Underwriting in Insurance

Definition
Underwriting refers to the process that a large financial service provider (bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage, or credit). The name derives from the Lloyd's of London insurance market. Financial bankers, who would accept some of the risk on a given venture (historically a sea voyage with associated risks of shipwreck) in exchange for a premium, would literally write their names under the risk information that was written on a Lloyd's slip created for this purpose.

Insurance underwriting
Insurance underwriters evaluate the risk and exposures of potential clients. They decide how much coverage the client should receive, how much they should pay for it, or whether even to accept the risk and insure them. Underwriting involves measuring risk exposure and determining the premium that needs to be charged to insure that risk. The function of the underwriter is to acquireor to "write"business that will make the insurance company money, and to protect the company's book of business from risks that they feel will make a loss. In simple terms, it is the process of issuing insurance policies.

Trade-off
The underwriting exercise is a trade-off between new business and survival. If the company sets very high standards for risk; the company may loose market. If the company charges too much premium; then it may loose competitive advantage.

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Each insurance company has its own set of underwriting guidelines to help the underwriter determine whether or not the company should accept the risk. The information used to evaluate the risk of an applicant for insurance will depend on the type of coverage involved. For example, in underwriting automobile coverage, an individual's driving record is critical. As part of the underwriting process for life or health insurance, medical underwriting may be used to examine the applicant's health status (other factors may be considered as well, such as age & occupation). The factors that insurers use to classify risks should be objective, clearly related to the likely cost of providing coverage, practical to administer, consistent with applicable law, and designed to protect the long-term viability of the insurance program.

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The underwriters may either decline the risk or may provide a quotation in which the premiums have been or in which various have been stipulated, which restrict the circumstances under which a claim would be paid. Depending on the type of insurance product (line of business), insurance companies use automated underwriting systems to encode these rules, and reduce the amount of manual work in processing quotations and policy issuance. This is especially the case for certain simpler life or personal lines (auto, homeowners) insurance.

Underwriting In Life Insurance

It has been said that responsible people buy life insurance for one of two reasons; they either love someone or they owe someone. However, purchasing life insurance is not as easy as buying any other type of financial product. Just because someone wants life insurance and is willing to pay for it, does not automatically mean that an insurance company will offer to insure them. Once someone applies for life insurance coverage, the application must go through a strict underwriting process by the insurance company before an individual is eligible to even purchase the policy.

Process of Underwriting
Today in the 21st century the underwriting process of a life insurance policy is still a mystery to most in the financial professionals and especially to their clients. In essence the underwriting process includes the following three steps: 1. Examination of the application 2. Decision as to whether to insure 3. Determination of the premium

The Life Insurance Applicants Responsibilities

The Insurance Acts detail that an applicant for life insurance is obligated to report all relevant information about their health and financials that will allow an insurance company to properly evaluate a potential insureds suitability for coverage. The applicant is required to provide 4 types of personal information on their application for insurance coverage: 1. Details on income and lifestyle. 2. Medical history of applicant. 3. Medical history of applicants family. 4. Hazardous occupation/activities.

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A life insurance policy is referred to as a contract of uberrima fides. This term means in utmost good faith. The insurer depends on the applicant for complete disclosure. The range of negative consequences that can result from making misrepresentations on a life insurance application may range from a delay in approval or the voiding of the policy.

The Insurance Agents Role

The agents primary role in the underwriting process is to record the clients information on an application on the insurance form. This process is called field underwriting. The responsibilities the agent has regarding the application include collecting information accurately and completely, educating the client on consequences of incorrect information and witnessing the clients signature on application. The types of information that the agent will collect in the application for life insurance are the applicants name, age, gender, annual earned income, net worth, date of birth, gender, smoking status and medical history. The agent will write down the product details which include the amount of coverage, type of policy, dividend option if relevant, duration of policy, premium payment period and riders.

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As well general information from the applicant will be collected in the application such as:
Is there existing insurance coverage? Have previous applications been declined? Are there other pending applications? Does the applicant engage in hazardous activities? Has the applicant had their drivers license suspended? Does the applicant have a criminal record? Who will be the named beneficiary and what is their relationship to life insured?

If the applicant qualifies they may receive a Temporary Insurance Agreement (TIA) after the application is completed. The TIA provides coverage while the underwriting process is completed.

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The agent must inform and educate the applicant that by signing the application for insurance they are authorizing that their medical history will be released to the Medical Insurance Bureau (MIB). The MIB is somewhat like a credit bureau and exists to share medical information among insurers. There is an MIB Pre-notice form that is left with the applicant to read after the application is signed

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Lastly, after the application is signed by the applicant and before the application is delivered to the insurance company the agent is required to fill out what is referred to as an Agent Report. The Agent provides notes and comments about the applicant on the application that might assist in the underwriting process.

The Insurance Companys Role

Insurance legislation states that once someone is offered a life insurance policy by an insurance company that was based on truthful information provided by the insured, the insurer most honour the contract for the duration of the policy and for as long as the premiums are paid. Therefore the insurance company must be sure that providing coverage to an insured is a good investment for the company. In essence both the insurance company and the policyholder make a bet with each other. The insured is betting that one day they will die and the insurance company is betting that the insured is not going to die today. The policy is issued only after the insurance company underwriters have reviewed the inspection and medical report. This report is prepared by a third party interviewing the applicant to confirm the information. The objective of the inspection report is to determine whether or not the face value applied for is justifiable.

Delivery of the Contract

The final requirement in creating a legal contractual agreement between the policy owner and the insurance company occurs only when the policy is delivered to the applicant.

The policy holder is only bound to the insurance contract after receipt, examination and their acceptance of the policy. The prompt delivery and proof of delivery are very important for insurance policies because a delayed delivery may create a danger of a change in insurability of the insured from the time the underwriting is completed and the policy is delivered.

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