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Chapter 1: What is Underwriting?

Underwriting is the function of evaluating the subject of insurance, whether a person,
property, profession, business, or other entity, and determining whether to insure it. The
underwriter must apply company standards to each applicant, and, based on these
standards, ascertain whether the application represents an acceptable risk.
Underwriting is the foundation of the insurance transaction process.The term
underwriter arose out of marine insurance. In the 17th Century, merchants who were
willing to take on a portion of the risk for voyages would list the amount of the
voyage they were willing to insure and sign their names underneath a contract that
detailed the terms of the risk. These merchants became known as underwriters
because they wrote their names under the contract terms. Since that time, the
insurance business has evolved and policies are no longer underwritten by
individuals who insure risks, but the term underwriter continues to be applied to
those who review and select risks to insure.

Factors in Underwriting
The factors used during the underwriting process vary somewhat based upon the type of
insurance being underwritten. If people are being insured, such as under life, health
and disability insurance, key factors used in the underwriting process may include:

Age;
Sex;
Health and health history;
Occupation and occupation history;
Financial condition;
Personal habits such as smoking or drinking alcohol;
Size of the policy; and
 Current insurance in force.

If property is insured, as in homeowners, automobile, and commercial property

insurance, underwriters may review factors such as:

Type of the property;

Value of the property;
Condition of the property;
Construction materials used in the property;
Potential hazards surrounding or within the property;
Age of the property;
Use of the property;
Security measures and other loss control measures associated with the
property;
Upkeep of the property;
Location of the property;
Current insurance in force on the property; and
Prior losses associated with the property.

If a business or business operations are being underwritten under insurance such as

general liability and professional liability insurance, factors that underwriters will
weigh include:

Type of business;
Size of business;
Financial condition of the business;
Financial condition of owners;
Business cycles affecting the business;
Liability exposures;
Experience of key employees and owners; and
Past losses experienced by the business.

Functions of Underwriting
Underwriting involves examining application forms, supporting documents such as
appraisals or bills that verify the value of property, or medical reports that verify the health
condition of an individual, looking at insurance maps that provide information relevant to
the statistical possibility of certain types of loss, reviewing statistical data applicable to the
risk to be insured, reviewing company records regarding the application and evaluating
site inspection reports. Upon a thorough examination of all the data, underwriters
then assign rates to the application, or decline to issue a policy if it does not meet
underwriting standards. During the entire process, the underwriting department
frequently communicates with agents, inspectors, adjusters and other field
personnel.

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 just property policies, just casualty policies, just personal property
policies, just professional liability policies, and so on.

Property and Casualty Underwriters

Within the property and casualty field, underwriters often specialize in a particular type of
property or casualty coverage. Within this field there may be fire underwriters,
homeowner underwriters, automobile insurance underwriters, inland marine
underwriters, commercial property underwriters, personal property underwriters,
commercial general liability underwriters, professional liability underwriters and
Workers Compensation underwriters, for example.

These underwriters, whether they perform underwriting tasks for one line of insurance or
for many lines, must understand the risks involved with each line of insurance for which
they underwrite and the available and practical methods of dealing with these risks. They
must also be able to gather and understand the various resources used to evaluate
each application and determine whether the applicant meets company underwriting
standards. Such resources may include site inspection reports, business or personal
financial statements and reports, and if a business is being insured, statistical reports
generated by the industry in which the business falls, as well as statistical reports
from the property and casualty insurance industry that are applicable to the risk.

Personal Line and Commercial Lines

A further distinction among property and casualty underwriters is whether they
underwrite personal lines or commercial lines. Although both individuals and
businesses need property and liability coverages, the insurance needs of an
individual are very different from the needs of a business. In addition, there are
many, many types of businesses and therefore many different sorts of risks
associated with these varying business types. Therefore, within the commercial lines
area, there may be many specialized underwriting functions.

If an underwriter works with commercial lines applicants, the underwriter is generally

familiar with risk management principles and methods as they apply to the type of
business being insured. Such underwriters also are knowledgeable regarding the type
and scope of risks associated with various business occupancies. They understand
that the risks related to running a supermarket are different from those that exist
when operating a manufacturing plant. Depending on the insurer, a commercial
property and casualty underwriter may even specialize in underwriting specific types
of businesses. For example, if an insurer markets to those needing boilers and
machinery insurance and also to those with extensive data processing facilities, one
set of underwriters may work with the boilers and machinery applicants and another
set work with those with data processing protection needs.

If a property and casualty underwriter works with personal lines applicants, the
underwriter will have a deep understanding of the specific risks facing individuals, such as
homeowners or drivers. A homeowner’s insurance underwriter will understand
differences in home construction materials, the safety impact of various security
systems, and other factors that determine the rates and insurability of a
homeowner’s applicant. A personal automobile insurance underwriter will be an
expert in understanding the various safety features in all makes of cars, what types of
drivers are statistically found to be safe drivers, and so on. An underwriter working
with highly valuable personal property owned by an individual will be familiar with
appraisal reports and appropriate security measures that should be taken to protect
the property.

Life and Health Underwriters

Another area of specialty for underwriters is life and health insurance. A life and
health insurance underwriter is familiar with things such as the impact of medical history
and other health issues on insurability. The health or life underwriter is able to read and
understand medical reports such as the attending physician statement and data
gathered from the Medical Information Bureau. Due to the extensive regulatory
environment surrounding health insurance, health insurance underwriters are also
very familiar with state and federal regulations regarding health coverage.

Liability Underwriters
Liability insurance underwriters must be familiar with the liability risks found inherently in
commercial businesses, professionals, or individuals. They must also be able to evaluate
past losses, judgments, and settlements in terms of the likelihood of reoccurrence in
order to determine relative future risk. They must also be familiar with current trends
in court judgments and with liability laws in order to property evaluate high-risk
applicants.

Group Underwriters
Many types of insurance are written on a group basis, and health insurance is often
written in this manner. Group insurance is handled somewhat differently than individual
policies for underwriting purposes. Generally in life and health insurance group programs,
a rate is established that applies to the entire group to be insured. This rate is established
by analyzing the characteristics of the group as a whole, as well as individuals within
the group. This rate is generally reviewed and revised on an annual basis.

Under some types of group underwriting, individual rates are assigned to individuals
within the group, but a discounted rate is applied because the individual is part of
the group, so the insurer’s marketing costs are reduced on a per coverage basis. A
group offering automobile coverage to its members may have rates assigned in this
way.

Some forms of group insurance, especially when offered as part of an employer’s

benefit package, are subject to special federal and state regulations. Because group
underwriting differs in operations and regulation from individual underwriting, an
insurer may use specialized underwriters for group insurance.

Underwriting Decisions
When evaluating applicants, underwriters determine whether insurance on the
applicant will be:

rejected;
issued on a standard basis;
issued on a preferred basis or;
issued on a substandard basis.

Rejecting Applicants
Insurers reject applications for insurance when they find that the applicant represents a
risk that falls outside of the underwriting standards established by the insurance company.
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 reject an application, insurance principles such
as insurability and indemnity, the marketplace in which the insurer sells its products
and the profit the insurer hopes to make on its business.

Issuing Policies on a Standard Basis

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

Issuing Policies on a Preferred Basis

If an application falls within the lowest risk boundaries of the underwriting standards, the
policy is issued on a preferred basis. Preferred rates represent 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.

Issuing Policies on a Substandard 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 three basic options when it offers a substandard
policy issue to an applicant. It may:

issue the policy with a higher premium than would be required for a standard policy
issue the policy with limited benefits
issue the policy with certain exclusions

Higher Premium
The insurer may charge a higher premium to applicants deemed to be of higher risk
than those who would be considered a standard risk as long as those higher rates fall
within certain parameters. First, if the insurance policy is one that requires that rates
be filed with the state in which the policy is issued, the rate must be approved by the
state. Secondly, the rate may not be discriminatory. The insurer must charge every
insured with the same characteristics the same rate. Thirdly, in some states higher
premium may not be charged based on certain items as defined in state statutes.
The insurer must of course comply with such statutes in determining whether to
charge higher premium rates.

Limit Policy Benefits

Insurers may also respond to substandard applicants by offering a policy with limited
policy benefits. Again, whether the insurer may limit benefits is regulated by state
law. For example, under long-term care policies, some states require that policies
offer a minimum home health care benefit limit as a certain ratio of the nursing
home benefit limit. Therefore, a long-term care insurer could not limit the home
health benefit on a policy in a manner that would not comply with such a law.
Assuming state regulations are followed, an insurer could offer lower policy limits on
certain coverages to a substandard applicant, or could offer lower policy limits for all
coverages to such an applicant. Dealing with substandard applicants by limiting
policy benefits is most common in commercial coverages.

Excluding Certain Provisions from Coverage

Another option an insurer may have is to offer a substandard applicant a policy that
excludes coverage for certain property, insureds 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 state regulations. This type of exclusion is most
common in commercial property and liability coverages. For example, an insurer may
cover all the property owned by a business, except that within a building whose
operations have been discontinued. Or, 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.

Monitoring Underwriting Decisions

Once a policy is issued, underwriters continue to monitor the policy from an underwriting
perspective. Such monitoring is done at policy renewal, commonly every six or twelve
months, and as claims occur. Depending upon the type of policy and its provisions
regarding rate increases, rates may be increased at renewal, or the insurer may make
the decision not to renew the policy. Changes in rates or the decision to non-renew
are only made if allowed by policy provisions and applicable regulation. Decisions to
modify rates may be based on the actual claims experience over the last policy
period for a specific insured, as may occur with Workers Compensation insurance
and various commercial property policies, or may be based on a rate change for an
entire class of policyholders or category of insurance. State regulations often limit
factors that may be used to increase rates. For example, a state may not allow an
increase in automobile rates until three claims have been paid under the policy. The
decision for non-renewal, if allowed by regulation and policy terms, is typically done
only if the insured has excessive claims or the insurer has decided to discontinue
offering the type of insurance the policy represents.

The agent also has a role in the monitoring of underwriting decisions. The agent
should meet with each client on an annual basis to review coverages and ensure all
information on file with the insurer is accurate and up-to-date. This review of coverage also
serves the purpose of making sure the client’s insurance needs are properly met. Contact
between the agent and client outside of the annual review may also result in the
receipt by the agent of updated policy information. Updating policy information is an
important part of the ongoing underwriting process. The agent must promptly and
accurately submit such information to the insurer’s home office.

Summary
The factors used during the underwriting process vary based upon the type of
insurance being underwritten.
Underwriting involves the examination and evaluation of application forms
and supporting documents, assigning rates to a policy or declining to issue a
policy.
Generally, underwriters work as specialists for a particular line or lines of
insurance.
Underwriters have four options when underwriting an application. These
include determining whether the insurance on the applicant will be rejected,
issued on a substandard basis, issued on a standard basis, or issued on a
preferred basis.

Once underwriting is complete and a policy issued, the underwriting decision is

monitored as claims are received and upon renewal. The agent also is responsible to
assist in monitoring insureds through each contact with that insured, and must
forward appropriate updates to policy information promptly and accurately to the
insurance company.
QuizzesStatus
1
What is Underwriting? Review Questions

Course Progress

Chapters

Chapter 1: What is
Underwriting?
Chapter 2: The Underwriting
Process (Part 1)
Chapter 2: The Underwriting
Process (Part 2)
Chapter 2: The Underwriting
Process (Part 3)
Chapter 2: The Underwriting
Process (Part 4)
Chapter 2: The Underwriting
Process (Part 5)
Chapter 2: The Underwriting
Process (Part 6)
Chapter 2: The Underwriting
Process (Part 7)
Chapter 2: The Underwriting
Process (Part 8)
 Chapter 3: How Legislation
Impacts Underwriting (Part
1)
Chapter 3: How Legislation
Impacts Underwriting (Part
2)
Chapter 3: How Legislation
Impacts Underwriting (Part
3)
Chapter 3: How Legislation
Impacts Underwriting (Part
4)
Chapter 4: Reinsurance and
Underwriting
Chapter 5: Better
Underwriting
Understanding Insurance
Underwriting FINAL EXAM
(IL 72788)

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