Guiding principles of Underwriting

13th July 2021 1 By indiafreenotes

Underwriting has to do with the selection of subjects for insurance in such a manner that general company objectives are met. The main objective of underwriting is to see that the risk accepted by the insurer corresponds to that assumed in the rating structure. There is often a tendency toward adverse selection, which the underwriter must try to prevent. Adverse selection occurs when those most likely to suffer loss are covered in greater proportion than others. The insurer must decide upon certain standards, terms, and conditions for applicants, project estimated losses and expenses through the anticipated period of coverage, and calculate reasonably accurate rates to cover these losses and expenses. Since many factors affect losses and expenses, the underwriting task is complex and uncertain. Bad underwriting has resulted in the failure of many insurers.

The primary purpose of careful selection is to avoid adverse selection, to reject those insurance applicants who are posing as a standard risk, even though they are actually a higher risk.

The 2nd underwriting principle is to have proper balance within each rate classification, meaning that those with higher than expected losses should be offset by those with lower than expected losses. Insurance applicants with similar loss-producing characteristics are grouped together.

Each member of the class is charged the same rate, but not all will have the same actual losses. Therefore, the basis for establishing the premium will not be valid unless those with higher actual losses are offset by those with lower actual losses.

The final underwriting principle is that there must be equity among policy owners, where the same rate should be charged for each insurance applicant that has the same expected losses. Otherwise, charging the same rate to a group where the individuals have a different expected loss would create a situation where those with lower losses or subsidizing those with higher losses. Eventually, the overcharged subgroup will eventually find lower insurance rates offered by other companies, leaving the individuals with higher expected losses in the subsidized group, which will create losses for the insurance company.

  • Prudent underwriting reduces the chances of Physical, Moral, and Morale hazards.
  • To reduce the possibility of adverse selection against the insurer.
  • Underwriting helps in determining the expected loss potential of the proposed insured and selecting a price in line with this expected loss.



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