Underwriting is a process of assessing the creditworthiness or risk associated with a potential customer. The objective of underwriting is to decrease the number of losses resulting from risks. Underwriting starts when the company has established its underwriting policy, which states the criteria to be used for insuring applicants based on their credit history. This enables an underwriter in decision-making.
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The main purpose of underwriting is to classify clients in a proper manner into relevant risk classes. Moreover, it helps to protect insurance companies from clients who are more likely to make fraudulent claims.
An individual who decides to accept or reject an application is known as an underwriter.
An insurer’s underwriting policy is usually decided by the top-level management and the insurer’s chief underwriter. Generally, the insurer has their internal underwriting guide in which the underwriting policy is stated in detail.
This guide generally specifies:
- Terms of insurance to be written
- Territories to be developed in the insurance market
- Forms and rating plans to be used by agents
- Amounts of insurance premium to be written
- Policies requiring approval by a senior underwriter
As a rule of thumb, underwriters should select only those cases where the actual loss experienced is unlikely to exceed the loss experience forecasted in the rating structure. Underwriters should aim to decrease adverse selection of proposals.
Role of an Agent in Underwriting
During the underwriting process, the proposer and agent are in direct contact with each other. This kind of underwriting is also known as primary underwriting. The primary functions of an agent that are related to underwriting are:
- Ensuring that the proposal form is completely filled without any mistakes by the proposer
- Checking whether the questions have been answered honestly by the proposer without any prejudice. Any elements of misrepresentation or incomplete information must be avoided.
- Ensuring that the answers given by the proposer are recorded as objectively as possible
Since an agent is in direct contact with the proposer and also acts as his/her advisor, he/she is in a good position to assess the proposer’s purpose of buying insurance. Based on the discussion and personal interview of the proposer and family members, the agent is in a position to assess the responses provided by them. Any contradictory information given by the proposer should be checked further.
The underwriting process is facilitated when the required documents and the proposal form are submitted by the agent in a timely manner. In case of any additional pre-policy medical check-ups, the agent usually helps the proposer with the necessary appointment in the networked diagnostic centres and ensures quick submission of reports. In many instances, the policy in the case of accepted proposals may be given to the agent for delivery.
In the case of proposals that get rejected, the agent can personally explain the reason(s) for the rejection along with the insurer’s official letter citing reasons for the same. The agent may also advise on alternatives to such proposers.
Process of Underwriting
Although the guidelines for underwriting insurance vary across insurance companies, the process of underwriting insurance is the same for all of them. It is a systematic process that comprises a number of steps, which are listed below:
Collecting data
For evaluating a potential risk, an underwriter needs to collect data related to the nature of risk to be covered, previous records of the proposer, etc. For example, in the case of health insurance, the underwriter needs to collect data such as the past medical history of the prospective insured, medical test reports, loss history of the previous insurance company and any other information that may apply.
Analysing the data
Once the required data has been gathered, the underwriter scrutinises the data to convert it into meaningful information. An insurer may have different levels of authority among underwriters. Depending on the level of authority possessed by an underwriter, the case may be referred to the next in authority for final opinion.
Identifying alternatives
Once information is analysed, the underwriter makes a decision to select options available to him/ her for disposal of applications of the proposer. These options are generally related to the type of risk class to which potential policyholders are assigned and are described as follows:
- Accept the proposal when the policy is issued
- Reject the proposal for coverage
- Accept the proposal with specific conditions for coverage
Once an application is accepted, it is forwarded to the policy processing department for completion. In the case of rejection of the application, the agent or the client receives a letter of rejection. In case any further information is required, the application is sent back to the insurance agent for review.
Post-selection Underwriting
Sometimes, it may be possible for an insurer to review and re-evaluate policyholders by analysing the lines of business where the insured risk can be cancelled or renewed at the discretion of the insurer. In post-selection underwriting, the insurer decides whether or not to continue a policy further. In cases where losses have been exceptionally high, the underwriter may mandate an increase in premium or co-payment on a claim. The extent of usage of the post-selection under-writing may vary from insurer to insurer.
Restrictions
Post-selection underwriting can be exercised only in cases where an insurer has the option to cancel or decide whether or not to renew the insurance policy. Due to the newer laws that have been imposed recently, an insurer is restricted to exercise this option. This has been done because it imposes a hardship on the policyholder.
Some laws mandate the insurer to give an adequate notice period before cancellation of the policy, whereas some laws prevent the insurer from mid-term cancellation once the policy completes a specific duration of time. Furthermore, there are laws that prevent the insurer from cancelling a policy on the basis of caste, age, sex, gender, etc. This kind of restriction may prove to be detrimental in the long run as insurers become increasingly selective about the risks they accept.
Credit Scoring
Credit scoring is used as a tool by insurers for underwriting the insurance policies of vehicle owners and homeowners. In earlier times, credit scoring was used by lenders who would develop credit risk for mortgage, credit cards and car loan applications. Commercial bureaus, also known as credit bureaus, provide lenders with information related to the credit history of loan applicants.
For example, ChoicePoint-, an Atlanta-based company, is a credit bureau operating in the United States. It maintains a database known as CLUE (Comprehensive Loss Underwriting Exchange) that serves as the basis of credit scores generated. There is a controversy in the use of credit scoring since it is thought that credit history and the current status of an individual or his/her loan-paying capabilities are unrelated. Insurers argue that credit scoring enables them to classify applicants according to the risk of loss posed by them in order to price a policy with greater precision.
