What is underwriting?

Underwriting is one of the most important functions in the financial world wherein an individual or an
institution undertakes the risk associated with a venture, an investment, or a loan in lieu of a premium.
Underwriters are found in banking, insurance, and stock markets. 

Underwriting in insurance / who is underwriting?

In the insurance world, underwriters determine whether an insurance agency should undertake the risk
of insuring a client. They determine the risk and exposure of clients and also how much insurance should
be granted to a client, how much they should pay for it and whether or not to offer an insurance policy
to the client in the first place. 

Who is underwriter?

Insurance Underwriters

Insurance underwriters, much like mortgage underwriters, review applications for coverage and accept
or reject an applicant based on risk analysis. Insurance brokers and other entities submit insurance
applications on behalf of clients, and insurance underwriters review the application and decide whether
or not to offer insurance coverage. Additionally, insurance underwriters advise on risk
management issues, determine available coverage for specific individuals, and review existing clients for
continued coverage analysis.

What an underwriter does?

I work as a senior underwriter with Globe wire Insurance Company.

As an underwriter, I review applications received for insurance cover and decide whether to accept or
decline them. I do this by assessing the risk associated with the applicant and figuring out the adequate
premium. In short, I make sure that our insurance business runs profitably.

Objective of Underwriting:

The main objective of underwriting is to ensure that the overall mortality and other insured
contingencies experienced are no worse than that assumed by the actuary in calculating the premium
rates.

Function of Underwriting:

The major function of underwriting is to review the applications received for grant of insurance cover,
the applicants assessed and selected and their risk classified after arriving at an appropriate premium
commensurate to the risk they bring into the portfolio.

Practices:

The underwriting practices should ensure underwriting profits for the company by aligning them with
the assumptions made by the actuaries of the company with respect to the mortality and the morbidity
experience.
Mortality Rates:

Mortality rates are impacted by various factors e.g. nature of occupation, financial status of the
individual, his/her lifestyle, history of alcohol consumption, tobacco consumption etc. It may be noted
that the actuary does base his assumptions on such parameters for different kinds of products and the
demographics at which these are to be used.

Underwriting: Selection & Classification:

Insurance companies are required to maintain a careful selection of lives through prudent selection and
classification criteria at the underwriting stage, to avert underwriting losses, since these losses directly
impact the profitability of the company and its financial standing.

Criteria – Selection & Classification:

 Liberalized norms:

In certain instances of diseases or medical conditions, where the life expectancy is seen to have
improved due to advancement of science and technology, the companies tend to liberalise their
underwriting norms at the point of sale and have a more lenient view in the selection process as a
marketing strategy to attract inflow of new business and augment their policy base. This needs very
careful monitoring to ensure that the expected mortality profits do not end up as unexpected losses for
the insurance company.

 Select Period:

It is generally observed that in the immediate years following the underwriting process, the mortality
experience of the insured population ( the rate at which insured people die) is low as the individual has
just been 'selected' through an underwriting process and the appropriate premiums collected. The
effect of this selection process of underwriting is expected to diminish over a period of 4-5 years from
the time the life was underwritten. The period for which the effect of selection lasts is called the "select
period".

 Non-disclosures:

In case of gross non-disclosures at the point of sale by the lives covered, with regard to their adverse
medical / personal history, their financial status, their occupation etc, could impact the decision
adversely, thereby contradicting the aforementioned assumption on "selection" of lives.

Concepts of Underwriting: Premiums

The premium paid by each assured has to be sufficient to cover the risk or liability which the individual
brings to the pool or insurance portfolio. In order to achieve this, a premium table prepared by the
actuaries is used wherein the indicative standard premiums for such “standard lives” are given.
Standard Lives:

Post selection, if the predictive mortality does not deviate much as compared to that indicated in the
mortality table provided by the actuaries, such individual lives would be required to pay the "standard"
premium.

Mrs. Purohit, whom we met in the previous screen, will fall under this category. She will pay the
standard premium.

Sub-standard lives:

If the individual life shows a higher mortality than the standard lives in the mortality table, the individual
would be termed as a "sub-standard" life and would be required to pay extra premium to cover the
additional risk they bring to the pool or insurance portfolio.

Mr. Sharma, whom we met in the previous screen, will fall under this category. He has been an X-Ray
technician for 15 years and X-Ray radiations could have harmed his body in the long run. He may have to
pay extra premium.

High-risk lives:

If the mortality risk is found to be substantially high as compared to the mortality table, the risk can be
postponed (in case the risk predicted reduce with the passage of time) or even declined (if the risk is
very high and is either predicted to remain static or increase in the future). This is necessitated as no
amount of extra premium would be sufficient to take care of the very high extra mortality.

Mr. Gonsalves, whom we met in the previous screen, will fall under this category.

Concept of Underwriting: Factors to be analyzed

 Personal lifestyle of the individual; past medical history and current medical status

 Physical and mental status of the life to be proposed

 Nature of occupation that the life to be covered follows and whether it is hazardous

 Medical history of family members, which will indicate whether the individual is prone to certain
hereditary diseases

 Personal hobbies and avocations, whether they are hazardous in nature

 Financial status, and the individual’s existing insurance cover (in force and lapsed)

 Country and city of residence and the regions of the world that the individual travels
Concepts of Underwriting: Risk Assessment

When assessing a risk, all relevant factors which add to the risk must be considered thoroughly before
accepting a proposal. For example, a person with a history of allergic bronchitis or asthma, who works in
a cement factory or cotton fiber industry in a dusty environment, is considerably at higher risk than a
person with the same history but working as an administration executive in an office environment.
There is a higher probability of certain illnesses to run in families, which impacts the mortality adversely,
and the premium may need to be adequately increased or provided by altered terms of acceptance.

Basis on which risk is assessed:

 Mortality:

Mortality is measured in life assurance contracts.

Mortality refers to a fatal outcome or death. Mortality is defined as expected number of deaths during a
defined period (rate of death), usually a year out of a defined population. In other words, mortality
means expressing the expected number of deaths during an instantaneous time interval as a proportion
of the existing population. The number of deaths in a given time in a given population is the mortality or
the death rate. The mortality tables used by actuaries for pricing insurance products are prepared
separately for males, females, children and people of various ages.

 Morbidity:

Morbidity is measured in health insurance / critical illness products.

Morbidity is defined as the expected number of people becoming ill or sick over a given period, usually a
year. It also means the frequency with which a disease appears in a population. Morbidity rates help
insurers predict the likelihood that an insured will contract or develop any number of specified diseases.
The morbidity tables used by actuaries for pricing insurance products are prepared separately for males,
females, children and people of various ages.

Assessing the individual Risk:

Based on the mortality assumptions for a product, the underwriter assesses the risk as per the
standards laid down by the company.

 If the sum assured is greater than the routine non-medical limits of the insurer (MSAR—Medical
Sum-at- risk) then depending upon the level of sum assured, various forms of medical evidence
are obtained e.g. Existing or past health condition of the person whose life is to be insured.
 Medical evidence may also be obtained when a disclosure is made on the proposal which
requires further assessment.

 Experience of insurance companies shows that most of the proposals are generally accepted at
standard rates; however, there are cases which cannot be accepted on these terms due to an
adverse medical condition or for some other reason (e.g. adverse life-style, occupation etc).

The underwriter evaluates whether a case can be accepted at standard rates or not based on all the
factors mentioned above.
 Assessing the individual Risk: High-Risk cases:

High-risk cases, if accepted, adversely affect the insured portfolio. Being too lenient in underwriting with
applicants could lead to wide deviation from the mortality assumptions, resulting in losses to the insurer
in the form of early claims.

 How the risk are assessed in high-risk cases:

1. Cases declined:

If the risk is found to be on the higher side in a case, altered acceptance methods with adequate
loading are applied, or at times the risk may be declined altogether, especially if the risk is very
high and an early claim is foreseen.

2. Cases Postponed:

In cases where the initial risk is unacceptable at the point of underwriting, but is expected to
improve over a period of time, the case can be postponed for six months to two years. After the
initial high-risk period has elapsed, the applicant would be evaluated and assessed afresh.

3. Exclusions:

In cases where a particular part of the risk is unacceptable due to an existing condition,
exclusion may be placed limiting payment in the event of death from a particular cause (e.g. war
risks, aviation risk). Exclusions are used more frequently for health insurance, where the client is
granted cover with exclusions instead of totally declining the case.

Selection of Lives: Selection against Insurer:

If all proposals were offered the same terms (i.e. similar premium) there would be a tendency for the less healthy
lives to take more interest in life assurance than the healthier ones. This tendency is known in the insurance parlance
as “selection against insurer”. So a life assurance company must avoid being selected against.

Life assurance is guided on the fundamental principle of “utmost good faith” (uberrima fides) whereby the insurer
relies heavily on the information given by the proposer. On assessment, if no differentiation is made between
“standard” and “sub-standard” lives, there will be a tendency of more sub-standard lives to get insured.

Hence the insurance company has to assess individual risks in such a way that the mortality experience of those who
have been accepted at ordinary rates matches the actuarial assumptions. The underwriter will also ensure that the
terms offered to the sub-standard lives are reasonable and fair, not only to the proposer but also to the other policy-
holders and the insurer.

Classification of Risk:
RISK
 STANDARD RISK SUB-STANDARD RISK

ACCEPTANCE ON POSTPONED DECLINED

CHARGE EXTRA PREMIUM ACCEPT WITH MODIFIED DECREASIN LIEN SPECIFIC

Types of Extra Risk:

Acceptance of risk on special terms involves charging of extra premium for the extra risk.

Increasing extra risk:

These types of risks may or may not be major risks at the time of commencement of the policy. However, as
time goes by, their effect is likely to become more significant; for example, in case of high blood pressure or
obesity. The proposer may not be symptomatic at commencement of risk, but his condition of hypertension
or obesity is likely to have an adverse impact on the cardiovascular system.

To cite another example of increasing risk, if somebody is suffering from chronic lung condition, it could, over
a period of time, result in adverse health conditions resulting in an increased risk that could be life-
threatening.

Decreasing extra risk:

This is exactly the reverse of an increasing risk. The risk of recurrence of risk is maximum at the time the
individual applies for insurance cover and decreases over a period of time, with proper supervision and
medication.

For example, when an applicant who has just been diagnosed with pulmonary tuberculosis applies for a
policy, he is not in an insurable condition. This is because he brings along a high mortality to the portfolio, if
accepted at that stage. However, with the passage of time, and after having undergone medical supervision,
medication schedule and rest, he gets better, and after some time becomes almost a standard life. As the
years go by without further symptoms, the risk of a recurrence becomes negligible or nil.

Constant extra risk:

This is a kind of extra risk, wherein the mortality risk remains the same throughout the duration for which the
life assured is exposed to the risk, e.g. an occupational risk such as being a pilot in the air force. So long as this
person's occupation continues to be in the air force as a pilot, there is no decrease in risk , even after 3 -5
years, as the risk is due to an accident. However, if this pilot pursues another job-profile, like working in an
administrative office in-lieu of a pilot's job, his risk profile changes drastically and favorably and his extra
premium can be removed as he is then a standard risk.

Those applicants who pose an extra hazard due to occupation, foreign travel etc. are usually regarded as
standard lives with a superimposed risk, and such extras can be generally removed when that risk ceases.

Underwriting decisions:

Various decisions are possible as an outcome of the underwriting process. Let's take a look at them.

1. Acceptance with a level extra premium throughout the tenure.

In this type, a level extra premium system is used to charge the applicants for constant or increasing extra
risks throughout the policy term. If an increasing extra is charged, it would be very difficult to
operationally administer it, as it would be then necessary to monitor the health of each individual.
Alternative will be to charge everybody an average increase of premium. If the average of extra premium
is charged, those whose health conditions terms are favorable or good, would cease to pay the premium
by walking out on the insurance cover, whereas those whose medical condition remains bad or is
showing deterioration would continue the cover.

2. Temporary extra premium:

Where the extra risk is of a reducing kind, it would not be fair to charge a level extra premium to this
individual as he would discontinue the policy. Hence, a temporary extra may be charged for a short pre-
determined period, until which the extra risk would have either diminished, or ceased to exist.

3. Diminishing Lien:

In this method of acceptance, a reduced basic sum-assured is paid, if death occurs during lien period. In
other words, a debt is created as a pre-determined amount if death were to occur within a stipulated
period. The amount of debt is maximum at the time of commencement of the policy and it gradually
decreases by a certain amount with each passing year and the debt gets fully cancelled after a certain
period. However, even when the debt is operative, the bonuses are paid in full under a “with-profits”
policy and not on the diminished sum assured. Also, when the debt is operative, and death occurs by an
accident, no lien is applied and the claim is paid on the full base sum-assured basis.

4. Acceptance at ordinary rates with exclusion imposed on the cover”

This clause restricts the payout of a claim for the full cover if death were to occur under certain specified
conditions or denies claim payment under certain conditions. For example, policies that have a special
exclusion imposed that does not pay any claim if the person dies in an air crash while on aviation duty,
but would pay the claim in full if he was travelling as a fare-paying passenger and death were to occur in
an air-crash. These exclusions are not appreciated by ordinary persons and they lead to litigations e.g. If
policies, with such exclusions are issued and assigned to mortgage loans, and death claim denied, these
could lead to legal battles and also aggrieved beneficiaries.

5. Postponement of deferment of acceptance of risk:

There could be situations where the health condition of a client is currently risky or uninsurable at the
time of application, as he has been medically advised to undergo a surgery and post-operative treatment.
Since there exists a possibility of improvement in his health after the surgery and necessary treatment, it
 would not be fair to decline the proposal. It is therefore deferred or postponed for a specified period.
This benefits both the client – who gets a fair premium charged to him post a favorable change in health
– and the insurer, who is absolved from accepting a very high-risk case at the policy commencement
stage.

6. Declinature of acceptance of risk:

There are some proposals that are not acceptable on any terms and for which there is no possibility of
medical improvement, which makes them unconducive for acceptance even with suitable loadings and
exclusions in the future. These proposals need to be declined. Each insurer has its own standard of
underwriting and, therefore, thresholds for declinature vary from product-to-product and company-to-
company. It is possible that some companies, who have a high risk appetite may sometimes be willing to
offer terms to a proposer who has been declined by other insurers by appropriate loading and altered
terms.