factors that might causes losses

All the factors that might affect the insurance product are selected and their loss making effect is studied.

In motor/vehicle insurance, the following factors factors can be selected for rating:  The make and model of the vehicle  Vehicle age etc.

59


2. Collect data on these loss making factors over a period of time

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. 3. Calculate pure premium

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 Premium =

Actual loss + Loss adjustment expenses Number of Exposure units

4. Calculate gross premium

Pure risk premium is then loaded for expenses, inflation, commission, etc. to arrive at the gross premium that is charged to the customer.

[Gross

Premium = Pure risk premium + load ]

b) Loss ratio method

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

2.3 Analysis of class rating method The class rating system demarcates risks on the basis of loss-producing characteristics into identifiable, specific classes, representing the average expected costs (both claims and administrative) for that particular class. 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 premium rate. Hence to overcome shortcomings of the class rating method, insurers popularly use the Individual rating method.

60


In which of the following methods is the premium adjusted on the basis of actual loss experience of the insurance company? A Pure risk premium method B Loss ratio method C Experience rating method D Merit rating method

3. Learn about premium rating methods – the individual rating method. [Learning Outcome c] 3.1 Introduction to Individual or merit rating method Throughout the world, owing to the vast progress made by information technology, the current trend is to rate a risk according to its ‘individual merit’ or based on a ‘small sub-segment of the overall population’. 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.

3.2 Main features of Individual or Merit Rating Method Main features of Individual or merit rating method are as follows: 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  The costs for small entities whose experience is not credible should be determined solely based on risk sharing.  Very large entities whose experience is credible might have their premium costs solely based on risk bearing.  Entities in between these extremes should base their costs on a weighting of risk sharing and risk bearing.

61


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 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  Schedule rating method  Experience rating method  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:  Location of the property  Size  Present condition of the property  Construction  Occupancy  Operating Methods  Protection or safety measures  Other exposures  Housekeeping & Maintenance  Loss Prevention or control Measures  Management outlook and attitude towards Loss prevention / control measures

62


Schedule rating plan

A schedule rating plan gives  Rate credits for good physical and other features of a risk and  Loading of rate for risk aggravating or bad features. The additional characteristics include  physical hazards,  moral hazard,  existence of safety programme,  improved technology,  management control,  compliance of corporate governance and Government regulations etc. These are applicable to the particular businesses in a specified class. The main features of schedule rating method are as follows:

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:  recent changes in exposure such as the addition of a swimming pool in an apartment complex or  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.

63


3.4 Experience rating method It is another type of merit rating method where class rate or schedule rate is further adjusted upward or downward based on the past loss experience of the particular client for a reasonable period (generally 3 to 5 years). In this method:  If the insured’s loss experience is better than average for the particular class of clients, the class rate is further reduced.  If the loss experience is worse than the class average, the rate is increased.

64


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. Hence, in experience rating method, loss history is used to draw conclusions about the future loss possibility. Where can experience rating method be applied? 

This method can be applied in situations where previous losses, after adjustments, are representative of the losses that can be expected during the period to be rated.  Experience rating makes sense, only if there is sufficient representative data for the portfolio being rated to calculate a sensible estimate of the premium.  Experience Rating is generally restricted to customers paying large amount of premium for different classes of businesses for a reasonably long period. Factors taken into account for arriving at the premium rate

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:  past loss experience of that particular insured; or  new exposure characteristics (e.g., loss control measures adopted) of that insured Objective of Experience Rating Method

The objective of experience rating method is to determine a more equitable rate for an individual risk based on the evidence presented by its own experience. It is recognised that individual risks within a classification are not alike and that there exist inherent differences such as variations in:  plants and premises layout,  operating processes,  the materials involved,   

the management of the plant, the morale of employees, loss prevention approaches and  in relation to the community in the area of operation

65


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. Basic mechanics of an experience rating plan

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.  Beyond the limit, the premium is loaded by stipulated percentages, so that the overall premium-claims ratio is kept at an acceptable level.  Similarly, if the claims experience is favourable then a stipulated percentage of discounts are given.  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.

3.5 Types of experience rating method The Experience rating method is further classified into two types:  Prospective Experience Rating method and  Retrospective rating method Prospective Experience Rating Method

In prospective experience rating, the experience of a risk over a continuous past period is used to calculate the rate for the period for which cover is being provided. Usually, a minimum period of either 3 or 5 years is taken for arriving at the rating plan depending on the type of product and the usual time it takes for full development of claims under the portfolio.

66


Retrospective Rating Method In retrospective Rating Method, modification in premium rate is done at renewal of the insurance policy covering the risk based on experience of the individual risk that has developed during the policy period.

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. Retrospective Rating is widely used in the USA for Workmen's Compensation Policy, General Liability Policy, Auto Liability Policy, Property damage and Burglary policy for large firms.

3.6 Basis of Experience Rating Method Experience rating is based on the existence of variations in inherent hazard in the risks which come up for rating. Its objective is to measure to a finer degree the hazard of the individual risk on the basis of the risk's own experience. 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. In the experience rating process, no distinction can be made between similar individual accidents which are fortuitous and those which are indicative of the actual conditions of the risk.

3.7 Applicability of Experience Rating Method Experience rating is applicable wherever there is a large variation among the risks within a classification where individual risks are of such nature that they may be expected to develop individual risk experiences. 

Casualty Insurance: Many lines of casualty insurance have classifications that are somewhat non-homogeneous, resulting largely from the meager experience available and lack of knowledge of the elements which enter into the composition of hazards.

67


Considering only the qualification of having atypical risks within classifications, most casualty lines would be subject to experience rating. The further qualification of having individual risk experiences large enough to be of appreciable evidential value may be more restrictive. 

Workmen Compensation Insurance: Workmen Compensation Insurance can be subject to experience rating, as there is scope for losses to be controlled, to correct defective conditions and to enforce safe practices among employees.



Third Party Insurance: In third party insurance, the insured generally cannot control losses to the same degree for, the actions of the third party, over whom there is no control, also affect the losses.

3.8 Essentials of Experience Rating Method The essential operation of experience rating consists of:  comparing the actual risk experience and classification experience on a common premium and loss basis,  assigning to the risk experience a weight depending on the size of the risk premium and also assigning to the classification experience the complementary weight, and  deriving a rate therefrom 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.

In Workmen's Compensation Insurance, it is required to: 

"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.



The procedure then is to determine "adjusted losses", the weighted average of the risk's modified losses and the "expected losses" which are indicated by the premium at manual rates to derive the ratio of the adjusted losses to the expected losses and apply this ratio to the manual rates to obtain the final rates.

68




In determining the adjusted losses, the hazard is divided into "normal losses" hazard and "excess losses" hazard.



The weight or credibility assigned to the risk's experience is less in determining the adjusted excess losses than in determining the adjusted normal losses.

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.

3.9 Disadvantages of Experience Rating Methods 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. b) Lack of policy information for each claim : Another problem encountered in practice is the lack of policy information for each claim. If this information is not available, applying a trend and not capping at policy limit can significantly overstate the expected loss cost. Similarly, if deductible information is not available, applying a trend factor to a loss net of the deductible can significantly understate the expected loss cost. c) Change in expanding and contracting limits in experience period: If there have been significant changes in the book of business during the experience period such as expanding or contracting limits, then each experience period is on a different mix basis and therefore it is not appropriate to simply average between years. Furthermore, the projected loss cost would not be a true projection of the expected loss cost for a future period. When experience rating a portfolio that has experienced significant changes in the mix of business, actuaries often load l oad or give credit for these changes in exposure in their final experience rating results.

69


d) Completeness and Credibility of historical statistical data: The most important limitation of Experience rating plan relates to “Completeness and Credibility of the historical statistical data” that is used for arriving at the premium rate. If historical data is not reliable then premium rate would also not be reliable. e) Occurrence of loss is an uncommon event : The experience rating approach presents another problem prob lem when the occurrence of loss is an uncommon event or where there are very few risks of that class to develop a statistically supported rating basis. In such a situation, Experience rating is called Exposure rating. Diagram 4: Disadvantages of experience rating method

3.11 Exposure Rating Method Exposure rating method considers the insured risks, i.e. the portfolio composition, and the premium distribution commensurate to the risk. 

Under this rating approach, the premium rate is determined by an evaluation of the exposure to loss in respect of the risk concerned, independent of the actual claims.

70




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.

Overall, exposure rating aims at a premium rate or price based on portfolio analysis rather than on actual loss experience.

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 Exposure Rating Method

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. Process of Exposure Rating

Exposure rating and experience rating may be applied while rating renewals by adding weights to each using credibility rating. 

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.  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. It is mostly used in cases where there is no (or insufficient) representative claims experience available to calculate the burning cost. In such a case the insurer uses exposure rating to look back at the claims experience of another portfolio of the same kind.

71


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 t he nearest possible to the portfolio po rtfolio under study should be selected. Exposure curve

In order to be able to use the claims experience of a different portfolio, the portfolio in question has to be put into a suitable form and represented as a loss distribution. This presentation of loss distribution in graphical form, in the form of curves, is known as exposure curve, which is based on distribution models of claims sizes. 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:  The insurer’s consultant has come out with a World Health Organisation report of India on the incidence of Stroke (cerebral vascular accident).  Similarly, the consultant has come out with incidence rates of Cancer, Blindness, and Liver & Kidney transplants.  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.

72


Facts of the case

The following are the important facts that are used in the rating process: 

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.



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.



In case of blindness, the studies reveal that 20 members per 1,00,000 suffer blindness either from accidents or disease.



In case of liver & kidney transplant, it is given as 40 members per 1,00,000 of population.



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.

73


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 as below: Stroke incidence Cancer incidence Blindness incidence Liver & kidney transplant incidence Total Total claims incidence rate

200 60 20 40 320 0.0032 (the number of incidences per 100,000 insured)

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 Margin for profit Administration & overheads

@25% @ 10% @20%

The technical claims incidence rate is 0.0032/0.55 = 0.005818 For a sum insured of Rs 100,000, the Rs 582 technical premium is The insurer proposes a loading of  20% over the above premium which is for age band of 35-45  25% on the premium of 35-45 age band for 46-60 years. 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. thereof. However, there are 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.

74


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? A Loss ratio method B Experience rating method C Merit rating method D Schedule rating method

Summary 

 





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. 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. In insurance business, rate adequacy measurement is quite complicated because the insurer cannot foresee the actual costs at the time of selling the policy. 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. 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:  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.  Individual rated products: includes all such insurance products, where premium is determined based on an individual’s exposure to loss.

75



The correct answer is A. Internal tariff rated products is an example of class rated products. Answer to TY 2

The correct answer is B. In loss ratio method, premium is adjusted on the basis of actual loss experience of the insurance company. Answer to TY 3

The correct answer is D. In Schedule rating method, the individual risk rating system does not directly reflect an entity’s claim experience.


_____________ includes non-life products product s that are specially designed to suit sui t the specific needs of clients. A Class rated product B Customised product C Exposure rated product D Insurance of large risk Question 2

Which of the following is correct? A Gross premium = Risk premium + Load B Net premium = Pure risk premium + Load C Gross premium = Pure risk premium + Load D Net premium = Pure risk premium + Load

76


Question 3

Which type of premium rating approach is used in Group Mediclaim and Group Personal Accident Policies? A Prospective rating method B Retrospective rating method C Merit rating method D Schedule rating method Question 4

Under which rating approach, the premium rate is determined by an evaluation of the exposure to loss in respect of the risk concerned, independent of the actual claims. A Prospective rating method B Retrospective rating method C Exposure rating method D Schedule rating method


The correct option is B. Customised products include on-life products that are specially designed to suit the specific needs of clients. Answer to SEQ 2

The correct answer is C. Gross premium = Pure risk premium + Load

77


Answer to SEQ 3

The correct answer is B. Retrospective rating method is used in Group Mediclaim and Group Personal Accident policies. Answer to SEQ 4

The correct answer is C. In exposure rating method, the premium rate is determined by an evaluation of the exposure to loss in respect of the risk concerned, independent of the actual claims.

78


CHAPTER 5

FILE AND USE OF REGULATIONS 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. The processes are examined further in Chapter 6.

a) List the goals of market conduct supervision for insurance business. b) Describe the procedures for filing of rates and policy forms for regulatory review. c) Explain the basic components in evaluating insurance products. d) Briefly explain the stage of insurance market in India. e) Understand IRDA requirements for consideration and review of insurance products. f) Classification of products in accordance with the File and Use guidelines of IRDA.

79


1. List the goals of market conduct supervision for insurance business. [Learning Outcome a] 1.1 Introduction Insurance business is one of the risk management methods for the society, and in the process of risk-proofing the society against covered perils and losses, the risk of failure of an insurance company is one which the society cannot really bear. Insurance regulation has been promoted worldwide with a view to ensure that there are inbuilt safeguards so that any tendency of the insurer towards market failure is corrected in a timely manner. Failures can arise from rash or inefficient financial conduct or unprofessional market conduct which includes behaviour of the insurers towards customers. As a measure to ensure that policyholders are given equitable treatment, competition is introduced in insurance markets so as to serve consumer interests. However, over-competitiveness and unfair competitive practices can in turn destabilise markets and eventually lead to insolvencies. In order to ensure stability in the market performance, the regulator supervises the market conduct of insurers.

1.2 The goals of market conduct supervision Specifically, the goals of market conduct supervision of insurance business are to:  promote efficiency in the conduct of insurance business; 

ensure that solicitation, procurement and servicing of insurance are performed only by persons and entities with specified requisite qualifications and practical training and and adherence to code of conduct;



ensure that persons and entities assisting in the assessment and settlement of claims adhere to the specified professional qualifications and code of conduct;

 protect the interests of the policy holders in matters concerning assigning of

policy rights, insurable interests, fair and prompt settlement of valid claims and fulfilment of the terms and conditions of contracts of insurance;

80




ascertain that insurers adhere to approved rates, advantages, terms and conditions of insurance products that they offer to the general public;



encourage insurers and intermediaries to adopt and observe best international practices on market conduct in their dealings with policyholders and the general public;



gather information by undertaking inspection and conducting enquiries and investigations;



ensure that members of professional organisations connected with insurance and reinsurance business are duly qualified and competent and that they adhere to appropriate codes of professional ethics and standards;

To achieve the above goals, the regulator should be cognizant of competitive forces and take actions that foster a healthy marketplace. The regulator must be alert for any possible unfair and discriminatory rating and underwriting practices as well as overly restrictive policy provisions.

Which of the following are the goals of market conduct supervision for insurance business? (i) To gather information by undertaking inspection and conducting enquiries and investigations (ii) To ensure that members of professional organisations connected with insurance and reinsurance business are duly qualified and competent (iii) To ascertain that insurers adhere to approved rates, advantages, terms and conditions of insurance products that they offer to the general public A B C D

(i) and (ii) (ii) and (iii) (i) and (iii) (i), (ii) and (iii)

81


2. Describe the procedures for filing of rates and policy forms for regulatory review. [Learning Outcome b] Market Regulation includes regulation of insurer’s products, prices and market practices. Though the operational systems of monitoring of insurer’s products and prices vary from country to country and regulator to regulator, the concepts remain the same. Fundamentally, policy forms need to be filed with the regulator to conform to maintenance of basic standards which include compliance with laws and regulations, proper pricing, acceptable customary practices etc .

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:

82


Diagram 1: Types of rate regulatory systems

1. Open competition laws / no filing laws / no prior approval: In developed insurance markets, there may be many players with products ranging from a single specialist area (e.g. health insurance) to a wide range of covers with complex ratings. In many of these territories, there is no requirement to file rates or policy wordings as the regulator relies on market competition to act as a self-regulating mechanism preventing insurers from over-pricing or dominating the market.

Under these circumstances, the regulator relies on the competitive forces to determine the rates based on the market – one example would be the U.K insurance market. 2. Prior approval: Under prior approval systems, policy forms and and rates must must be filed and approval obtained by the state insurance department before they can be used in the market. The regulators assess 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.

83


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 F&U system, the insurers are 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 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. 5. Flex rating regulation : It is a law prevailing in the US insurance market under which insurers are required to obtain prior approval for rates that exceed a certain percentage above or below the rates previously filed. Here, floor rates can be fixed based on Minimum Loss Ratio requirements.

In developed insurance markets, there would be a number of players offering a wide range of products with complex rate filings. Prevalence of competition prevents insurers from over-pricing or gaining control over the market. In such cases, there is no need to file rates or policy forms, and in some jurisdictions, certain lines and rates are are exempted from filing or approval requirement. In these cases, the regulator relies on the competitive forces to determine the rates based on the market. 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.

84


Whatever may be the mode of regulation, the objective is to maintain a healthy balance between the market goals and adequate policyholder protection.

Filing of rates and policy forms for the regulator’s review ensures the protection of ___________. A The consumer only B The insurer only C Both the consumer and the insurer D Neither the consumer nor the insurer

Which of the following systems represents a compromise between the prior approval system and the no-file system? A File and Use Laws B Flex Rating Regulation C Use and File System D None of the above

3. Explain the basic components in evaluating insurance products. [Learning Outcome c] The basic components in evaluating insurance products are as under:

1. Definition of product

An insurance product can be defined as an insurance policy contract, where there is acceptance of specified risks by the insurer against a predetermined price called premium obtained from the client.

It includes any plan of insurance designed to meet the insurance requirements of a client or class of clients. The contingencies insured under the product should be clear and provide transparent cover which is of value to the insured.

85


2. Product design Product design is the process by which insurance companies develop their insurance policies as per requirements of the policyholders. Based on the prevailing practices, the policy document consists of Preamble, Recital Clause, Schedule, Operative Clause, Terms and conditions and Exclusions etc.

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. Pricing of insurance products plays an important role in design and development of the product. It is arrived at after taking into consideration the claim losses/burning costs, operating expenses, investment income, reinsurance costs and a margin for profitability etc.

4. Rate Rate is the price per unit of insurance. There are three important methods of rating viz. (i) Class rating: it involves applying various factors to a base rate evolved out of characteristics of an insured / or a group of homogenous risks. (ii) Individual risk rating: it can be experience rating wherein the past claim experience of a person or group is used to adjust the premiums of the future. Failure to incorporate experience shall result in either loss of business, in case of good experience, or underwriting losses in case of a bad experience. (iii) Sometimes, it can be based on exposure to the losses, such as catastrophe risks. At times, where the quantum of probable losses is very high or risk is heavy, the rates are driven by reinsurance markets, as the primary insurer is not in a position to underwrite the risks in his own capacity and needs support from the reinsurance market.

86


In which of the following is the regulator NOT concerned when considering product evaluation? A Definition of Product B Pricing C Resourcing of Underwriting Personnel D Design of Product

4. Briefly explain the stage of insurance market in India. [Learning Outcome d] It is a known fact that competition can generally ensure more customer choices and options and also more more reasonable pricing. However, perfect competition competition also requires adequate knowledge of the product and its intricacies. In the Indian context, the insurance market is in an ascent stage. The level of financial literacy is poor in the country, and the awareness levels of insurance products among the general public are not satisfactory. sati sfactory. Hence, the regulator has adopted the File & Use model for filing of the products, as it gives leverage to the regulator to review the policy forms and rates and raise objections in case the product does not meet the th e regulatory standards towards protection protecti on of the interests of the policyholders. In an attempt to increase competition for overall development of the market, the general insurance sector was opened up by removing tariffs with effect from 1 st January, 2007. The de-tariffing was contemplated to be done in a phased manner to ensure that there is a logical sequence to follow in opening up of the competition. To begin with, insurers were not allowed to vary the coverage, terms and conditions, wordings, warranties, clauses and endorsements in respect of erstwhile tariff. A detailed mechanism of the File & Use procedures being practiced in Indian insurance market is described in the following Learning Outcomes. In the Indian context, the insurance market is in the ________ stage. A B C D

Developing Emerging Growth Maturity

87


5. Understand IRDA requirements for consideration and review of insurance products. [Learning Outcome e] The requirements of IRDA relating to design and rating of insurance products are as follows:

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.

For example, clauses on renewal of insurance, basis of insurance, due diligence, cancellation, arbitration etc., should have similar wordings across all products.

88


The policy should provide simple dispute resolution procedures and also state in simple language the process of arbitration of disputes.

4. Real risk transfer The product should be a genuine insurance product of an insurable risk with a real risk transfer. “Alternate risk transfer” or “financial guarantee” business in any form will not to be accepted.

5. Policyholders’ interests protection 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. The details are as under: 

If the proposed schedule of rates is derived from an existing schedule of tariff / non-tariff rates: there should be adequate statistical information on the claims experience at current schedule of rates.



If the rates are based on the generally prevailing market level of premium rates: the insurer should be able to demonstrate the reasonableness of the variation from the currently prevailing level of rates.

89




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.



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.



Where statistical support for a particular risk classification is not available , it can be rated by comparison with rates based on statistics for a risk of comparable hazard. But, where no statistical basis is available, arbitrary variation of rates will not be acceptable.

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.

8. Margins for management expenses and commissions etc. 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.

90


9. No unprincipled activity in the name of competition 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 B C D

Only (i) Only (ii) Both (i) and (ii) Neither (i) nor (ii)

6. Classification of products in accordance with the File and Use guidelines of IRDA. [Learning Outcome f] 6.1 Classification of products 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.

The products are further classified into the following 5 sub-categories:

91


Diagram 2: Classification of products

1. Class rated products (i) Internal tariff rated products All rule based underwriting products fall into this 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.

Some of the examples of Class rated products are:  Fire insurance up to a certain sum insured or category of risk limitations,  Motor insurance other than fleets,  Personal Accident insurance other than groups,  Health insurance other than groups,  Burglary insurance, Fidelity insurance and so on.

(ii) Packaged or customised products 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’.

These will include insurance packages like Homeowner’s Comprehensive or Shopkeeper’s Comprehensive or Banker’s Blanket insurance and so on.

92


2. Individual rated products (i) Individual experience rated products Actual claims experience of the concerned insured and his requirements determine the designing of the experience rated products, rates, terms and conditions of cover. These will typically be insurance with a high frequency but low intensity of loss occurrence.

These will include Cargo insurance, group insurance for PA or Health, Motor fleets, Hull insurance and so on.

Exposure rated products 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.

Typically, these will be risks where the occurrence of a loss is an uncommon event or where there are very few risks of that class to develop a statistically supported rating basis. The exposure rating may derive from rates for similar risks in other markets or be based on hazard evaluation done for other reasons such as for risk management.

(ii) Insurances of large risks 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.

93


According to File & Use guidelines, large risks are: 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; 2. Rs.100 crores or more per event for liability insurance.

However, a product cannot be placed under this category by merely referring to a reinsurer for the rates and terms. It should genuinely relate to risks that are not within the underwriting or rating capability of Indian insurers. However, where insurance covers properties at several locations and one of those locations qualifies as large risk, insurance of all the locations covered under that policy can be treated as large risk provided that all the properties are under the ownership of a single insured and are covered under one policy. Reinsurance is expected to be placed abroad solely on a need basis and only after satisfaction of the national retention capacity. This is the category of risks that is the most susceptible to pressures of competition and where insurers may take a rather bold stand purely because their own stake in the risk may be small with most of it being reinsured. 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

94


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? A Retail Health insurance B Burglary insurance C Office Insurance D Products Liability

Summary 

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.  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, statemade rates, and no filing required. Framework State Mandated Rates

Description Rates determined by the insurance regulator. Insurers must use the rate or may file a deviation to charge a rate below the published rate. Prior Approval Rates must 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.

95


Framework File and Use (No Waiting Period) Use and File

Informational File No File



  



Description Rates must be filed with the insurance regulator prior to their use. The rates may be used immediately. Specific approval is not required but the regulator retains the right of subsequent disapproval. Rates must be filed with the insurance regulator within a specified period after they have been placed in use. Rates must be filed with the insurance regulator for informational purposes. No formal review of the rates occurs and no supporting documentation is required. Rates are not required to be filed fi led 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.

Market regulation encompasses a number of different aspects of insurers’ activities, including:  Rates  Policy forms and terms  Underwriting practices  Marketing and distribution  Claims adjustments India is changing fast in so many ways – demographics, income etc. – all having an impact on insurance and regulation Product evaluation has to be a consistent process with recognised headings such as product definition, design, pricing and rating. Subsequently, product review involves further detail, including prudent underwriting, simplified language/terminology and looking after the policyholders’ interests Classification of products is divided between class rated and individually rated products – these have their own sub-divisions, including package policies and reinsurance driven covers.

96



The correct option is D. All the given statements are the goals of market conduct supervision for insurance business. Answer to TY 2

The correct option is C. 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

The correct option is A. File and Use laws represent a compromise between the prior approval system and no-file system. Answer to TY 4

The correct option is C. The regulator is not concerned with resourcing issues. Answer to TY 5

The correct option is B. In the Indian context, the insurance market is in an emerging (nascent) stage.

97


Answer to TY 6

The correct option is B. Statement (ii) is incorrect as in the case of rates being 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. Answer to TY 7

The correct answer is C. Office policies are a Package contract.

Self Examination Questions Question 1

Under which of the following systems is a range established for insurance rates? A File and Use Laws B Flex Rating Regulation C Use and File System D Prior Approval System 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 B C D

File-and-use No-filing required Flex-rating Prior-approval

98


Question 3

Insurance companies are subject to many laws and regulations. The principal areas regulated include all the following EXCEPT: A Sales practices and consumer protection B Rate regulation C The number of policies sold D Formation and licensing of insurers Question 4

Which of the following is rule based underwriting of products? A B C D

Individual experience rated products Internal tariff rated products Exposure rated products Packaged / customised products

Question 5

Which of the following products is also described as ‘Special Contingency Policies’? A B C D

Exposure rated products Individual experience rated products Internal tariff rated products Packaged / customised products

Question 6

In addition to the “promotion of competition so as to enhance customer satisfaction through increased consumer choice and lower premiums”, what other key objective the IRDA does not have? A Design of the Tariffs security B Ensuring the market’s financial security C Regulating the marketing and distribution of products D Appointing a qualified actuary

99


Answers to Self Examination Questions Answer to SEQ 1

The correct option is A. Under the flex rating system, a range is established for insurance rates and insurers are permitted to change their rates in both upward and downward directions within the established range in response to market conditions. Answer to SEQ 2

The correct option is D. The rating law described is a prior-approval law. Under prior-approval, state regulators must approve the rates before they can be used. Answer to SEQ 3

The correct option is C. The number of policies sold is not regulated. State regulators will, however, consider the ability of the insurer to discharge any liabilities that may arise from the policies sold. Answer to SEQ 4

The correct option is B. All rule-based underwriting products fall into the category of internal tariff products. Answer to SEQ 5

The correct option is D. Packaged / customised products are also described as ‘Special Contingency Policies’. Answer to SEQ 6

The correct option is D. The regulator is not interested in appointing an actuary.

100


CHAPTER 6

APPLICATIONS OF FILE AND USE REGULATIONS 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.

a) Briefly explain IRDA File and Use requirements. b) Explain the role of the Board in relation to the underwriting policy. c) Briefly explain the roles of: (i) Moderator (ii) Compliance officer (iii) Appointed actuary (iv) Advocate d) Discuss the practical applications of the guidelines including Form A, Form B, Form C and Form D.

101


1. Briefly explain IRDA File and Use requirements. [Learning Outcome a] For selling any general insurance product in the Indian market, it is essential to comply with the requirements of File & Use (‘F&U’) guidelines prescribed by IRDA.

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: 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 A

102


2. Explain the role of the Board in relation to the underwriting policy. [Learning Outcome b] Insurance business is the primary function of an insurance company and it is essential for it to have its underwriting policy approved by the Board of Directors. The Board approved Underwriting Policy is required to be filed with the Regulator. Product design, rating, terms and conditions of cover and underwriting activity shall be consistent with the approved underwriting policy of the Board. 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: a)

The underwriting philosophy of the company in the matter of underwriting profit expectation;

b)

Whether each product shall stand on its own or be cross-subsidized among products sold to one client - it is important to note that even though a client’s total portfolio may be profitable overall on gross basis, the position on net of reinsurance basis can be a loss because different percentages are reinsured in different classes of business.

103


c)

Whether the insurer will underwrite any business on a planned underwriting loss basis and if so, how the Board will control the effect of such underwriting on the insurer’s solvency margin and the aggregate exposure to such losses. The Board needs to be conscious of the likely need to further strengthen the capital of the insurer if underwriting losses continue.

d)

The margins that will be built into the rates to cover acquisition costs, promotional expenses, expenses of management, catastrophe reserve and profit margin and the credit that t hat will be taken for investment i nvestment income in the design of rates, terms and conditions of cover, and how they will be modified based on the actual operating ratios of the insurer etc. The margins must have a relationship to the actual operating ratios of the insurer.

e)

The list of products that will fall into each of the 5 sub-categories listed in the File & Use guidelines.

f)

The delegation of authority to various levels of management for quoting rates and terms and for underwriting in each of the above mentioned 5 subcategories of products.

g)

Appointment of 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 are driven by the reinsurance market.

h)

The role and extent of involvement of the Appointed Actuary in review of statistics to determine rates, terms and conditions of cover in respect of internal tariff rated risks and products designed for a class of clients.

i)

The internal audit machinery that needs to be put in place for ensuring quality in underwriting and compliance with the corporate underwriting policy.

j)

The procedure for reporting to the Board on performance of the management in underwriting the business, including the forms and frequency of such reports. The reporting forms must be detailed enough to highlight any emerging problems at an early stage and enable the Board of Directors to monitor the profitability and spread of business on an ongoing basis.

Responsibility for the overall compliance vests with the Chief Executive Officer. There can be a designated senior officer, identified for specially ensuring compliance of the ‘F&U’ requirements.

104


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 Board approved Underwriting Policy is required to be filed with _________ A B C D

The Insurer The Regulator The Underwriter The Agent

3. Briefly explain the role of: (i) Moderator (ii) Compliance officer (iii) Appointed actuary (iv) Advocate [Learning Outcome c] 3.1 Role of moderator 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.

105


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” is a senior officer appointed by the insurer to ensure compliance with the requirements of the ‘F&U’ guidelines. 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 is a qualified actuary who is appointed or retained by the Board of Directors of the company to prepare the statement of actuarial opinion. 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.

106


In respect of long-term insurance products, the Appointed Actuary should also state the basis on which the reserve for unexpired risk will be calculated.

In health insurance for example, the occurrence of a disease is not a random event and the actuary may develop mathematical models to determine the likely exposure to certain diseases following a stated number of disease-free years or following other diseases. These will then influence reserving requirements. 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. This is considered an important requirement by the regulator. The periodicity of review of emerging claims experience to determine any changes needed in rates, terms and conditions of cover should also be stated in the certificate. Where an insurer designs or quotes for new products without reference to adequate statistical data support for the rates, terms and conditions, the basis of rating such products shall be recorded in detail and such basis shall be based on sound and prudent considerations.

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.

107


3.4 Role of advocate 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 nondisclosure 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.

Internal technical audit 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 Department has the responsibility of bringing in self-discipline in underwriting. The department should have audits as per the direction of the Board and the reports of the Technical Audit shall be placed before the Board of Directors.

The role of ________ is to ensure that the insurer does not act improperly under the pressure of competition. A B C D

Compliance officer Appointed actuary Moderator Advocate

108


The _________ is appointed by the insurer to ensure compliance with the requirements of the File & Use guidelines. A B C D

Compliance officer Appointed actuary Moderator Advocate

4. Discuss the practical applications of the guidelines including Form A, Form B, Form C and Form D. [Learning Outcome d] Every new product or revision of an existing product in respect of products classified as Class rated products needs to be furnished with the following documents. Diagram 1: Documents to be furnished for the classification of products

109


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

It is a questionnaire to be completed and signed by the Principal/Designated Officer furnishing the complete information of the product.

The contents of this form are as follows:

1. Product details 

Class of Insurance : the class of general insurance refers refers to the segment reporting list in IRDA Accounts Regulations viz. Fire, Marine, and Motor, Miscellaneous etc., under which the product will be classified.



Name of Product: the name should not be misleading with regard to the scope of cover 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.



New OR Revision of Existing Product : new products are expected to be materially different from other products being sold by the insurer.



If Revision, If Revision, Name of Earlier Product: if there were any points of concern with the earlier product, then it is essential to resolve them satisfactorily at the time of considering the revisions. In case any product is withdrawn from the market, the same name should not be used for a subsequently designed product.



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.

110


2. Product features 



Contingencies Covered: the contingencies covered should be normal insurable perils. The cover should not be in the nature of a financial guarantee or “ART” (Alternative Risk Transfer) cover. The covers should not be of exotic nature or covering contingencies not related to the interests of the insured under the policy. Indirect insurance products such as insurance covers in the nature of derivatives may not be allowed. This is because in addition to issues stated earlier, the basis of reserving for all such covers cannot be as per the traditional method of calculating reserve for unexpired risks. Basis of Cover: Benefit Payment Basis: existence of insurable interest is important under such policies. Indemnity Basis with Deduction for Depreciation: the policy should clearly spell out the basis of deduction for depreciation and whether such basis is fair.

“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. 

Right of Recovery under Subrogation: if there is need to protect the right of recovery, the steps to be taken on occurrence of a loss, should be clearly set out.



Excluded Perils: whether any peril that is normally covered under such products is excluded in i n this product; if so it should be clearly brought out in product documents.



Declined Risks: the list of declined risks should provide a logical justification for such declination.

111




Special Features, if any: these will be features not ordinarily found in insurance products of the type under consideration. Existence of such features should add value from the insured’s point of view, and should reflect the underwriting prudence in providing such insurance, in its proper pricing.

3. Marketing 

Target Market: the appropriateness of the product for the market market and the scope for business should be considered.



Sales Channels Planned to Sell the Product: the sales channels should be appropriate to access the target market and should be cost efficient.



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.



Acquisition Cost to be Incurred Including Commission or Brokerage : if the acquisition costs are pegged too low in relation to the sales channel to be used, there is likely to be an adverse selection of risks offered for insurance or the sales targets may not be realized. One basis of comparison will be the acquisition costs used by other insurers for similar products. However, this can be lower than the maximum permitted by the law or regulations.

4. Underwriting and claims 

The Delegation of Authority for Underwriting and for Quoting Rates and Terms: should be commensurate with the technical and underwriting skills required.



The Delegation of Authority for Processing and Settlement of Claims : should match the technical skills of the authorized persons. Where the authority is centralized, one should enquire into any possible delays in processing and settlement of claims arising from such centralization. It is reasonable to expect authority to be delegated based on claim amount, to various levels of officers in the organization.



Reinsurance Arrangements Specific to the Product: in case it requires consultation with reinsurers for underwriting or is controlled by the reinsurer for settlement of claims, and where reinsurers play an active role in the process of underwriting and claims, one should be mindful of the problems that can arise if the reinsurers take a very strict view in dealing with claims.

112




Underwriting Manual and Claims Processing Manual in Respect of the Product: the manuals should provide sufficient guidance to the underwriting personnel and claims personnel. The instructions given should be consistent with good underwriting and claims practices. The policyholder’s interest should also be taken into account sufficiently.

5. Actuarial support 

Name of Appointed Actuary: the person should be one approved by IRDA. If not, the insurer should state the reason for proposing a different person’s name.



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.



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.



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 i n respect of sums insured, premiums and claims. If not, the insurer must state how the data to validate the premium loadings or discounts dis counts related to those risk factors will be generated and how the experience by those risk factors should be monitored.



Periodicity of Compilation and Analysis of Data for Review of the Rates and Terms: ideally, data should get captured as soon as the business is underwritten, and such data should be automatically available to the Claims module and statistical module of the database. As soon as a claim is intimated the Claims module should be able to draw the relevant information about the risk from the underwriting database, and also keep track of all subsequent movements in the claims processing. Analysis should be annual or more frequent.

113




Basis of Reserving for Unexpired Risks In Respect of Long-Term Products: where the premium charged covers risks extending over several years, or where the exposure to loss is not uniformly spread over the duration of the policy, the reserve for unexpired risks should take into account the premium required to run the risk beyond the balance sheet date. The proper reserving basis can be a mathematical formula that takes into account the intensity of loss exposure over the period of insurance and any factors related to discounting of premium to take note of investment income. The simplest formula in respect of a long-term policy with uniform exposure to loss over the duration of the policy may be, to provide that portion of the premium as the period of risk beyond the balance sheet date bears to the total period of insurance.

6. Rates and terms 

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.



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.



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.

114




Where the Insurance is to be Provided on First Loss Basis or with Deletion of the Condition of Average: in a class that is normally insured on full sum insured basis and subject to condition of average, the basis of the first loss rating scale or the basis to dispense with the Condition of average should be supported by actuarially determined rating scales.



Where the Insurance is to be Provided with a Higher than Normal Deductible or Franchise: the basis on which premium reduction will be allowed for the higher deductible or franchise should be stated. The discount scales for deductibles should also be actuarially determined.



Where the Product is a “Package” Product Designed for a Specific Client or Class of Clients : these are products designed for specific individual/ class of clients. As there are similar individual products, it would be required to outline the variations that will wil l be made and the basis of rating such variations.



What are the Elements of Insurance put together in the Package : the elements of insurance put together in the package should be clearly defined.



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.



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.



Is there an Internal Guide Tariff or is Each Risk Rated Individually? Generally, a product designed for a class of clients will carry an internal tariff. If so, the suitability and adequacy of the rating basis and rate levels should be assessed.



If Each Risk is Rated Individually, at what Management Level are Rates and Terms Quoted and what is the Basis for Deriving the Premium Rates? The level at which rating decisions would normally be at a reasonably high management level and there should be a reasonable logical basis defined for deriving the rates quoted.

115




Where the Product is Experience Rated: here the experience of the particular client or class of clients is only required to be used as a rating basis.



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.



At what Management Level are Rates and Terms Quoted? The management level should reflect sufficient maturity and also should exclude persons responsible for business development.



At what Level of Management can the Insurer Decide to Ignore the Experience in Quoting for the Insurance? This should be a fairly senior level decision because it may involve underwriting business at a known underwriting loss.



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.



Where the Product is Exposure Rated: How is the Exposure Evaluated? Here, in case the experience is not insurance based, one can also rely on technical literature on risk exposures and loss experience.



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.



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.

116




Where Rates and Terms are determined by Reinsurers or Other Underwriters: The level of management at which a decision is made regarding the acceptance of rates and terms quoted should be mentioned. The insurer should also have a clearly defined policy with regard to the acceptance of changed policy wordings and the minimum rates and terms required for such acceptance. Where rates are quoted based on reinsurance quotes, it is important to ensure that the terms quoted to the client are the same as those quoted by the reinsurer. Where the insurer desires to vary terms from those quoted by the Reinsurer, one should carefully consider the implications of increased retention exposure and properly price the product for the increased exposure.

7. Documents The following documents and certificates are needed to be attached while filing a product with the IRDA. a) Documents for class rated products: (i) Prospectus (ii) Sales literature (iii) Proposal Form (iv) Policy wording (v) Wordings of various endorsements (vi) Claim Form (vii) Underwriting Manual and Claims Manual 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. The form is required to be signed by the Principal Officer or Designated Officer, with date and seal of Designation.

117


General aspects of product filing In respect of package policies that were filed earlier and where only the rates of premium have been changed, it is sufficient to file the proposed rates immediately with a confirmation that the proposal form, policy and endorsement wordings remain unaltered and follow up later with filing of a copy of the same within 3 months of the introduction of the altered product. Where the Underwriting Manual and Claims Manual is product specific, it should be filed with the product filing. Where these manuals are of general application, they may be filed once and reference may be made to it with product p roduct filing instead of filing filin g it every time. Any changes specific to the product being filed should be stated with the product filing. Any changes to the Manuals in general, should be filed separately as and when such changes are made.

4.2 Form B

It is the certificate to be given by the Principal Officer or Designated Officer, confirming that: 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.

118


4.3 Form C

It is the certificate to be given by the Appointed Actuary confirming that he has certified the product after studying the requirements of the File and Use Guidelines in relation to the design and rating of insurance products. 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.

119


Chapter summary 

    

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. The insured must have an underwriting philosophy and policy approved and agreed at board level. Overall responsibility lies with the CEO. There are a number of roles with specific responsibilities including moderator, compliance officer, actuary, board, lawyer and auditor. Regulations refer to two Categories of Product – Class rated and Individual rated. 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 correct option is C. The insurer is not permitted to offer any product for sale until all queries pertaining to the th e 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

The correct option is B. The Board approved Underwriting Policy is required to be filed with the Regulator. Answer to TY 3

The correct option is C. The role of moderator is to ensure that the insurer does not act improperly under the pressure of competition.

120


Answer to TY 4

The correct option is A. The compliance officer is a senior officer appointed by the insurer to ensure compliance with the requirements of the File & Use guidelines.


For certain reasons, the regulator can withdraw products – which of the following is NOT one of these reasons? A The product is not appropriate for any reason B The product does not carry rates, terms and conditions that are fair between the parties C It has unsatisfactory documentation D It is not available in regional language Question 2

While filing an insurance product with the IRDA, the insurer needs to justify: A B C D

The rate of the product The design of the product The amount of premium to be charged The tenure of the insurance

Question 3

The underwriting policy placed before the Board should cover: The list of products that will fall into each of the 5 sub-categories listed in the File & Use guidelines B The role and extent of involvement of the Appointed Actuary in review of statistics to determine rates, terms and conditions of cover C The delegation of authority to various levels of management for quoting rates and terms D All of the above A

121


Question 4

Which of the following is correct regarding the compliance officer? He should hold responsibility for underwriting He should be junior in the organisation He shall be responsible to file a complete list of all products falling under categories as defined in File & Use guidelines D His role is to ensure that the insurer does not act improperly under the pressure of competition A B C

Question 5

Which of the following is not likely to be the responsibility of the Insured’s Lawyer? A B C D

Ensuring product documents are written in an unambiguous language Ensuring product documents clearly explain the nature and scope of cover Ensuring policy documents are in an agreed size Ensuring proposal form requests information on matters material to the contract

Question 6

“Determining the requirements for compiling and analysing data on sums insured” is the responsibility of: A The Actuary B The Lawyer C The Board of Directors D The CFO Question 7

The Appointed Actuary has a responsibility for which of the following Regulator’s forms? A B C D

Form A Form B Form C Form D

122



The correct answer is D. Unavailability in regional language is not an issue. Answer to SEQ 2

The correct option is A. 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 correct option is D. The underwriting policy placed before the Board should cover all of the above mentioned points. Answer to SEQ 4

The correct option is C. Option A is incorrect as the Compliance Officer shall not be an officer who also holds responsibility for underwriting. Option B is incorrect as 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. 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

The correct option is C. Options A, B and D are correct with reference to Form D.

123


Answer to SEQ 6

The correct option is A. The actuary is the person responsible for this action. Answer to SEQ 7

The correct answer is C. The Appointed Actuary is responsible for Form C.

124


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.

a) Understand the elements of risk management framework. b) Discuss the tools for effective underwriting.

125


1. Understand the elements of the risk management framework. [Learning Outcome a] 1.1 Concept of Underwriting

Underwriting is the process by which an insurer determines:  whether or not to accept a risk and,  if accepted, the terms and conditions to be applied and  the level of premium to be charged

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.

1.2 Commercial considerations The litmus test in underwriting is individual risk profile in relation to potential for losses and not other commercial considerations, even though it is a known fact that commercial considerations do weigh depending on the underwriting philosophy laid down by the Board of the insurer. It is however a fact that commercial considerations can increase the risks for the insurer and create a premium deficiency situation which can have undesirable consequences.

1.3 Consistent underwriting decisions The most desired quality in underwriting decision making is consistency, because consistent judgment generates predictable results, or at least results that are more predictable than otherwise. Consistency in underwriting decisions will lead to improvement of underwriting decision-making processes and produce better underwriting result. Without the application of consistent underwriting judgment, companies are vulnerable to competitors who may be more focused, organised and have better tools and technology.

126


To be consistent and profitable in underwriting of risks, we require certain tools which can help and guide us in achieving desirable underwriting results. In order to understand the importance of underwriting and the significance of tools of underwriting, it may be useful to understand the risk management framework for enabling effective use of these tools in order to be consistent and profitable.

1.4 Risk Management Framework The risk management framework typically consists of the following elements: Diagram 1: Risk Management Framework

a) A statement of the insurer’s willingness and capacity to accept risk : This is the underwriting philosophy of the insurer as to what, what not and how much to accept. ` b) The nature of business that the insurer is to underwrite including:  Classes: the classes of insurance to be underwritten;  Geographical areas: the geographical areas in which these classes will be underwritten;  Types of risks: the types of risks that may be underwritten and those that are to be excluded; and  Criteria for reinsurance: the criteria for the use of reinsurance in different classes of insurance business to be underwritten

127




Retention limits: risk and aggregate concentration of retention limits and could include things like per event or per risk or per policy or per class or per type exposures.

c) Details of the formal risk assessment process including:  The criteria used for risk assessment;  The method(s) for monitoring emerging experience;  The method(s) by which the emerging experience is taken into consideration in the underwriting process 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). e) Methods for monitoring compliance with underwriting policies and procedures such as:  Internal audit (where it is established that the internal audit unit has the appropriate skills and experience to perform such activities);  Reviews by areas of coverage or portfolio management;  Peer review of policies underwritten (including details of the staff responsible for undertaking the peer review, the frequency of such reviews and reporting arrangements for the results);  Assessments of brokers’ procedures and systems to ensure quality of information provided to the insurer and  In the case of reinsurers, audits of ceding companies to ensure that insurance assumed is in accordance with treaties in place. The underlying theme of the above risk management framework is to identify and assess the risk properly and effectively in relation to the expected losses and premium to be charged. This will help to build an efficient process of risk evaluation and acceptance.

The process of underwriting helps the underwriter in deciding which of the following? A B C D

Whether to accept the risk Whether to reject the risk Whether to accept the risk or reject the risk If accepted then the terms and conditions to be applied and the premium to be charged

128


2. Discuss the tools for effective underwriting. [Learning Outcome b] 2.1 Approaches that can serve as tools for underwriting Broadly speaking the following approaches can serve as tools for underwriting in general:  The underwriting philosophy of the company  The underwriting policy of the company  The use of reporting forms on trends emerging on the claims front  Stated methods of taking emerging claims experience (both at macro and micro levels) into account for acceptance and rating of risks i.e. underwriting process Diagram 2: Approaches that can serve as tool for underwriting

2.2 Tools for increasing effectiveness of underwriting process To achieve these risk assessment and management practices in underwriting, the insurer requires certain tools, which can help in achieving optimum utilisation of resources with concomitant profitability of the portfolio. The following are some of the important tools that insurers use in increasing effectiveness of the whole process of underwriting.

129


Diagram 3: Tools for increasing effectiveness of underwriting process

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.

2.3 Insurance Documentation This comprises all documents that evidence the contract of insurance and all other related matters pertaining to that contract. They consist of the following Diagram 4: Insurance documentation

130


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 Importance of proposal form from view point of proposer The proposal form is a very important document in insurance. The insurance contract is based on the principle of utmost good faith, wherein whatever the facts, as given by the proposer are accepted and no verification is possible by the insurer at the time of acceptance of his proposal. So, any misstatements or incorrect information provided in the proposal form can be construed as violation of the principle of utmost good faith and may result in the denial of claim.

Importance of proposal form from view point of insurer 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. An insurance policy is an evidence of a contract between the proposer and the insurer who undertakes to cover the risk for indemnification of losses if any, subject to the terms and conditions of the policy issued. For this the written request of the proposer becomes the offer. Acceptance of the offer by the insurer by receipt of premium is an essential element of the insurance contract. The printed proposal form contains questions designed to elicit all material information about the particular risk proposed for insurance and the questions vary according the nature and class of insurance proposed. A proposal form is compulsory in all classes of insurance with the exception of marine cargo insurance. Insurers also depend on their inspection reports for large industrial risks.

131


Common questions asked in a proposal form Some of the common questions that are asked in a proposal form are:  Name and address of the proposer  Proposer’s occupation  Detailed description of the risk to be covered  Location of the risk  Value of the risk to be covered or sum insured  Previous insurance history  Loss experience  Any other information relevant to the subject Diagram 5: Common questions asked in a proposal form

ii) Policy Document, Conditions, Warranties and Exclusions An insurance policy contains many sections, such as  preamble,  insuring agreements,  schedule/s containing various details of the insured and the property or interest covered etc.,  exclusions,  conditions,  special endorsements,  warranties, if any

132


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.

Policy Terms and Standardised Wordings 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.

133


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

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.

Exclusion is an exception to the general statement of coverage contained in the policy.

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.

In a fire policy there can be: General exclusions: exclusions: war and allied perils Specific exclusions: subterranean fires 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.

134




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.  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.  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  as the location is not the same as mentioned in the policy and further  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.

Traditionally there were several endorsements to the motor insurance policies like IMT 26, IMT 11 etc. of the erstwhile motor tariff, which may still be used without the nomenclature. Similarly, specific standard endorsements were attached to the t he employer’s liability insurance or workmen’s insurance policy depending on the nature of industry in which the workmen are employed. These endorsements either restrict the coverage or impose additional conditions to be met by the insured or workmen for availing the benefit under the policy.

135


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.

iv) Reinsurance Placement Slip This is a very important document pertaining to risks which are reinsured on a facultative basis. The re-insurance broker prepares the slip containing the  terms,  conditions,  deductibles and  premium rates for the risk proposed 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  terms,  conditions,  deductibles,  premium rates and  names of the other reinsurers along with their percentage of acceptances of the risk This is done as a temporary record of reinsurance arrangement for which coverage has been effected, pending replacement by a formal reinsurance contract by the lead insurer.

v) Insurance Certificate In some classes of insurances like motor insurance, the companies issue a certificate detailing the identification of the subject matter of cover and the period of insurance. It does not contain the full set of terms, conditions and warranties but merely certifies the insurance coverage to satisfy the Motor Vehicle Act.

136


vi) Cover Note

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.

Features of cover note 

Temporary period of 30 days: Usually the cover note is issued for a temporary period of 30 days and has to be replaced by a fully worded policy document.  Evidence of risk cover:For the insured it is the evidence that the risk he proposed for insurance is covered against the perils he desired.  Issue of fully worded policy document: The insurer issues the fully worded policy once he receives full details required for underwriting the risk, including documents like completed proposal form and all other relevant information required in documentary form like inspection reports etc.

vii) Renewal Notice

Renewal notice is the intimation given by an insurer to the insured, informing him of expiry date of the existing policy and date before which he should renew his policy by paying premium mentioned in the notice.

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

Deductible or Excess is an amount which the policyholder agrees to bear in any claim.Only the loss amount that exceeds the deductible is payable by the insurer.

137


The deductible could be either  a compulsory deductible or  a voluntary deductible A voluntary deductible is one that is voluntarily accepted by the insured in return for reduction in the rate.

Benefits of deductibles (a) Cost reduction through 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. (b) Elimination or minimising the possibility of moral hazard

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. 

Straight deductible: A straight deductible is expressed as a specified amount. For example say the policy mentions Rs.10000 as the straight deductible. In this case any loss that is less than the deductible amount of Rs.10000 will not be paid. If the loss exceeds Rs.10000, the insurer pays the loss amount over and above the straight deductible amount of Rs. 10,000. ]

138




Percentage deductible: A percentage deductible is expressed as a percentage of the loss amount. For example say the policy mentions 10% deductible. In this case it would mean the insurer would pay 90% of the loss amount.



Combination of straight and percentage deductible: The deductible is expressed as a percentage of the loss or sum insured, subject to specified minimum or maximum amount. This type of deductible is common in property and miscellaneous insurances.

Diagram 6: Types of deductibles

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.

139


Concept of co-insurance in US and some other western countries

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.

2.6 Reinsurance and Appropriate Levels of Retention of Account Reinsurance is a mechanism which insurance companies use to spread the risks assumed.

Reinsurance is a contract of insurance between a primary insurer and a reinsurer whereby the primary insurer transfers a part of its business to the reinsurer in return for a commission called the ceding commission.

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 cho ose 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.

140


Diagram7: Reasons for an insurance company to go for reinsurance

Retention by primary insurer Reinsurance agreements involve a transfer of loss exposures assumed by the primary insurer to the reinsurer. However, the reinsurer does not assume all the exposures to which the primary insurer is exposed. The reinsurance agreement requires that a portion of the exposure, known as retention, be retained by the primary insurer. Therefore, before a primary insurer enters into any reinsurance contract, the first and foremost decision he takes is the “retention”. It is the amount of each and every risk which the insurer would like to retain for his own account before ceding it to a reinsurer. This is the limit upto which the primary insurer wishes to pay for the losses, out of its own account by retaining proportionate premiums. Retention Limits: Neither too high nor too low

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.

141


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.

Factors for deciding amount of retention The amount of retention a company can have for any risk depends on factors like  paid up capital and free reserve,  expected gross premium,  class of business,  spread of risk,  composition and size of the portfolio,  past experience in a portfolio,  classification of risk,  geographical location and concentration of risks,  cost of reinsurance and type of reinsurance,  foreign exchange regulations and  inflation in the country etc.

Features of reinsurance programme 

Once a decision is taken, the insurer negotiates with possible reinsurers of repute for the treaty reinsurance depending on the estimated turnover and quantum of business, class wise and portfolio wise.  Generally, the treaties are arranged in layers depending on the reinsurance program of the company.  Normally, every insurance company enters into negotiated agreements for the ensuing year 60 days prior to the commencement of the ensuing financial year.

Treaty Slips Once, the necessary premium modalities are complied with, the reinsurer binds the agreement by issuance called as treaty slips indicating the  terms,  conditions,  deductibles,  commissions payable,  various warranties that are applicable and  method of settlement of accounts

142


Later the treaty slips are replaced with fully worded reinsurance treaties or policies by the reinsurer.

Bordereaux The ‘bordereaux’ is an important document in the process of reinsurance. It is a statement provided by the primary insurer or reinsured to the reinsurer, consisting of premiums ceded and claims reported, paid and outstanding which are relevant to the reinsurance arrangement. Basically, this is a statement of account for the period referred in the bordereaux.

2.7 Portfolio Management 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 

Motor Portfolio: The term portfolio means in the case of motor vehicles insurance of any kind as part of the motor portfolio.  Fire Portfolio: All the risks falling under the basic fire insurance comes under fire portfolio.  As mentioned above the same goes for other categories such as the marine cargo portfolio, marine hull portfolio, engineering portfolio and miscellaneous portfolio. How is portfolio management management effected?

Portfolio management is effected through deciding an effective portfolio mix like deciding on issues like  individual risk versus institutional risk,  single peril versus multi-peril,  individual insurance versus group insurance,  project insurances versus operational insurances etc.

Along with the above, constant monitoring of the portfolio is required to check for adverse results against the projected results.

143


Role of reinsurance in portfolio management 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 B C D

Withholding Limit Retention Limit Detention Limit Preservation Limit

144


Summary 

 



  





  

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. Commercial considerations can increase the risks for the insurer and create a premium deficiency situation which can have undesirable consequences. The risk management framework typically consists of the following elements:  Willingness and capacity to accept risk  Nature of business to underwrite  Details of formal risk assessment process  Nominating the appropriate approval authorities and their definitive limits  Monitoring compliance with underwriting policies and procedures Approaches that can serve as tools for underwriting  Underwriting philosophy  Underwriting policy  Use of reporting forms on trends emerging on the claims front  Stated methods of taking the emerging claims experience Insurance documentation comprises all documents that evidence the contract of insurance and all other related matters pertaining to the insurance contract. The proposal form is very important from the point of view of both, insurer as well as the insured. 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. 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. 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. Changes or amendments in the policy are carried out by the insurer by issuing endorsements under the policy. Reinsurance placement slip is a very important document pertaining to risks which are reinsured. 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.

145






   

Renewal notice is the intimation given by an insurer to the insured, informing him of the expiry date of the existing policy and the due date before which he should renew his policy by paying the premium mentioned in the notice. Deductible or o r Excess is an amount which the policyholder agrees to bear in any claim. Only the loss amount that exceeds the deductible is payable by the insurer. Types of deductibles include: Straight deductible, percentage deductible or a combination of straight and percentage deductible. Co-insurance means sharing of the same risk by multiple insurers or sharing of some portion of the risk by the insured. The reinsurance agreement requires that a portion of the exposure, known as retention, be retained by the primary insurer. Portfolio management is the technique and process of protecting the insurer’s balance sheet and financial stability by effectively managing each of the portfolios of risk that the insurance company underwrites.


The correct answer is D. The process of underwriting helps the underwriter in deciding.  whether or not to accept a risk and,  if accepted, the terms and conditions to be applied and  the level of premium to be charged Answer to TY 2

The correct answer is B. 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.

146



Warranties are special conditions based on the statements made by the ________. A B C D

Insurer Insured Underwriter Broker

Question 2

___________ is a clause contained in an insurance policy which describes the condition or type of loss that is not covered by the policy. A B C D

Exception Exemption Exclusion 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 B C D

Endorsements Modifications Variations Amendments

Question 4

A cover note is valid for how many days? A B C D

15 days 30 days 45 days 60 days

147


Question 5

i) In some countries co-insurance means sharing of the same risk by multiple insurance companies. ii) In some countries co-insurance means sharing of some portion of the risk by the insured Which of the following statement is correct? A B C D

Only statement i) is correct Only statement ii) is correct Both statement i) and ii) are correct Both statement i) and ii) are wrong


The correct option is B. Warranties are special conditions based on the statements made by the insured. Answer to SEQ 2

The correct answer is C. ___________ is a clause contained in an insurance policy which describes the condition or type of loss that is not covered by the policy. Answer to SEQ 3

The correct answer is A. 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.

148


Answer to SEQ 4

The correct answer is B. A cover note is valid for 30 days. Answer to SEQ 5

The correct answer is C. Both the statements are correct In some countries co-insurance means sharing of the same risk by multiple insurance companies In some countries co-insurance means sharing of some portion of the risk by the insured

149


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.

a) b) c) d) e

Classification of Insurance Covers. Named Peril Policy. All risk insurance cover. Package Policy and Customised Insurance Policy. S ecia eciall Cov Cover ers. s.

150


1. Classification of Insurance Covers. [Learning Outcome a] The insurance companies classify different types of insurance covers offered to policyholders in many ways. Broad classification of such insurance covers is as follows: 1. Insurance of Property: This relates to assets covered based on either market reinstatements/new replacement value or any other valuation basis. All types of property can be insured which have fundamental financial value and the basis of valuation can vary based on requirements. 2. Insurance of Earnings/Profits: This type of insurance is becoming more common. This is also known as Loss of Profits (LOP) or Business Interruption (BI) insurance or consequential loss insurance. 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. 4. Insurance of Persons: This type of insurance covers persons where the indemnity is not followed in the strict senses, and most insurance is in the form of fixed benefits.

Broadly speaking, property insurance policies are on indemnity basis and all policies on human life are benefit ones. Classification by Class of Business

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.

151


Diagram 1: Sub classification by type of insurance cover

The reason for classification is because insurance policies cater to various sections of markets like householder, small trader, large corporate house and different types of service organisations, whose risk perceptions are different from one another and have to be addressed with different insurance coverages. 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.

Classification by Type of Insurance policy Insurance policies underwritten in non-life insurance can be broadly classified on the basis of perils covered such as: a) b) c) d) e)

Named Perils Cover Multi Peril cover All Risks cover Package/Customized cover Special Cover

152


An insurance policy covers perils which can be cause of __________. A B C D

Damages Injury Loss All of the above

2. Named Peril Policy. [Learning Outcome b] Named peril policy provides only coverage on losses incurred to property from perils or events named in the policy. It contains conditions conditi ons which cover what the insurer thinks is the most likely perils. 

It provides coverage for all direct loss or damage caused by specific perils mentioned in the policy.



It can be either a single peril or a multi-peril policy.



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.



Standard Fire & Special perils policy, Motor Comprehensive insurance etc. can be examples of named perils policy.

 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.

153




A discount on premium is offered if perils are deleted from the standard policy.

Exclusions of riot and strike perils in Standard Fire and Allied Perils policy gives benefits for discount in premium.



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’.



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.

Other examples of named peril policies: Marine Institute Cargo Clause ‘B’and ‘C’ Motor Package Insurance Policies Burglary Policies Critical Care Illness policies that cover specific tertiary t ertiary care contingencies.

Named peril policy providing coverage for direct loss can be either a ________ or a ______. A B C D

Package policy; Special policy Single peril policy; Multi peril policy Basic policy; Cover policy None of the above

154


3. All Risks insurance cover. [Learning Outcome c] 1. An “All Risks” insurance policy covers any risk which the contract does not specifically exclude. "All Risks" insurance policy covers direct physical loss or damage to the property insured unless the policy specifically excludes or limits the coverage. 2. In “All Risks” insurance policy, it is not necessary to name or list the insured perils since the t he intent is to cover all risks of damage or loss due to accidental circumstances.

Some examples of all risks policy:  All Risks cover for personal jewellery, valuables, works of art  Institute Cargo Clauses “A”, Inland Transit Clauses “A” in Marine Cargo class of business  Electronic Equipment Insurance, Erection All Risks, Contractors All Risk in Engineering class of insurance business  Industrial All Risks Policy etc.

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. 4. The history of ‘All Risks’ insurance can be traced to Marine insurance covers when policies were issued to cover ‘perils of the sea’. Over the period, the “All Risks” policies were designed to cover unique objects of art, jewellery, and other valuable items. 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. 6. The loss must be fortuitous, in other words, it must have happened accidentally, in an unforeseen manner. The burden of proof then shifts to the insurer to prove that loss was caused by an excluded peril.

155


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 typ e of o f policy p olicy 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: 

Breakage, cracking or scratching of crockery, glass, cameras, lenses, musical instruments and similar articles of brittle or fragile nature, unless caused by fire or accident to the means of conveyance. Since such fragile items are prone to losses due to regular usage, there is a need for such exclusion. Hence, in spite of the 'All Risks' nature, the coverage for fragile articles is restrictive as losses in the nature of wear and tear are not considered coverable.



Loss or damage caused by mechanical or electrical derangement/breakdown of any article unless caused by accidental external means. This means if the proximate cause of loss is a “breakdown”, the same is excluded. However, if the subject matter accidentally falls and in the process suffers a breakdown, the same is covered. This exclusion is applicable to traditional items like radio, watches etc.



Damage caused by any process of cleaning, dyeing or bleaching, restoring, repairing or renovation or deterioration arising from wear and tear, moth vermin, insects or mildew or any other gradually operating cause. The intention being that the the cause of the loss should be direct accidental physical loss.

9. A few underwriting areas of “All Risks” Insurance covers are: 

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 perils are not specifically listed. Hence, insurers may 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.

156




It is for an underwriter to decide if any exclusion can be added or waived and determine the premium, deductible or imposition of any special condition.



Absolute exclusions like war and allied perils, nuclear risks can not be deleted.



Some of the usually excluded excluded perils like mechanical/electrical/electronic breakdowns, riot, strike, malicious and terrorism perils may be held covered on extra extra premium and special conditions. Such peils are termed as ‘buy back’ covers.



Policy must be clear as to the geographical jurisdiction of the subject matter of insurance since an “All Risks” cover is also sought for property carried as an accompanied baggage/apparel.



Another confusion the word “All Risk” denotes is that all of the property concerned is covered. covered. In case the intention of the policy is to cover only 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 th e sum insured. If such a list li st 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: A B C D

All Risks inurance cover All purpose cover All peril policy None of the above.

157


4. Package Policy and Customised Insurance Policy. [Learning Outcome d] 4.1 Package Policy 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. Important features of Package policy: 

Various ‘individual policies’ that are already available with the insurer are bundled into various sections and underwritten as one policy document.



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.



Advantage for the insured is that there is no need to deal with various insurers and different renewal dates.



Some package policies provide for extra covers that may not be available in an individual policy marketed by the insurer.



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.

158


4.2 Customised Insurance Policies The needs of the policyholders keep changing and vary with different professional and economic status they hold. They look for optimum insurance coverage as they pay premium for perils perceived by them. In order to respond to such needs, the insurers take special measures to customize insurance needs of the policyholders by developing tailor made insurance policies for the risks exposed. Such policies are called by different names like Customized Policies, Special Contingency Policies or tailor made polices. The need for such policies also arises when existing products of insurers do not meet the insured’s requirements. 1. These policies are basically individually rated risks as per the ‘File and Use’ guidelines of the IRDA. 2. The underwriting of customised policy involves specialised risk assessment as from the view of limited experience and non availability of readymade pricing formula. 3. The underwriting of customised insurance covers for property damage calls for collection of extensive data like:  Nature of property (machinery, whether fragile etc.)  Highest value per location  Limit per accident/ per policy period  Basis of valuation  Need for such an insurance (whether standard types of covers are not available) 4. A risk analysis has to be done based upon risk profile of the insured. The probability of a loss occurring and financial effects of the same are to be precisely analysed. The perils covered need to be clearly listed in the policy. 5. There are different contingencies under which a policy is customized: 

Those risks not covered in the list of standard policies available with insurer.

 New covers needed to be insured i nsured in addition to standard existing covers

such as Standard Fire Policy supplemented by peril of ‘Accidental External Damage’. 

Event insurances like that for a cricket match where any of the ‘manmade’ or ‘Acts of God’ perils may result into personal injury, property damage as well as loss of revenue.

159




Personal forms of customised polices such as covering a footballer’s legs or a pianist’s fingers and hands.



Tailor made Health Insurance Policy.

6. The underwriting of customised policy requires high level of knowledge and experience and therefore is usually reserved for the insurer’s senior underwriters. 7. Pricing of customised insurance policy is usually linked to premium under a readymade policy for a similar risk duly modified by requirements.

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 _________ A B C D

Customised Insurance Policy Package policy All risk policy None of the above

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. 1. This policy is mainly used in circumstances where occurrence of total loss is virtually impossible.

In case of burglary risk, a total loss is practically impossible in respect of heavy machinery and bulk commodities stored loose like sulphur rock phosphate etc.

2. The burglary policy is issued with a sum insured expressed as a percentage of the full value e.g. 25% of full value of Rs. 100 lakhs.

160


Diagram 2: Underwriting Safeguards for a Burglary insurance Policy on First Loss Basis

3. An additional underwriting measure called ‘partial average’ condition may be incorporated which w hich provides that if the total value of stocks s tocks is more at the time of loss than the total value declared for the purpose of insurance, an average condition will be applied only a rateable share of loss is paid. 4. Following rating factors are considered:  Maximum probable loss due to the nature of stock.  Full value of stock  Percentage of full value as sum insured  Normal rate for full value of insurance. 5. Following table is an illustration of a simple rating method:

Cover for 75% of full value 65% of full value 50% of full value 25% of full value

Rate 90% of full value rate 80% of full value rate 70% of full value rate 50% of full value rate

(Note: It is to be noted that according to “File and Use” guidelines of IRDA, the rating schedule for first loss policies has to be vetted by an Actuary)

161


5.2 Fire Declaration policy  This policy is issued on stocks which are subject to marked

fluctuations in quantity.  The insured is required to take the policy for the highest sum insured

that he predicts during the year and pay a provisional premium.  The policyholder has to declare periodically the actual values of stock.

These values are added on the expiry of the policy and premium calculated on average of the values with provision for adjustment of premium.  Refund of premium is subject to retention of 50% of provisional

premium (minimum premium). 5.3 Floating policies 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. 2. A combined Declaration and Floating policy can also be issued if needed.

Diagram 3: Underwriting Safeguards for Fire Floating policies

162


3. The policy may be subject to extra premium as the exposure to hazard is higher. 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. 7. The policy is issued for an amount representing the insured's estimated annual turnover of shipments/ consignments until the sum insured is exhausted when it can be reinstated. For each declaration, a certificate of insurance which may be needed by banks is issued. 8. Under Fidelity Guarantee insurance a number of specified employees can be covered in the floating policy not for individual amounts but for a specified sum of guarantee applicable to the whole group. This sum insured should be fixed by the insured to ensure that it should be adequate to cover the largest single loss that may arise as a result of any one employee or more employees acting in collusion. 9. Recently, such floating policies have come into vogue to cover all the members of a family under one sum insured in Medical insurance. 10. Valuation of property is another area of concern in underwriting. Claims under policies are settled on the basis of the basic value of the property (value of a similar property on the day of loss less depreciation). 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.

163


5.4 Valued Policies 1. In Fire insurance, valued policies can be issued on properties whose market value cannot be as ascertained e.g. works of art, curios, manuscripts, obsolete machinery etc. 2. Fire insurance is subject to the valuation certificate being submitted and found acceptable by the insurers. 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.

Under a Fire Declaration policy, refund of premium is subject to retention of ____ provisional premium. A B C D

25% 65% 50% 75%

Summary 

Liability arises from the law of tort and may arise owing to insured negligence, causing personal injury and damage to property of others.



A peril can be the cause of injury, damages or loss.



A discount on premium is offered if perils are allowed to be deleted from the standard policy.



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.

164




A policy which combines two or more types of insurance covers into one policy is called ‘Package Policy’.



First Loss Policy is mainly used when total loss is virtually impossible to occur.



A valued Fire insurance policy is subject to the valuation certificate which should be accepted by insurers.


The correct option is D. 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

The correct option is B. A named perils policy can cover either one or more than one specified perils Answer to TY 3

The correct option is A. Answer to TY 4

The correct option is A. 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

The correct option is C.

165



Which of the following is a not named perils policy? i. ii. iii. iv.

Motor Package Insurance Policy Burglary Policy Industrial All Risks policy Marine Cargo policy on Institute Cargo Clauses ‘B’ & ‘C’

A B C D

ii, iii i, iv iii 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: A B C D

Fire floating policy Fire declaration policy First loss policy None of the above

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: A B C D

Minimal Loss Coverage Partial Average Coverage Customised Coverage None of the above

166



The correct option is C. Answer to SEQ 2

The correct option is A. Fire Floating policy covers in one sum insured stocks stored in different specified godowns. Answer to SEQ 3

The correct option is B.

167


CHAPTER 9

UNDERWRITING PROFITABILITY AND REUNDERWRITING STRATGIES 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.

a) Learn about underwriting profit / loss. b) Learn about areas where adverse results can appear. c) Discuss about reviewing the underwriting policy or reunderwriting.

168


1. Learn about underwriting profit / loss. [Learning Outcome a] 1.1 Underwriting Profit / Loss Underwriting profit or loss is the amount of money that an insurance company gains or loses owing to its operations excluding investment earnings. Underwriting profit

Profitability is required in underwriting of risks so as to ensure a. increasing financial strength for the insurer b. capability to assume more risks and c. pay claims and meet all liabilities in case of unforeseen catastrophes 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

[Profit

=

Premium Amount

−

Losses (claims)

−

Expenses Incurred

]

Therefore if the premium underwritten is more than claims paid and expenses incurred then the underwriter has made a profit. profi t. 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. The losses reported may balloon on account of large catastrophes or owing to unforeseen legislation or court verdicts and the social milieu in the country especially relating to law and order may cause more than expected losses.

169


1.2 Underwriting philosophy The steps towards planning for underwriting profitability include 

Step I: to have a proper underwriting philosophy developed by senior underwriters of the insurance company,  Step II: get it duly vetted by top management and actuary of the company  Step III: Get it formally approved by the Board

The underwriting philosophy will result in drafting underwriting policies of the company and practices to be followed through underwriting manual and rating tables. Decisions based on the underwriting approaches of the company, an insurer has to factor in the following: a) Lines of business to be written b) Competitiveness of the rating c) Comprehensiveness of the covers offered d) Segments and areas where the products are to be sold e) Intermediaries that may be used and the commissions offered f) Reputation for service and especially in claim service g) Management expense ratio Diagram 1: Factors to be considered

170


1.3 Written premium Vs. Earned premium 

The estimation of underwriting profitability of an account begins by determination of the earned premium and not by the written premium.



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 1 st July will be 50% of the written premium and on 31st December it will be 100%.



A comparison of the written premium and earned premium can indicate the dynamism of the insurer in premium growth.



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.

1.4 Computation of losses 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

1.5 Underwriting profitability ratios There are a number of ratios that insurers use to measure profitability of their underwriting operations. There are three ratios that are commonly used. a) Loss ratio: The formula for calculating loss ratio is as follows Loss ratio =

Incurred losses x 100 Earned premium

This ratio is indicated by incurred losses divided with earned premium for the period desired.

171


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 Expense ratio =

Underwriting expenses x 100 Written premium

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

[Combined

ratio

=

Loss ratio

+

Expense ratio ]

Combined ratio represents the overall profitability of the insurer. A combined ratio over 100% indicates an underwriting loss and if the ratio is below 100% profitability is indicated. The combined ratio needs to be calculated with wi th care as insurers have to maintain large reserves which are payments that need to be made in future for losses that have already occurred. If these reserves are not accurate the loss ratio will not reflect the true profitability. The combined ratio normally considers only underwriting profits. The investment profit that the insurers make is not factored in. An insurer can improve underwriting profitability by taking necessary decisions on any of the above referred three primary elements that affect underwriting performance.

1.6 Underwriting restrictions Profitability can be increased by raising the rates or by ensuring that more premiums per policy are written or by underwriting more risks. However it is often found that by merely underwriting more policies the loss ratio may not necessarily be controlled. Therefore insurers re-examine the underwriting norms and go for better selectivity of risks for underwriting. Underwriting restrictions can be imposed across all lines or specific lines and certain segments of insureds may not be offered cover and so on.

172


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.

1.7 Underwriting audits 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.

173


Which of the following statement is correct for measuring the profitability of an insurer? A B C D

Profit = Losses (claims) – Premium Amount – Expenses Incurred Profit = Premium Amount – Losses (claims) – Expenses Incurred Profit = Expenses incurred – Losses (claims) – Premium Amount Profit = Premium Amount – Losses (claims) + Expenses Incurred

2. Learn about areas where adverse results can appear [Learning Outcome b] The following are the areas where adverse results can appear:

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 If the underwriting guidelines are not being correctly applied or are ineffective, then the remedial steps lie in enforcing more discipline among underwriters, sales force and other intermediaries, training them and so on. It may also be that the guidelines may require review and updating. These revisions may take time for redrafting, implementing and training of the underwriters and others in the sales process.

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:  by way of endorsements in the policy and  by revising the entire policy wording

174


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 There is inefficiency in claim settlement and possible frauds and over payments are not being eliminated. This requires tighter control on claim assessors and more oversight on the patterns of claims being lodged to understand any leakage that may be taking place owing to moral hazards and / or physical hazards not considered by the underwriters. There could also be unnecessary claim expenses leading to adverse results.

6. High Exposures   

Introducing deductibles or increasing them Introducing sub-limits for certain types of losses Imposing compliance with safety measures and codes such as building codes  Avoiding high risk concentrations or geographical areas  Re-rating loss prone segments

7. High Expenses Controlling expenses has positive effects on profits. It reduces the combined ratio and the reduced expenses can be passed on to insureds by lowering the rates, which may result in high premium volumes and goodwill. Expenses can be controlled by increasing efficiency and productivity of the insurer’s employees as also through training and experience build up. Secondly by technology upgradation and resulting ease of doing business can help to reduce costs.

175


3. Discuss about reviewing the underwriting policy or reunderwriting [Learning Outcome c] 3.1 Reunderwriting

Reunderwriting is the process by which the profitability of a portfolio is managed and the claims that take place are duly examined for identifying the loss exposures and taking necessary correction for implementation.

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  unusual frequency: more number of claims than were estimated or  more severity: more amounts to be paid out than was the expected norm The understanding in insurance practice is that:  if the loss frequency is more the problem lies in the policy selection and  if the severity of losses is beyond estimation it indicates a rating inadequacy problem

3.2 Claims Analysis  In a situation of deteriorating claim results, the claim database need to be

analysed as to whether there is a pattern in the losses.  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.  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.

176


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.

3.3 Loss cause analysis 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  the loss was preventable or  took place because of negligence or carelessness of the insured or  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.

3.4 Corrective actions 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. The corrective actions can be implemented by one or more of the following steps: 1. Non-renewal of all policies which has an undesirable loss exposure especially those policies displaying moral or morale hazards. 2. Cancel the policies midterm if material misrepresentation misrepresentation has been made in the proposal. 3. Modification of coverage by various methods available such as increase in deductible, modification of terms and conditions through endorsements or warranties and so on.

177


4. Examination of adequacy of sums insured in the policy to avoid underinsurance and increase premium per policy. 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. 7. Modify the underwriting guidelines: Subject to approval of the regulator the guidelines for underwriters and acceptance of business can be suitably modified. This will enable the insurer to modify discounts offered or to increase rating factors and deal with all the other aspects which increase losses but were not factored in the earlier guidelines. 8. Modifications based on changes in the environment: In the Motor Insurance market, for instance, the pattern of vehicles manufactured or sold may change. If sale of scooters in India has decreased, while that of motorcycles increased rapidly, such changes can have substantial effect on the claim patterns. Review of such changes whether for better or for worse has to be monitored. 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.

178


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.  Lower than standard rates are offered to better class of insureds  Average rates offered to median class and  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. Diagram 2: Corrective actions

179


3.5 Implementation of corrective actions 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  in changing the rates, terms  in training the underwriters and sales wings  to obtain necessary approvals and  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.

3.6 Cause of underlying problems The entire review process requires a thorough understanding of the special characteristics of relevant portfolio, regulations that concern that portfolio and competitive position of the insurer in the marketplace. Thus there is a need to understand the underlying problems which can arise from  deficiencies in underwriting policy,  changes in economic conditions of the area concerned,  technological or demographic changes,  new requirements of regulatory process,  actions of competitors in the marketplace  actions of legislatures, courts and consumer interest action groups So far as underwriters are concerned, understanding of the special characteristics of relevant portfolio and realigning it to realities of the market place will obtain planned results. Thus Motor insurance has to factor in changes in technology where, for instance, individual parts are now replaced by assemblies in case of repair, and repairs are now not done and replacements of parts are found more economical in terms of time costs as well as efficiency and customer satisfaction.

180


3.7 Underwriting Audit The purpose of underwriting audit is to give feedback to the underwriter and to the management on the appropriateness of implementation of underwriting policy and interpretation and use of the underwriting / rating manuals. The deviations are reported so that the underwriter and the company may be helped to improve underwriting process as outlined in underwriting philosophy adopted by the Board. The audit team will examine underwriting process of a department or an office on a structured basis to examine the spirit of compliance, the individual judgment exercised by the underwriter and the results generated thereby. The auditor will examine the environment for profitable underwriting based on special conditions of the area of operation and steps taken by the underwriters to adapt to changing conditions not envisaged in the underwriting manual. The audit may report both the success factors as well as deviations or failures that caused losses or can cause future losses.

Re-underwriting of portfolio or portions of portfolio Underwriting audit is normally based on a sample of policies drawn and examined individually as also overall analysis of the portfolio based on various underwriting reports that can be generated. The audit report may advise the department to review and begin to re-underwrite the portfolio or portions of the portfolio that has deviated from planned results.

Audit recommendations The audit process compares trends seen in underwriting with underwriting guidelines of the insurer. The audit process notes actual risk profile of the portfolio that is being b eing examined and makes relevant detailed detai led notes no tes on deviations which are currently causing losses or are likely to cause losses against the planned results. Accordingly suitable recommendations are made for improvement by the concerned department. The department that is being audited may accept or reject the report or parts of it and justify their actions or may accept the same and make necessary changes as suggested. The higher management as well as the Board Committee would be apprised of findings of audit department, compliance by the concerned office and corrective action at the company level, to take care of deviations in a timely manner.

181


3.8 Review of claims and special events Deteriorating loss ratio when not related to a catastrophic event or series of events can cause a difficult situation to the insurer to unravel the correct reasons for the losses. Nevertheless the insurer's various concerned departments departments must begin to collect and sift the evidence so as to reach right conclusions and eliminate root causes of deterioration. Review of claims can be cause-wise and size-wise and be compared on month to month or year to year basis. Review of claims can also be on the basis of  consumer segments,  sales channels used or repair establishments  loss assessor wise  geographical area wise Such analysis will begin to show patterns that can be useful for going back to the underwriting norms that may need review to correct the slide in the claims ratio.

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.

182


In this, strategies need to be developed for review of underwriting or reunderwriting and aligned with competitive and regulatory requirements. c) Reduction in combined ratio: Finally the costs of the insurer need to be reduced to bring the combined ratio down and if possible to pass on the benefits of lower costs to insureds so as to win more market share and customer goodwill. The role of underwriting audit in generating underwriting profitability cannot be underestimated and a properly set up underwriting audit department can be great boon to underwriters, the top management and the insuring public.

Which of the following is the correct way of revising policy wording? A Only by way of endorsements in the policy B Only by revising the entire policy wording C Either by way of endorsements in the policy or by revising the entire policy wording D Neither of the above

Summary 

 



 



Underwriting profit or loss is the amount of money that an insurance company gains or loses owing to its operations excluding investment earnings. The profitability of an insurance company is measured as follows Profit = Premium Amount – Losses (Claims) – Expenses incurred 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. 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. Earned premium is that part of the premium in a policy which is being earned as the risk period progresses. 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. Common ratios that insurers use to measure profitability of the underwriting operations are: Loss ratio, expense ratio and combined ratio.

183


   



 



The loss ratio can be decreased by a more careful examination of claims and claim assessments. Whenever unacceptable loss ratios emerge the compliance of underwriting policies and guidelines needs to be checked through an underwriting audit. Areas where adverse results can appear include: rating, underwriting, policy wordings, reserving, claim processing, high exposures, high expenses 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. The corrective actions can be implemented by one on e 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. Corrective actions should begin with implementation of the easiest for those policies which will generate the desired improvement. 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. 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.


The correct answer is B. The following statement is correct for measuring the profitability of an insurer Profit = Premium Amount – Losses (claims) – Expenses Incurred. 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

184



The underwriting philosophy developed by senior underwriter needs approval from which of the following? A B C D

Only Actuary of the company Top management of the company Top management and Board of the company Top management, Actuary and Board of the company

Question 2

The estimation of underwriting profitability of an account begins by determination of the _________. A Earned premium B Written premium C Both are one and the same D None of the above Question 3

Which of the following is correct for combined ratio? A B C D

It is combination of loss ratio and miscellaneous ratio It is combination of loss ratio and expense ratio It is combination of expense ratio and miscellaneous ratio It is combination of profit ratio and miscellaneous ratio

185



The correct option is D. The underwriting philosophy developed by senior underwriter needs approval from the top management of the company, the actuary and the Board. Answer to SEQ 2

The correct answer is A. The estimation of underwriting profitability of an account begins by determination of the earned premium. Answer to SEQ 3

The correct answer is B. Combined ratio is combination of loss ratio and expense ratio.

186


CHAPTER 10

PROTECTION OF POLICYHOLDERS’ POLICYHOLDERS’ INTERESTS Chapter Introduction This chapter aims to provide you with an understanding about the provisions of IRDA (Protection of Policyholders’ Interests) Regulations, 2002.

a) Understand the Protection of Policyholders’ Interests Regulations issued by IRDA.

187


1. Understand the Protection of Policyholders’ Interests Regulations issued by IRDA. [Learning Outcome a] 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 Policyholders’ particularly by technical wing of the t he insurer i nsurer is the Protection of Policyholders’ Interests Regulations, 2002 . This regulation is intended to ensure, among other things, that insurance is provided on equitable terms and conditions. The insurers need to fulfill their obligations in accordance with these terms and conditions. Insurers ought to support and equip consumers through enhanced disclosures. It is the duty of each and every insurer to promote greater market discipline. The rights of policyholders to make informed choices regarding their selection of insurance products and service providers need to be respected and preserved. These are articulated by way of various regulations by the Regulator who has the duty to ensure that the insurers comply with the obligations cast on them.

Insurance Regulatory and Development Authority (Protection of Policyholders’ Interests) Regulations, 2002 The regulations lay down various stipulations to be followed by insurance companies with regards to:  point of sale  proposal for insurance  grievance redressal procedure  matters to be stated in a life insurance policy  matters to be stated in a general insurance policy  claims procedure in respect of a life insurance policy  claims procedure in respect of a general insurance policy  policyholders’ servicing  other general guidelines 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

188


Diagram 1: IRDA (Protection (Protecti on of Policyholders’ Interests) Regulations, 2002

1.1 Point of Sale Prospectus: A prospectus of any insurance product shall clearly  state the scope of benefits  state the extent of insurance cover  explain warranties, exceptions and conditions of insurance cover  clearly spell out the allowable rider or riders on the product with regard to their scope of benefits

189


Diagram 2: Contents of the prospectus

a) Complete disclosure

An insurer or its agent or other intermediary shall provide all material information in respect of a proposed cover to the prospect to enable him/her to decide on the best cover that would be in his or her interest. 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.

1.2 Proposal for insurance a) Proposal form

A proposal for grant of cover, for general insurance business, is necessary (except in case of a Marine insurance cover where current market practices do not insist on a written proposal form).

190


b) Where proposal form is not used

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. ins urer.

1.3 Grievance Redressal Procedure a) Grievance redressal mechanism

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

The information in respect of Insurance Ombudsman shall be communicated to the policyholder along with the policy document and as may be found necessary. The system of Insurance Ombudsmen has been put in place in terms of the Rules for Public Grievances, 1998 notified by the Government of India. The Ombudsman entertains grievances pertaining to personal lines insurance. His jurisdiction and powers are as spelt out in the Rules.

1.4 Contents of a General Insurance Policy a) Insured details: A general insurance policy shall clearly state the name and address/es of the insured and financiers, fin anciers, where applicable. b) Property details: It must contain a full description of the property or interest insured and details of the location or locations of the property or interest insured along with appropriate values.

191


c) Period of insurance: The period of insurance has to be mentioned in the policy. 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 pol icy 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. e) The policy terms and conditions must be clearly stated. f)

It must also contain details of obligations of the insured under the policy etc.

Diagram 3: Contents of a General Insurance Policy

1.5 Claim Procedures The regulations prescribe obligations of a general insurance company as well as the insured in respect of claims. An insured or claimant shall give notice to the insurer of any loss arising under the contract of insurance at the earliest or within such extended time as may be allowed by the insurer. On receipt of such a communication, a general insurer shall respond immediately and give clear indication to the insured on the procedures that he should follow.

192


Role of the Surveyor in Claim Processing a) Appointment of surveyor: In cases where a surveyor has to be appointed, it shall be so done within 72 hours of the receipt of intimation from the insured. b) Submission of report: A surveyor shall communicate his findings to the insurer within 30 days of his appointment. In special circumstances he may seek an extension but in no case shall take more than 6 months from the date of his appointment to furnish his report. c) Discharge of claim: An insurer shall dispose of a claim within 30 days of receipt of the survey report. 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.

1.6 Policyholders’ Servicing The regulations prescribe various requirements relating to policyholders’ servicing. a) Any communication received from a policyholder shall be responded to within 10 days of its receipt. Such communications may relate to  recording change of address,  issuance of a duplicate policy,  issuance of an endorsement under a policy noting a change of interest or sum assured or perils insured,  financial interest of a bank etc. b) These ought to be carried out and responded to within the set time frame. c) An insurer shall also give prompt guidance on the procedure for registering a claim.

1.7 Mutual Obligations It is to be borne in mind that the regulations not only cast obligations and duties on an insurer but on an insured as well. The requirements of disclosure of ‘material information’ regarding a proposal or policy apply to both the insurer and the insured. Responsibility Responsibility of the insured

A policyholder shall furnish all information that is sought from him by the insurer and also any other information which the insurer considers as having a bearing on the risk to enable the latter to assess properly the risk sought to be covered by a policy. The policyholder has the duty of assisting the insurer in prosecution of a proceeding or in the matter of recovery of claims which the insurer has against third parties.

193


1.8 Policyholder awareness Protecting policyholders not only entails laying down of regulations and monitoring the companies and/or agencies involved for compliance with the provisions but also a proactive role by way of enhancing awareness among policyholders regarding their rights and duties. The insurers, the intermediaries and all other stakeholders have a responsibility in ensuring that the customers get educated in insurance matters so that they may take informed decisions. While the IRDA has its own publicity programmes from time to time, the insurers and intermediaries too have their respective publicity policies and programmes. There have to be concerted efforts on the part of all stakeholders.

1.9 Disclosures by Insurers 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. File & Use

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. 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.

The insurer shall communicate all decisions to the proposer within a reasonable period not exceeding _______ from receipt of proposals by the insurer. A B C D


194


Summary  





  



   

IRDA has issued the Insurance Regulatory and Development Authority (Protection of Policyholders’ Interests) Regulations in 2002. 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. Where the prospect depends upon advice of the insurer or his agent or an insurance intermediary, such a person must advise the prospect dispassionately. 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. Every insurer needs to have in place proper procedures and effective mechanism to address complaints and grievances of policyholders. Insurance Ombudsman details shall be communicated to the insured along with policy document and as may be found necessary. 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. 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. An insurer shall dispose of the claim within 30 days of receipt of the survey report. Any communication received from a policyholder shall be responded to within 10 days of its receipt. The IRDA stipulates various disclosures - financial and others, which have to be complied with by the insurers. 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.

195



The correct answer is C. The insurer shall communicate all decisions to the proposer within a reasonable period not exceeding 15 days from receipt of proposals.


In claims where a surveyor has to be appointed, it shall be so done within _____ of the receipt of intimation from the insured. A B C D

24 hours 48 hours 72 hours 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 B C D


196


Question 4

Any communication received from a policyholder shall be responded to within ______ of its receipt. A B C D



The correct option is C. In claims where a surveyor has to be appointed, it shall be so done within 72 hours of the receipt of intimation from the insured Answer to SEQ 2

The correct answer is B. 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

The correct answer is B. 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

The correct answer is A. Any communication received from a policyholder shall be responded to within 10 days of its receipt.

197


CHAPTER 11

RESEARCH AND DEVELOPMENT IN UNDERWRITING, RATING AND PRODUCT INNOVATION – CHALLENGES AHEAD 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.

a) Understand new areas where challenges are occurring in the field of insurance. b) Understand reasons due to which underwriting errors can occur. c) Learn about product innovation.

198


1. Understand new areas where challenges are occurring in the field of insurance. [Learning Outcome a] 1.1 Need for research and development in the field of insurance a) Need for research and development: in the field of insurance, in particular with reference to underwriting and rating, product innovation cannot be overemphasised in view of the dynamic nature of changes in the profile of risks offered for insurance, expectations of customers and innovations coming into the field. b) Challenges for the underwriter: The challenges in this area are considerable for the underwriter due to  continuous flux in the risk fields being dealt with,  new and emerging profile of losses,  unforeseen catastrophes that take place intermittently and  changes in the economic, environmental, technological, legal and social landscapes in which the insurer operates c) Role of emerging technologies: There are many emerging technologies that may aid loss minimisation such as connectivity anytime/ anywhere, increasing use of Global Satellite Positioning Systems (GPS), ability to carry out complex analysis, modeling and so on. d) Genetic changes: A wide variety of genetic changes are being contemplated for human life betterment, which all have implications in the area of life and health insurance. Underwriters are looking at these and other innovations to monitor risks as well as remedies for reducing and pricing existing and emerging risks.

1.2 New areas where challenges are occurring 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.

199


With innovation, R&D and rapid introduction of new products in market, new and completely unforeseen problems emerge. A fast business cycle implies more insurance requirements in untested areas for risk ri sk management. b) New vulnerabilities with hazards remaining the same: Activities in the world are becoming highly interlinked. When something goes wrong in one place, the whole inter-connected system goes haywire globally in unanticipated ways. Certainly, the danger of linkages have been seen in failures of large organisations like Enron and such losses only portend new potential vulnerabilities and liabilities that continue to emerge. Today, many companies are linking their strategic domains like financial systems into electronic supply chains with their partners. This results in a massively interconnected industrial financial system.

A skillful insurer spots an opportunity when one network problem somewhere brings down an entire inter-connected industry supply chain. There is need for insurance against resultant manufacturing delays, assembly lines, plant shutdown and lost sales. c) Untested insurance: An ever-increasing number of new challenges are surfacing, which no one was able to predict years ago. New forms of genetic risks pose ever increasing challenges. Previously unseen new environmental challenges threaten to damage, dislocate, and destroy lives, assets, opportunities and progress.

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. d) Growing need for international insurance coverage: A form of insurance is emerging that involves need for international coverage such as in Aviation or Marine hull insurance. The prospect is suddenly being confronted with problems imposed by fellow humans of the world in areas like viruses, hacker attacks and larger global problem of terrorism etc. Concepts like probable maximum loss l oss are becoming redundant to assess such catastrophic risks by the insurers. Human ingenuity is needed to respond to such issues in the insurance domain, starting with ad hoc solutions and transitional techniques.

200


It is becoming increasingly necessary for underwriters to be attuned to rapid changes taking place as the issues relating to risk are becoming more and more complex. New concepts of coverage such as parametric insurance offers new techniques, which may not indemnify pure losses, but agree ex ante to make a calibrated payment upon occurrence of a triggering event. The triggering event may be a catastrophic natural event, which may ordinarily precipitate a loss or a series of losses. This has considerable advantages such as  absence of moral hazard,  immediate possibility of payment on the occurrence of the trigger event,  saving of claim investigation and assessment costs,  waiver of considerable time consuming documentation and so on 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. Diagram 1: New areas where challenges are occurring

1.3 Innovative Rating Programmes Rate Making

Underwriters and actuaries have begun to construct more complex risk classes by considering various additional differentiating factors.

201


In motor insurance, factors such as    

yearly mileage driven, number of other drivers in the household, use of a garage, additional anti-theft devices etc. can obtain different rates

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. Regulatory requirements: There are also compounding factors such as common regulatory requirements on the industry, attempting to make sure that insurance is affordable. This will limit the maximum amount of premiums that can be asked of customers, irrespective of their accident behavior. Therefore, even when considering long standing customers it is unavoidable that good risks or drivers subsidise bad risks or drivers to some degree. 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.

202


This shifts the emphasis of the industry from the problem of “determining optimal premium” to the issue of “ improving customer relationship” by:    

identifying low risk customers, adjusting their premiums in order to win their loyalty, improving customer retention and increasing market share

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.

1.4 Data, Concepts, Terminology Availability of appropriate data

Like for any other data mining task, the most fundamental requirement is availability of appropriate and credible data. In the context of insurance policies, this requires information:  on the policyholder,  on the risks covered,  on cumulative risk behavior and  optionally on a variety of additional factors that may be relevant Setting of rates for new and existing customers

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.

203


The bonus malus system is the system of penalising or rewarding of customers based on their yearly accident claims. 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. For any given customer, it can be estimated as the product of:  the likelihood of submitting a claim and  the expected size of claim 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.

In practice, of course, there are many operating expenses in a business, including buildings, equipment, and personnel, that need to be taken care of, irrespective of number and size of claims that may occur. None of these costs are included i ncluded in the pure premium - neither are underwriting u nderwriting costs, such as commissions to agents and brokers included. The actual premium therefore is always substantially higher than the pure premium.

1.5 Why underwriting matters? Underwriting activity faces intense pressure in a deregulated market for various reasons such as    

industry competition, overcapacity, customer pressure and other relevant factors

204


Diagram 2: Why underwriting matters?

Every company faces the dilemma of volume vs. profitability. Poor underwriting can actually worsen the problem in both cases:  bad underwriting can initially destroy profitability in unseen manner and  can destroy volume in due course Without necessary capital or return on risk assumed, further volume build up will not be permitted. The underwriter has the challenge to meet two difficult targets,  one, how to carry out a proper risk assessment and pricing, and  second, how to convince the client that the price quoted is the best value for money

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? A Yearly mileage driven B Number of other drivers in the household C Additional anti-theft devices D All of the above

205


2. Understand the reasons due to which underwriting errors can occur. [Learning Outcome b] Reasons due to which underwriting errors can occur 2.1 Faulty information collection 

The insured or the intermediary may not disclose information other than asked for.  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.  Once relevant information is available, careless processing or understanding of the information can also affect proper underwriting.  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.

2.2 Exposure Measurement Once information is obtained, exposure measurement is a matter of skill of the underwriter and the tools he uses to evaluate it. Exposure measurement can be on various parameters such as:  frequency  severity  extent of concentration and  similar other considerations

2.3 Coverage Structuring The cover that is to be structured must offer value to the customer and at the same time must be correctly priced. Underwriters, instead of deepening their expertise, may resort to either:  short changing the customer by trying to offer a lower cover than what is sought or  leading the insurer to under pricing by short charging the premium

206


Structuring the cover is an option that helps to secure a negotiated balance between the need for the widest cover desired by customer and obtaining a fair price for it.

2.4 Wrong Pricing Rate setting is a challenging task and needs to take into account:  industry level claims experience,  expertise of the Head Office underwriting team,  book experience of the office concerned along with  specific client experience 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 und erwriter’s personal judgment, as also to t o execution executio n errors and infatuation of meeting market pricing measures. Aggressive Pricing: Underwriters can no doubt aggressively price better than average risks within a class, but then take care to load or conservatively price worse than average risks, as otherwise the portfolio will suffer price erosion. Underwriters, if knowingly or unknowingly, are judged only on the basis of premium growth and not on profitability can legitimise their pricing decisions using clever methods to use only selective information collection and this creates long term problems and compromises data integrity. Winning in the market should not damage the long term chance of surviving in the market. 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, under-pricin g, poor data quality and anticipated errors in underwriting execution.

This begins the process of rates becoming increasingly disconnected from realities in the market and leads to loss of confidence in underwriting and pricing abilities of the insurer. Meanwhile, the unit underwriters may feel that the actuaries and senior underwriters are out of touch with ground realities, and they begin to disregard the filed rates and follow their own judgment, which can be subjective or follow some ad hoc rules or patterns for pricing the risks that come before them.

207


Diagram 3: Reasons due to which underwriting errors can occur

3. Learn about product innovation. [Learning Outcome c] Product innovation Product innovation process involves the following Diagram 4: Product innovation process

208


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.

3.1 Identifying customer needs This is done by monitoring: a) Internal staff reports  Intermediaries’ feedback  Surveyors’ reports  Underwriters’ reports

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. b) Current customer trends

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

The identification of emerging market trends require projections and assumptions based on environmental scanning. d) Market research

Insurers perform marketing research to determine whether the assumptions made about customers’ needs and trends, as well as about any proposed products and services are correct.

209


3.2 Identifying the need for changes in existing products Insurers monitor their portfolios and identify key indicators of problems or opportunities for new policy developments / changes to existing policies. The key indicators that can trigger need for changes in product are:  changes in number of new policies sold,  number of existing policies renewed,  loss ratio,  changes that can increase or decrease risk profile of the portfolio

3.3 Determining reasons for changes in portfolio Based on changes identified in the key indicators, insurers ask additional questions, make assumptions and perform investigations to determine reasons for the changes. While some insurers take an analytical approach by collecting and analysing data in sequential steps, other insurers take a more intuitive approach by asking questions and by investigating likely reasons for changes. A losing portfolio may be failing to compete in the basic insurance marketing features: product, price or service.

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:  to the customer (meeting the customers’ needs) and  to the insurer (meeting the profit and growth objectives)

3.5 Making corrective changes After studying reasons for changes in the portfolio, the insurer may address problem areas by making suitable corrective changes in respect of:  Policy wordings (contract clause) to meet needs of customers  Eliminating ambiguity in coverage and exclusions which might have resulted in claims that had not been anticipated while pricing the policy.  Insurers responding to customer needs by offering endorsements to extend current coverage or new coverage.  Service changes a) Premium payment through Electronic Fund Transfer (EFT) or credit cards b) Providing 24 / 7 call centers for customer care and claims assistance c) Providing cashless facility for claimants with tie ups with auto garages, hospitals etc.

210


3.6 Preparing product proposals An effective proposal contains following basic components: a) b) c) d) e) f) g)

Proposal overview giving purpose of the proposal Customer need and identification Proposed new product or change and how it will meet needs of customers Marketing environment and potentiality Post / benefit analysis Expected results and monitoring process Recommended action

3.7 Regulatory compliances 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.

At the time of underwriting, exposure measurement is done on the basis of which of the following parameter/s? A Frequency B Severity C Extent of concentration D All of the above

Summary 

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.  New areas where underwriting challenges are occurring  New potential hazards  New vulnerabilities with hazards remaining the same  Untested insurance  Growing need for international insurance coverage  Underwriters and actuaries have begun to construct more complex risk classes by considering various additional differentiating factors.

211






 





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. For setting proper rates, the underwriter requires appropriate data on policyholder, on risks covered, on cumulative risk behavior and optionally, on a variety of additional factors that may be relevant. Pure premium is the premium that would be sufficient to offset all accident claim costs. Underwriting activity faces intense pressure in a deregulated market for various reasons such as:  industry competition,  overcapacity,  customer pressure and  other relevant factors Reasons due to which underwriting errors can occur include:  Faulty Information Collection  Exposure Measurement  Coverage Structuring  Wrong Pricing Product innovation process  Identification of customer needs  Identifying need for changes in existing products  Determining reasons for changes in portfolio  Determining cost and benefits of new products and product changes  Making corrective changes  Preparing product proposals  Regulatory compliances


The correct answer is C. In case of Motor insurance, other things being the same, use of additional antitheft devices in a car can lead to a prospect getting lower rates compared to other prospects.

212


Answer to TY 2

The correct answer is D. At the time of underwriting, exposure measurement is done on the basis of following parameters:  frequency  severity  the extent of concentration and  similar other considerations


Giving insurers the freedom to decide pricing of their products is known as ______. A B C D

De-tariffing Re-tariffing Free-tariffing 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 B C D

Net Premium Gross Premium Pure Premium 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 obt aining a fair price for the cover. A B C D

Constructing Structuring Configuring Organising

213



The correct option is A. Giving insurers the freedom to decide the pricing of their products is known as de-tariffing. Answer to SEQ 2

The correct answer is C. 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

The correct answer is B. Structuring the cover is an option that helps to secure a negotiated balance between need for the widest cover desired by the customer and obtaining a fair price for the cover.

214


CHAPTER 12

I.T. APPLICATIONS IN UNDERWRITING UNDERWRITING Chapter Introduction This chapter aims to provide you with an introduction to the relationships between IT (information technology) and Underwriting.

a) Explain how the need for IT applications in insurance underwriting emerged. b) Explain the role of IT applications in insurance underwriting. c) Discuss the role of technology in insurance underwriting process.

215


1. Explain how the need for IT applications in insurance underwriting emerged. [Learning Outcome a] The insurance industry is undergoing profound changes as a result of:  globalisation,  deregulation, and  technology

In essence, the insurance industry is moving from a product oriented industry to a customer oriented service provider.

1. Deregulation allowed non-insurance companies, such as banks, even retailers, to enter insurance market and compete against the established firms. At the same time, deregulation also allowed insurance companies to enter different financial markets requiring development and marketing of new products and identification of potential customer groups. 2. Globalisation emphasized this change, and insurance companies are now facing competitors from many parts of the world, many of which move aggressively into new markets trying to attract customers with low rates and improved services. 3. Challenging market conditions, led by accelerating price competition, are causing insurers to look more closely at streamlining their underwriting procedures to defend or improve their profitability. Inevitably, this is creating a new focus by senior management on data, technology and process management.

Although underwriting is a basic building block of the insurance process, traditional methods often are slow, inefficient, inconsistent and inaccurate. Therefore, to support underwriting optimisation and ensure improved underwriting profitability, insurers must develop new strategies and deploy technologies to automate and manage the underwriting process better.

216


These include  development of real-time information access;  an electronic workspace for sales staff and underwriters to collaborate;  streamlined information and data collection with third-party providers;  reduced dependence on paper;  automation of simple underwriting decisions; and  analytical methods to reduce underwriting risk

IT applications are necessary in insurance underwriting because of which of the following reasons? A Impact of globalisation B Challenging market conditions C Slow and inefficient traditional methods of insurance process D All of the above

2. Explain the role of IT applications in insurance underwriting. [Learning Outcome b] Technology further added to the momentum of change, mostly due to different aspects of computerisations, such as general access to computers, the Internet, and software to support business operations.

2.1 Advantage of general access to computers General access to computers allowed:  decentralisation of computer resources within a company; and  different business units and departments to develop many more business models, product variants and customer segments than was possible before As a result, emphasis shifted from the traditional product portfolio to innovative products targeting selected customer segments. 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.

217


Creating a fully automated and efficient underwriting process requires an insurer to determine and deploy Enterprise wide architecture to integrate different software / hardware components in use and to be acquired, to gain maximum mileage from process automation.

Such architecture should meet requirements of both internal and external customers like:         

Underwriters, Sales Teams, Agents, Channel partners like Bank assurance, corporate agents, Brokers, Reinsurers, Co-insurers, T.P.A.s, Dealers, Corporate and individual clients, Surveyors, Advocates, Banks, Regulators and Other stake holders

The following diagram outlines a conceptual I.T. System Architecture of a medium / large Insurance Enterprise. Diagram 1: I.T. Enterprise Architecture

218


219


The technology selected for automation of the insurance business process should be state-of-the-art and next generation. It should have the following features:  Service Oriented Architecture  Scalable with growth and needs of the company  Capable of Integrating with existing Legacy Systems  Minimum Development Time and Risks  Capable of delivering high ROI (Return on Investment)  Supports both real-time and batch processing.  Capable of communicating with different open technologies and external systems for data transfer  Industry data standards such as ACORD’s & XML, enabling a wide range of strategic applications across multiple channels and systems

The Information Technology Systems (both Hardware and Software) deployed across the enterprise should support and provide following services with speed,


The technology selected for automation of the insurance business process should be state-of-the-art and next generation. It should have the following features:  Service Oriented Architecture  Scalable with growth and needs of the company  Capable of Integrating with existing Legacy Systems  Minimum Development Time and Risks  Capable of delivering high ROI (Return on Investment)  Supports both real-time and batch processing.  Capable of communicating with different open technologies and external systems for data transfer  Industry data standards such as ACORD’s & XML, enabling a wide range of strategic applications across multiple channels and systems

The Information Technology Systems (both Hardware and Software) deployed across the enterprise should support and provide following services with speed, flexibility and functionality:              

 

Underwriting Policy administration Premium collections and Financial Accounting Claims administration Client management - CRM Brokerage & commissions Banks – Bank Assurance & Finance Work Flow management Document and image management Information ordering Brokers, Agents, Loss Assessors Appraisal T.P.A. Business processor Business intelligence a) Data Mining b) Risk Management c) Rate Making d) Product Development e) Actuarial Issues Co-insurers and Re-insurers Management Compliance and Regulatory Issues

220


2.2 Advantages of the internet 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. 2. The Internet also enables competition from a new breed of insurance organisations through E-business, much leaner, with fewer agents, if any, and with fewer branch offices, if any, but quite able to compete world-wide for customers. 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. This trend toward individualisation of services and policies is supported and implemented by increasingly sophisticated business software. Relevant areas are:  storage and retrieval of customer, policy, and business data in databases and data warehouses and  use of the data in data mining systems

2.3 Advantages of software in supporting business operations 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/nonlife 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).

221


This 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:          

Target marketing Cross-selling Fraud detection Customer Relationship Management Rate making Capital adequacy monitoring Investment strategy Reinsurance strategy Allocation of capital Strategy and business planning

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.

222


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.

Customer relationship management focuses on the "life-time-value" of a customer and addresses various issues such as customer acquisition, retention, loyalty, cross-selling etc.

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. Finally, rate making is the topic of immediate concern in times of increased competitive pressure. The price of a policy is usually the most direct way that a competitor can use in order to increase his market share. The same forces that were discussed above are at work here: a movement away from standard policies with broadly defined risk classes, moving toward individualised risk assessment, and almost individualised pricing. The methods used to set policy rates are undergoing change, and it is data mining again that can contribute innovative solutions to this task. In essence, data mining will allow to consider many more factors in the rate making process than was possible before. A combination of manual and paper-intensive processes that are time consuming and inefficient, as well as hard-coded rules embedded in multiple systems that are difficult to change and maintain, are driving up costs for insurance companies.

223


For which of the following reasons is the emphasis of insurance companies shifted from the traditional product portfolio to innovative products, targeting selected customer segments? A General access to computers B Increase in number of customers C Increase in number of insurers D None of the above

Which of the following focuses on life time value of customers? A Target marketing B Value analysis C Customer relationship management D Predictive data mining

3. Discuss the role of technology in insurance underwriting process. [Learning Outcome c] Technology has started playing a greater role in improving efficiency and effectiveness of underwriting. The insurers have started realising that Predictive modelling, risk segmentation and product management are critical components of underwriting. The use of analytics and exploitation of internal and external data sources allows for creation of better risk segmentation and improving underwriting efficiency. Technology has helped some insurers to achieve a level of sophistication in underwriting that allows them to review only exception to business rules, which profitability. provides consistency and increased profitability

With the advent of technology, Rules Engines, Analytical, Business Intelligence and Audit Tools are now readily available that allow insurers to assess, manage and execute selection and pricing of risks at a transactional level and at a portfolio level. Investments in underwriting automation have yielded consistently lower combined ratios for insurers across the globe.

224


Underwriting is a rational process in which technology can bring consistency and speed.

3.1 Emerging technologies that can help insurers improve the underwriting process Straight-through processing; exception based underwriting; integration of systems with the sales force and sales force automation tools; incorporating sophisticated business rules to facilitate underwriting at the point of sale; and integration of supporting documents, third-party and other internal systems etc. are strategies that will reduce underwriting costs.

3.2 Role of insurers in making the underwriting process more efficient to improve profits Business process automation/management is a key enabler [of efficient underwriting]. The use of business rules engines, implementing workflow efficiencies and accessing information to make better decisions all drive increased bottom-line profit. The closer we get to straight-through processing, the more efficient companies will become. Sophisticated business rules engines, exception-based underwriting, improved analytics for rate modelling; decisioning systems and business process management are critical initiatives. 1. Management of underwriting workflow

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

Management of business rules and decision support. It is imperative that insurers reduce the amount of manual underwriting that takes place. Underwriting business rules should be documented and managed. A rules repository can then be used to filter incoming i ncoming cases to automate the decision d ecision completely or provide a decision recommendation.

225


3. Underwriting case management

Additionally, insurers must have a Web-based solution for underwriters to better manage their cases. This solution must be tightly integrated with the decision platform and with imaging and workflow systems. It should have enhanced analytical capability to assess risk, and be able to receive electronic data from both internal and external sources. Case management information should be realtime, which will enable the underwriters to quickly make decisions and improve accuracy of risk assessment. A new class of integrated and configurable decision-management decision-management applications is now available to insurance companies. The applications consist of robust analytic modelling or scoring capabilities and actionable rules to immediately execute underwriting decisions and push these decisions to the point of sale. Using advanced analytics empowers insurers to more granularly segment customers based on more accurate predictions of customer behaviour. This allows them to determine the most appropriate product offerings and pricing levels.

3.3 How are packaged underwriting systems evolving, in terms of capabilities and response to market trends? 1. More and more packaged underwriting systems are incorporating the technologies and capabilities discussed above. Inclusion of rules to streamline the process, Web services and XML for integration with other applications makes it easier to gain efficiencies. These also significantly improve time to market for product and rate changes. Most underwriting systems available today make it easy to collect and gather data to feed data warehousing solutions. Availability of current information and improved analytical tools enable timely and more informed decisions. 2. Web-based technologie t echnologiess make it possible for insurers to improve accuracy and speed of the underwriting process. They can respond to agents within minutes and dramatically reduce the turnaround time for policy issuance. To reduce iterative data collection that delays the underwriting process, reflexive questioning technologies allow for capture of additional data depending on the answers to application questions.

226


3.4 How best can insurers adapt their processes to leverage nextgeneration underwriting systems? The implementation and exploitation of the features, processes and information will be more challenging task for many and a cultural shift for some. The availability of current information can be used to more accurately evaluate and price the risk, develop current rating models and quickly adjust rating plans and products. Information that once had to be looked at long after business was written can now be immediately obtained and evaluated. Business rules engines remove people from generic processes and incorporate their expertise into the system. Exception-based underwriting, or the process where only high-risk or exception cases are handled through manual underwriting, can be established and used to improve decision consistency, speed the decision process, and help reduce the workload in underwriting department.

It is observed that many insurers in India have started using automated underwriting for class based products like Motor, Personal lines, packaged policies and manually underwriting Individually Rated and Exposure Rated policies.

Which of the following can be established and used to improve decision consistency, speed the decision process, and help reduce the workload in the underwriting department? A Business process automation B Rules engine C Exception based underwriting D Straight through processing

227


The benefits of technology based underwriting discussed above, can be summarised as follows: Diagram 2: Benefits of Technology based Underwriting

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.

In-depth underwriting analysis and process documentation can also be used in compliance and audit procedures, which may help with financial ratings in the future. These benefits will provide strategic value to insurers and will drive dramatic increases in operational efficiency in underwriting.

228


4. Justify that underwriting is both an art and a science. [Learning Outcome d] 4.1 Underwriting – a different perspective Underwriting has traditionally been viewed as both an art and a science. On one hand, insurance underwriting is very technical with its own specialised knowledge and mathematical tools, and on the other hand, one needs good judgement to apply these tools.

However, those organisations that lend more credence to the “science” of underwriting have used technology differently than organisations that viewed the underwriting process as an “art,” focusing on higher levels of human review for transactional risk decisions. 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.

4.2 The current model of underwriting Initially, underwriting automation took place as an extension of policy management systems, with the business rules and rating engines often hardcoded in the core application. Processing happened primarily on the “back end.” In the mid to late 1990s, more robust rules engines and stand-alone components (like external rating engines) were introduced along with the ability to configure individual software components and link them to legacy environments. These improvements allowed for increased flexibility and responsiveness in product development and deployment. The same improvements also enabled introduction of better risk evaluation controls during underwriting of new and existing business. As seen in Enterprise Architecture Diagram, this strategy provided increased automation within the core processes:  product creation,  quoting and rating,  risk evaluation, and  policy administration

229


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 eliminations of a manual routine underwriting process will lower costs and increase processing speed. There are no ready-to-use, off-the-shelf software solutions or technologies available to cater to or suit all requirements of all insurers. Insurers have to conduct the following exercise before selecting and implementing a new architecture / software solution for automation of underwriting and other business process:

Diagram 3: Exercise to be implementing software solution

conducted

before

selecting

and

Successful automation of processes and reaping the rewards of automation depends upon the vision and quality of I.T. Policy of a company’s top management and their efforts in implementing the same down the line in the organisation.

230


Insurers that couple predictive models, underwriting excellence concepts and modern rules-engine technologies will be able to automate state-of-the-art underwriting tools and techniques, which can drive optimal risk selection, pricing and performance management, putting a focus on both quantity and quality.

Summary 

 



 



The insurance industry is moving from a product oriented industry to a customer oriented service provider because of globalisation, deregulation and technology. Insurers must develop new strategies and deploy technologies to automate and manage the underwriting process better. Due to different aspects of computerisations, emphasis shifted from traditional product portfolio to innovative products targeting selected customer segments. 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:  Target marketing  Cross-selling  Fraud detection  Customer Relationship Management  Rate making  Capital adequacy monitoring  Investment strategy  Reinsurance strategy  Allocation of capital  Strategy and business planning Predictive modelling, risk segmentation and product management are critical components of underwriting. Benefits of technology based underwriting will provide strategic value to insurers and will drive dramatic increases in operational efficiency in underwriting. 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.

231



The correct option is D. All given causes are the reasons for need of IT application in insurance underwriting. Answer to TY 2

The correct option is A. General access to computers allowed a decentralisation of computer resources within a company and enabled different business units and departments to develop many more business models, product variants and customer segments than was possible before. As a result, emphasis shifted from the traditional product portfolio to innovative products targeting selected customer segments. Answer to TY 3

The correct option is C. Customer relationship management focuses on the "life-time-value" of a customer and addresses various issues such as customer acquisition, retention, loyalty, cross-selling, etc. Answer to TY 4

The correct option is C. Exception based underwriting can be established and used to improve decision consistency, speed the decision process, and help reduce the workload in the underwriting department.

232



Insurers must develop new strategies and deploy technologies: (i) To support underwriting optimisation (ii) To ensure improved underwriting profitability (iii) To support traditional methods of insurance process A B C D

(i) and (ii) (ii) and (iii) (i) and (iii) (i), (ii) and (iii)

Question 2

Which of the following has not been automated within the underwriting system? A Rating individual insurance proposals B Client renewal visit C Recommending acceptance/rejection of the risk D Issuing the documentation Question 3

Ratemaking involves providing sufficient income to pay for certain aspects – which of the following is NOT one of these? A Projected claims B Selling and administration expenses C Investment income D Margin for a reasonable return on the capital employed Question 4

Exception based underwriting enables which of the following? A Manual underwriting of complex cases B Rating of simple cases C Client management in the SME area D Identification of problematic young drivers

233


Question 5

C.R.M. stands for ___________. A B C D

Customer Relationship Management Commercial Rating Mechanism Critical Response Management Catastrophe Research Mission


The correct option is A. Traditional methods of insurance process often are slow, inefficient, inconsistent and inaccurate. Therefore, to support underwriting optimisation and ensure improved underwriting profitability, insurers must develop new strategies and deploy technologies to automate and manage the underwriting process better. Answer to SEQ 2

The correct option is B. It is not usual to automate the client visit (although it could very occasionally be done by video conferencing). Answer to SEQ 3

The correct option is C. 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.

234


Answer to SEQ 4

The correct option is A. Exception underwriting relates to the identification of complex cases leaving the system to handle simpler risks. Answer to SEQ 5

The correct option is A. Customer Relationship Management is the correct title.

235


GLOSSARY Data Mining: has been defined as "the nontrivial extraction of implicit, previously unknown, and potentially useful information from data" and "the science of extracting useful information from large data sets or databases". A class of database applications that look for hidden patterns in a group of data that can be used to predict future behavior. For example, data mining software can help retail companies find customers with common interests. The term is commonly misused to describe software that presents data in new ways. True data mining software doesn't just change the presentation, but actually discovers previously unknown relationships among the data. Data Warehouse: Abbreviated DW, a collection of data designed to support management decision making. Data warehouses contain a wide variety of data that present a coherent picture of business conditions at a single point in time. The term data warehousing generally refers to the combination of many different databases across an entire enterprise. Document & Image Management: The computerized management of electronic as well as paper-based documents. Document management systems generally include the following components:  An optical scanner and OCR system to convert paper documents into an electronic form  A database system to organized stored documents  A search mechanism to quickly find specific sp ecific documents Document management systems are becoming more important as it becomes increasingly obvious that the paperless office is an ideal that may never be achieved. Instead, document management systems strive to create systems that can handle paper and electronic documents together. 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. Legacy Systems: Typically, legacy applications are database management systems (DBMSs) running on mainframes or minicomputers. An important feature of new software products is the ability to work with a company's legacy applications, or at least be able to import data from them.

236


Open Technologies: An open architecture allows the system to be connected easily to devices and programs made by other manufacturers. Open architectures use off-the-shelf components and conform to approved standards. A system with a closed architecture, on the other hand, is one whose design is proprietary, making it difficult to connect the system to other systems 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. Service Oriented Architecture: Abbreviated SOA, an application architecture in which all functions, or services, are defined using a description language and have invokable interfaces that are called to perform business processes. Each interaction is independent of each and every other interaction and the interconnect protocols of the communicating devices (i.e., the infrastructure components that determine the communication system do not affect the interfaces). Because interfaces are platform-independent, a client from any device using any operating system in any language can use the service. System Architecture: A design. The term architecture can refer to either hardware or software, or to a combination of hardware and software. The architecture of a system always defines its broad outlines, and may define precise mechanisms as well. 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.

237

IC 45 Underwriting III ebook

Recommend Documents