Advanced

underwriting
960

2021
STUDY
TEXT
 Advanced
underwriting
960: 2021 Study text

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2 960/December 2020 Advanced underwriting

© The Chartered Insurance Institute 2020

All rights reserved. Material included in this publication is copyright and may not be reproduced in whole or in part
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Every attempt has been made to ensure the accuracy of this publication. However, no liability can be accepted for
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legal position. Specific advice should always be obtained before undertaking any investments.
Print edition ISBN: 978 1 80002 057 3
Electronic edition ISBN: 978 1 80002 058 0
This edition published in 2020

Reviewer for the 2021 edition

Michael Fake BA, FCII has spent his entire career in a variety of underwriting, sales, training and management
roles in general insurance, working with people at all levels.
Michael has core expertise in case and account underwriting and technical and personal development, including the
design and delivery of training and assessment programmes.

Acknowledgements
The CII would like to thank the following for their contribution to earlier editions of this study text:
Dr Laura Cochran BA, MA, PhD, ACII Chartered Insurance Practitioner (author of the first edition).
Roland Agard MSc, IRM, FCII, Nick Hankin BA, ACII, MBA, Andy Kean and Jamie McNabb, FCII, who reviewed the
first edition.
Elspeth Hackett, Head of Personal Lines, esure, and Tim Rourke, MSc, FIA, Head of Personal Lines Underwriting,
LV=, for reviewing and updating the 2014 edition.
Helen Hatchek BA (Hons), FCII, for reviewing and updating the 2015–2020 editions.
The CII would also like to thank:
• the following CII Underwriting Faculty Board members for their assistance with the first edition: Jeremy Diston,
Mark Hynes and Clive Nathan;
• the authors and reviewers of CII study texts 990 and 995, extracts from which are included in this text.
The CII thanks the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) for their kind
permission to draw on material that is available from the FCA website: www.fca.org.uk (FCA Handbook:
www.handbook.fca.org.uk/handbook) and the PRA Rulebook site: www.prarulebook.co.uk and to include extracts
where appropriate. Where extracts appear, they do so without amendment. The FCA and PRA hold the copyright for
all such material. Use of FCA or PRA material does not indicate any endorsement by the FCA or PRA of this
publication, or the material or views contained within it.
While every effort has been made to trace the owners of copyright material, we regret that this may not have been
possible in every instance and welcome any information that would enable us to do so.
Unless otherwise stated, the author has drawn material attributed to other sources from lectures, conferences, or
private communications.
Typesetting, page make-up and editorial services CII Learning Solutions.
Printed and collated in Great Britain.
This paper has been manufactured using raw materials harvested from certified sources or controlled wood
sources.
 3

Using this study text

Welcome to the 960: Advanced underwriting study text which is designed to cover the
960 syllabus, a copy of which is included in the next section.
Please note that in order to create a logical and effective study path, the contents of this
study text do not necessarily mirror the order of the syllabus, which forms the basis of the
assessment. To assist you in your learning we have followed the syllabus with a table that
indicates where each syllabus learning outcome is covered in the study text. These are also
listed on the first page of each chapter.
Each chapter also has stated learning objectives to help you further assess your progress
in understanding the topics covered.
Your Advanced Diploma study material has been designed to help you develop study skills
that you may not be familiar with. The aim is that you should engage actively with the text,
which contains a number of features designed to assist your learning and study.
You will be directed to alternative sources of theory and practice (useful websites/
additional reading), encouraged to learn from your own experiences (research exercises),
to think critically (critical reflections) and provided with opportunities to apply your
knowledge and skills through practical application (scenarios).

Guide to your study text

Additional reading or useful articles: Management decisions: are questions
provide valuable references to books, management may need to address. They
journals and articles on related subjects. encourage you to understand the
mindset of management.

Be aware: draws attention to important Refer to: Refer to: extracts from other CII study
points or areas that may need further texts, which provide valuable information
clarification or consideration. on or background to the topic. The
sections referred to are available for you
to view and download on RevisionMate.

Consider this: stimulating thought Reinforce: encourages you to revisit a

around points made in the text for which point previously learned in the course to
there is no absolute right or wrong embed understanding.
answer.

Critical reflections: challenge you to Research exercises: reinforce learning

think beyond the confines of the text. through practical activities.

Examples: provide practical illustrations Sources/quotations: cast further light

of points made in the text. on the subject from industry sources.

Key terms: introduce the key concepts On the Web: introduce you to other
and specialist terms covered in each information sources that help to
chapter. supplement the text.

Study skills
As we have already stated, the Advanced Diploma study material requires you to engage
with the text in a way that makes you capable of applying the knowledge you have gained to
practical work situations. While the text will give you a foundation of facts and viewpoints,
your understanding of the issues raised will be richer through adopting a range of study
skills. They will also make studying more interesting!
We will focus here on the need for active learning in order for you to get the most out of this
core text. However, the CII’s online learning site, RevisionMate, covers a range of other
study skills that will be helpful to you in more specific areas of your studies, such as using
diagrams and tables, how to approach case study style questions, and how to identify your
own learning style to help you approach studying in a way that best suits you and will get you
the best results possible.
4 960/December 2020 Advanced underwriting

Active learning is experiential, mindful and engaging

• Underline or highlight key words and phrases as you read – many of the key words
have been highlighted in the text for you, so you can easily spot the sections where key
terms arise; boxed text indicates extra or important information that you might want to be
aware of.
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numbers are clearly marked on the margins and key passages have been pulled out for
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that you have read in the context of a working environment and the scenario questions
are designed to make you think about applying the knowledge in the same way.
• Make connections to other CII units – throughout the text you will find ‘think back’ and
‘refer to’ boxes that tell you the chapters in other books that provide background to, or
further information on, the area dealt with in that section of the study text.
• Take notice of headings and subheadings.
• Use the clues in the text to engage in some further reading to increase your knowledge
of a particular area and add to your notes – be proactive!
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real life application, not just memorise it.
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https://www.cii.co.uk/knowledge-services/
Note: website references correct at the time of publication.
 5

Examination syllabus

Advanced underwriting
Purpose
To enable candidates to understand the management of the underwriting function in an insurance
organisation.

Assumed knowledge
It is assumed that the candidate has the knowledge gained from a study of the relevant sections of IF1
Insurance, legal and regulatory and M80 Underwriting practice or equivalent examinations.

Summary of learning outcomes

1. Analyse key regulation and legislation affecting the underwriting function

2. Evaluate underwriting strategy, policy and practice

3. Analyse the principles and practices of pricing

4. Evaluate the management of exposures in the portfolio

5. Evaluate planning, portfolio monitoring and operational controls

Important notes
• Method of assessment: Coursework – 3 online assignments (80 marks). Each assignment must be
individually passed.
• The syllabus is examined on the basis of English law and practice unless otherwise stated.
• Candidates should refer to the CII website for the latest information on changes to law and practice
and when they will be examined:
1. Visit www.cii.co.uk/qualifications
2. Select the appropriate qualification
3. Select your unit on the right hand side of the page

Published January 2021

©2020 The Chartered Insurance Institute. All rights reserved. 960
6 960/December 2020 Advanced underwriting

1. Analyse key regulation and legislation 5.3 Evaluate the techniques for monitoring underwriting
affecting the underwriting function results.
1.1 Explain the impact of legislation and regulation on 5.4 Evaluate the effect of monitoring and forecasting on
the underwriting function. the underwriting strategy.
1.2 Examine the relationship between the underwriting 5.5 Explain the significance of identifying the
function and solvency requirements. underwriting skill-set required, key performance
indicators and continuing professional development.
1.3 Examine the issues and implications of underwriting
business internationally. 5.6 Evaluate the use of underwriting licences and
auditing.
2. Evaluate underwriting strategy, policy
and practice
2.1 Analyse the relationship between the corporate,
reinsurance and underwriting strategies.
2.2 Explain the impact of various distribution channels
on the underwriting function.
2.3 Explain the implications of using binding authorities.
2.4 Explain the research required to ensure effective
underwriting policy.
2.5 Analyse the factors to be taken into account when
entering and withdrawing from classes of business
and markets.
2.6 Explain the significance of claims reserving policy
and practice on portfolio management.
2.7 Analyse the impact of product mix, segment mix and
cover mix on portfolio management.
2.8 Explain underwriting considerations to be taken into
account when establishing policy terms and
conditions.
2.9 Evaluate the importance of risk acceptance,
evaluation and control on the portfolio mix.

3. Analyse the principles and practices of

pricing
3.1 Examine the internal and external data required for
pricing.
3.2 Explain the various components to be taken into
consideration for pricing.
3.3 Explain how the different statistical methods are
used in pricing.
3.4 Examine the impact of the underwriting cycle on
portfolio management.
3.5 Examine claims information in relation to setting the
price, setting reserves and regulatory requirements.

4. Evaluate the management of exposures

in the portfolio
4.1 Explain aggregation and the techniques available to
measure exposure to single risks, single events and
catastrophes.
4.2 Evaluate emerging risks, including systemic losses.
4.3 Explain the various means of managing exposure
and enabling capacity, including reinsurance.

5. Evaluate planning, portfolio monitoring

and operational controls
5.1 Explain the process of planning, budgeting and
forecasting.
5.2 Explain the reasons for monitoring underwriting
results.

Published January 2021 2 of 4

©2020 The Chartered Insurance Institute. All rights reserved.
 7

Reading list Non-life insurance pricing with generalised

linear models. Esbjorn Ohlsson, Bjorn
The following list provides details of various Johansson. Heidelberg: Spinger, 2015.*
publications which may assist you with your
studies. Pricing in general insurance. Pietro Parodi.
CRC Press, 2015.*
Note: The examination will test the
syllabus alone. However, it is important to Reinsurance underwriting. Robert Kiln,
read additional sources as 10% of the Stephen Kiln. 2nd ed. London: CRC Press,
exam mark is allocated for evidence of 2017.*
further reading and/or the use of relevant
examples. Risk management for insurers: risk control,
economic capital, and Solvency II. Rene
The reading list is provided for guidance only Doff. 3rd/2nd ed. London: Risk Books,
and is not in itself the subject of the
examination. 2015/2011.*

The publications listed here provide a wider eBooks

coverage of syllabus topics. The following ebooks are available through
Discovery via www.cii.co.uk/elibrary (CII/PFS
CII study texts members only):
Advanced underwriting. London: CII. Big data revolution: what farmers, doctors
Study text 960. and insurance agents teach us about
Underwriting practice. London: CII. discovering big data patterns. Rob Thomas,
Study text M80. Patrick McSharry. Wiley, 2015.
Fundamental aspects of operational risk and
Insurance, legal and regulatory. London: CII. insurance analytics: a handbook of
Study text IF1. operational risk. Marcelo Cruz, et al. New
Books / eBooks Jersey: Wiley, 2015.
A practitioner's guide to Solvency II. Geoffrey Fundamentals of risk management:
et al. (eds.). London: Thomson Reuters, understanding, evaluating and implementing
2016. effective risk management. Paul Hopkin,
Analytics for insurance: the real business of Kogan Page, 2014.
Big Data. Tony Boobier. Chichester: Wiley, Handbook in Monte Carlo simulation:
2016.* applications in financial engineering, risk
Capital requirements, disclosure, and management and economics. Paolo
supervision in the European insurance Bradimarte. Hoboken: Wiley, 2014.
industry: new challenges towards Solvency Risk modelling in general insurance: from
II. Maria Grazia Starita, Irma Malafronte. principles to practice. Roger J. Gray, Susan
Palgrave Macmillan, 2014. M. Pitts. Cambridge: Cambridge University
Colinvaux’s law of insurance. 11th ed. Press, 2012.
London: Sweet & Maxwell, 2016. Uncertainty in risk assessment: the
Cyber risk. Michael Woodson. London: Risk representation and treatment of uncertainties
Books, 2016. by probabilistic and non-probabilistic
Digital insurance: business innovation in the methods. Terje Aven. Hoboken: Wiley, 2014.
post-crisis era. Bernardo Nicoletti. Journals and magazines
Basingstoke: Palgrave Macmilan, 2016.* The Journal. London: CII. Six issues a year.
Handbook of insurance. Georges Dionne. Post magazine. London: Incisive Financial
New York: Springer, 2013.* Publishing. Monthly. Contents searchable
‘Insurance intermediaries: underwriting online at www.postonline.co.uk.
agents’ in Colinvaux’s law of insurance. 11th The Economist. London: Economist
ed. Prof. Robert Merkin. London: Sweet & Newspaper. Weekly.
Maxwell, 2016.
Managing systemic exposure: risk Reference materials
management framework for SiFis and their Code of ethics. London: CII, 2014. Available
markets. Federico Galizia. London: Risk online at www.cii.co.uk/about/professional-
Books, 2013.* standards/code-of-ethics.

* Also available as an ebook through eLibrary via www.cii.co.uk/elibrary (CII/PFS members only).

Published January 2021 3 of 4

©2020 The Chartered Insurance Institute. All rights reserved.
8 960/December 2020 Advanced underwriting

Concise encyclopedia of insurance terms.

Laurence S. Silver, et al. New York:
Routledge, 2010.

Specimen guides
Specimen guides are available for all
coursework units.
These are available on the CII website under
the unit description / purchasing page. You
will be able to access this page from the
Qualifications section of the CII website:
www.cii.co.uk/qualifications.
These specimen guides are also available
on the RevisionMate website
www.revisionmate.com after you have
purchased the unit.

Exam technique/study skills

There are many modestly priced guides
available in bookshops. You should choose
one which suits your requirements.

Published January 2021 4 of 4

©2020 The Chartered Insurance Institute. All rights reserved.
 9

960 syllabus
quick-reference guide
Syllabus learning outcome Study text chapter
and section
1. Analyse key regulation and legislation affecting the underwriting function
1.1 Explain the impact of legislation and regulation on the 1A, 1D, 4C
underwriting function.
1.2 Examine the relationship between the underwriting function and 1B, 2B, 2C, 2D, 3A
solvency requirements.
1.3 Examine the issues and implications of underwriting business 1C, 3B
internationally.
2. Evaluate underwriting strategy, policy and practice
2.1 Analyse the relationship between the corporate, reinsurance and 2F, 2H, 3A, 3F, 4D, 8A, 8H
underwriting strategies.
2.2 Explain the impact of various distribution channels on the 3D
underwriting function.
2.3 Explain the implications of using binding authorities. 3D, 4E, 9K
2.4 Explain the research required to ensure effective underwriting 3C, 4C
policy.
2.5 Analyse the factors to be taken into account when entering and 2B, 2I, 3A
withdrawing from classes of business and markets.
2.6 Explain the significance of claims reserving policy and practice 6A, 6B
on portfolio management.
2.7 Analyse the impact of product mix, segment mix and cover mix 4D
on portfolio management.
2.8 Explain underwriting considerations to be taken into account 2B, 2E, 2G, 3C, 4C, 4E, 5B,
when establishing policy terms and conditions. 5C
2.9 Evaluate the importance of risk acceptance, evaluation and 4B, 8A
control on the portfolio mix.
3. Analyse the principles and practices of pricing
3.1 Examine the internal and external data required for pricing. 7A
3.2 Explain the various components to be taken into consideration 7C
for pricing.
3.3 Explain how the different statistical methods are used in pricing. 6C, 6D, 7B, 7C, 7D, 7E, 7F
3.4 Examine the impact of the underwriting cycle on portfolio 3C, 7D
management.
3.5 Examine claims information in relation to setting the price, setting 6B, 7B
reserves and regulatory requirements.
4. Evaluate the management of exposures in the portfolio
4.1 Explain aggregation and the techniques available to measure 8B, 8C, 8F, 8G
exposure to single risks, single events and catastrophes.
4.2 Evaluate emerging risks, including systemic losses. 8D, 8E
4.3 Explain the various means of managing exposure and enabling 2E, 2F, 8G, 8H, 8I
capacity, including reinsurance.
5. Evaluate planning, portfolio monitoring and operational controls
5.1 Explain the process of planning, budgeting and forecasting. 2A, 3A, 4A, 5A, 5B, 5C, 5D,
5E, 5F, 5G, 5H, 5I, 6B, 9H
5.2 Explain the reasons for monitoring underwriting results. 5G, 9A, 9F, 9G
5.3 Evaluate the techniques for monitoring underwriting results. 9A, 9B, 9C, 9D, 9E
10 960/December 2020 Advanced underwriting

Syllabus learning outcome Study text chapter

and section
5.4 Evaluate the effect of monitoring and forecasting on the 9F, 9G
underwriting strategy.
5.5 Explain the significance of identifying the underwriting skill-set 3E, 9B, 9H
required, key performance indicators and continuing professional
development.
5.6 Evaluate the use of underwriting licences and auditing. 9D, 9I, 9J, 9K, 9L
 11

Introduction
If you are studying the 960: Advanced underwriting Advanced Diploma in Insurance unit, it
is likely that you are already working in the insurance market as an underwriter. You may
aspire to a role in underwriting management or have recently been appointed to such a role.
Through previous study you already understand the fundamental issues relating to
underwriting policy, the legal and regulatory environment in which the general insurance
industry operates and its capital requirements. Through your own underwriting experience,
you understand in some detail one or more specific areas of general insurance underwriting
practice. The objective of this unit is to build on your existing knowledge by examining how
underwriting management, working with other areas of expertise, contributes to the effective
management and success of general insurance businesses.
By one definition ‘knowledge is the ability to take effective action’ and, as this unit is
concerned with the application of knowledge, you will be asked to imagine yourself in a
number of different underwriting management roles: for example, responsible for groups of
risks in an underwriting portfolio (product, scheme or branch account) or, as an underwriting
director, responsible to the board for all your company’s underwriting activities and
outcomes.
Irrespective of your level within a company, as an underwriting manager you are responsible
for the activities and decisions of the staff reporting to you and for the achievement of
financial and other business targets set by executive management. Your responsibility for
outcomes and results is mirrored by your role in developing plans, setting standards and
guidelines, monitoring results, auditing work, anticipating issues and taking action to tackle
them. As a member of the management team, you work closely with other professionals in
the actuarial, finance and claims teams, as well as colleagues responsible for compliance,
risk control, distribution/sales, operations/customer service, ICT and marketing. You also
work hard to maintain good relationships with your company’s reinsurers and third-party
suppliers.
 13

Contents
1: Regulation and legislation affecting the underwriting
function
A UK financial services regulation 1/3
B Capital and solvency requirements 1/7
C Competition 1/15
D Legal and regulatory constraints on scope of cover 1/20

2: Start-up scenario
A Business plan 2/2
B An underwriting perspective 2/3
C Investors 2/5
D Financial projections 2/6
E Risk management 2/7
F Reinsurers 2/8
G Risk appetite 2/10
H Go-live 2/11
I Start-ups versus established insurers 2/14

3: Strategy
A Corporate strategy 3/2
B Multinational business 3/6
C Marketing 3/10
D Distribution 3/19
E Operations 3/28
F Core elements of an underwriting strategy 3/31
G Scenario 3.1 3/34
H Scenario 3.2 3/35

4: Underwriting policy and practice

A Managing change 4/2
B Evaluating risk 4/4
C Establishing cover and terms 4/10
D Portfolio management 4/15
E Scheme underwriting 4/21
F Scenario 4.1 4/23
14 960/December 2020 Advanced underwriting

5: The planning process in underwriting

A Plans and budgets 5/2
B The underwriting manager’s role 5/4
C Assumptions and forecasts 5/5
D Expenses 5/6
E Cash flow and investment income 5/7
F Liaison 5/7
G An ongoing task – monthly monitoring 5/9
H Management and financial accounts 5/10
I Your plan and budget 5/11
J Scenario 5.1 5/11

6: Claims data and reserving

A Reserving policy and practice 6/2
B Claims reserving and underwriting 6/3
C Forecasting to ultimate: approaches and techniques 6/5
D Interpretation and use of claims information 6/10

7: Pricing
A Data for pricing 7/3
B Projecting claims experience 7/7
C Rating structures and prices 7/9
D Other pricing components 7/12
E Experience rating 7/15
F Exposure rating 7/17
G Scenario 7.1 7/18

8: Managing exposure
A Risk appetite and risk acceptance 8/2
B Accumulations and ‘clash’ 8/3
C Internal exposure data 8/4
D External environment 8/5
E Emerging risks 8/5
F Communicating exposure-related issues 8/7
G Aggregate management techniques 8/7
H Reinsurance strategy and procurement 8/9
I Alternative risk transfer options 8/13
J Scenario 8.1 8/18
 15

9: Monitoring and operational controls

A Plans, budgets and forecasts 9/2
B Key performance indicators 9/6
C Claims, reinsurance and exposure 9/6
D Audit 9/8
E Presentation of data 9/8
F Looking ahead as well as back 9/8
G Data mining 9/10
H People management 9/10
I Authority limits 9/11
J Other auditors 9/14
K Delegated authority 9/14
L Underwriting policy 9/15
M Scenario 9.1 9/15
N Scenario 9.2 9/16
O Scenario 9.3 9/17

Appendix 1: New Statesman article on asbestos A1/1

Appendix 2: Insurance Insider article on asbestos A2/1
Appendix 3: Claims development triangles: scenario analysis and A3/1
discussion
Appendix 4: Risk premium projection: scenario analysis and discussion A4/1
Appendix 5: Impact of pricing, expenses and volumes on profitability: A5/1
scenario analysis and discussion
Self-test answers i
Legislation v
Index vii
 Chapter 1
Regulation and legislation
1
affecting the underwriting
function
Contents Syllabus learning
outcomes
Introduction
A UK financial services regulation 1.1
B Capital and solvency requirements 1.2
C Competition 1.3
D Legal and regulatory constraints on scope of cover 1.1
Conclusion
Self-test questions

Learning objectives
This chapter relates to syllabus section 1.
On completion of this chapter and private research, you should be able to:
• explain how the financial services industry is regulated in the UK;
• examine the relationship between solvency requirements and the underwriting profession;
• explain the implications of competition legislation on the underwriting function;
• explain the impact of the FCA product intervention strategy, the Consumer Insurance
(Disclosure and Representations) Act 2012 and equality legislation on underwriting
decisions;
• explain the implications of the Insurance Act 2015 on the underwriting function; and
• explain the importance of data protection on the underwriting function.
Chapter 1 1/2 960/December 2020 Advanced underwriting

Introduction
A detailed explanation of the principles of regulation and summaries of the statutory and
legislative issues affecting the underwriting function will have been provided in units that you
previously studied. While this chapter will provide a brief overview of these important topics,
this unit intends not to repeat information but rather to build on it as appropriate to the
management of the underwriting function. For example, we will introduce the link between
the regulatory requirements to hold certain levels of capital and the decisions made by senior
underwriting managers about the types and level of risks their organisations wish to accept.
• Throughout this study text you will find references to relevant regulatory and legislative
matters, in particular legal and regulatory constraints on the scope of cover (the
Principles for Businesses (PRIN), the fair treatment of customers, the Financial
Ombudsman Service (FOS) and legal reforms, for example).
• Many references relate to Solvency II, which became effective from January 2016, as
understanding how this legislation is inextricably linked to many of the decisions made by
the senior managers (including underwriting managers) of an insurance company is
essential.
• The topic of competition has become increasingly important since it was included as one
of the FCA’s statutory objectives. Underwriting managers will need to be alert to the
changes made by the FCA and how they affect their organisation.

Reinforce
The 960 syllabus refers both to the understanding and application of key regulation and
legislation to the underwriting function. As an insurance professional, you are required to
understand and observe relevant legislation under the terms of the CII Code of Ethics
and those of your contract of employment. Given the range of applicable legislation
(relating to many matters in addition to those relating specifically to underwriting), this
could appear to be a potentially overwhelming task were it not for the sources of
assistance and advice available to you. Many suggestions for further reading and useful
websites have been included throughout this study text.
Your company’s legal and compliance teams can explain the precise implications of any
planned course of action - don't hesitate to seek their advice. You are obliged to be alert to
the possibility that a course of action may have regulatory and/or legislative implications
for your company. You must ensure that no precipitate or unauthorised action on your part
brings your company into disrepute or worse.

Key terms
This chapter features explanations of the following terms and concepts:

Capital model Competition Competition and Conduct risk

Markets
Authority (CMA)
Fair treatment of Insurance Act 2015 Insurance Minimum capital
customers Distribution Directive requirement (MCR)
(IDD)
Own risk and Product intervention Quantitative Return on capital
solvency requirements (ROC)
assessment (ORSA)
Solvency capital Solvency II Directive
requirement (SCR)
Chapter 1 Regulation and legislation affecting the underwriting function 1/3

Chapter 1
A UK financial services regulation
A1 Financial Services Act 2012
Since 1 April 2013 regulation of the UK financial services industry has been the responsibility
of the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA),
which jointly took over the majority of the duties carried out by the former regulator, the
Financial Services Authority (FSA), under powers granted by the Financial Services Act
2012. The PRA works alongside the FCA to form a ‘twin peaks’ regulatory structure in the
UK. A third body, the Financial Policy Committee (FPC), which sits within the Bank of
England, is responsible for monitoring emerging risks to the UK financial system as a whole
and providing overall strategic direction.

A2 Bank of England and Financial Services Act 2016

The Bank of England and Financial Services Act 2016 modified the Financial Services
Act 2012. The 2016 Act puts the Bank of England at the heart of UK financial stability by
strengthening the Bank’s governance and ability to operate more effectively as ‘One Bank’.
The PRA became part of the Bank, ending its status as a subsidiary, and a new Prudential
Regulation Committee (PRC) has been established. The PRC operates alongside the other
two Bank committees, namely the FPC and the Monetary Policy Committee (MPC).

Figure 1.1: Regulatory framework

Bank of England
Financial Conduct
Authority (FCA)
Monetary Policy Prudential Financial Policy Enhancing confidence in the
Committee (MPC) Regulation Committee (FPC) UK financial system by
Setting interest rates. Committee (PRC) Identifying action to facilitating efficiency and choice
Taking control of the remove or reduce in services, securing an
PRA’s most important systemic risk. appropriate degree of
financial stability and consumer protection and
supervision policy protecting and enhancing the
decisions. integrity of the UK financial
system.

Prudential Regulation Authority (PRA)

Enhancing financial stability by promoting the safety and soundness of
PRA-authorised persons, including minimising the impact of their
failure.

Prudential regulation Conduct regulation Prudential and

conduct regulation

Prudentially significant firms: Investment firms and

banks, building societies, credit unions, insurers and some investment exchanges, other financial
firms. services providers including
independent financial advisers
(IFAs), investment exchanges,
insurance brokers and fund
managers.

Source: HM Treasury

A3 The PRA
The PRA is part of the Bank of England and it has a close working relationship with other
parts of the Bank, including the FPC and the Special Resolution Unit.
The PRA is responsible for the prudential regulation and supervision of banks, building
societies, credit unions, general and life insurers and major investment firms. In total it
regulates approximately 1,700 financial firms.
Chapter 1 1/4 960/December 2020 Advanced underwriting

Under the Financial Services Act 2012, the PRA has three statutory objectives:
• a general objective to promote the safety and soundness of the firms it regulates;
• an objective specific to insurance firms, to contribute to the securing of an appropriate
degree of protection for those who are or may become insurance policyholders; and
• a secondary objective to facilitate effective competition.
In promoting safety and soundness, the PRA focuses on the stability of the UK financial
system by ensuring that authorised persons operate in a way that avoids adverse effects on
the system as well as by minimising the adverse effect that the failure of an authorised
person could have. A stable financial system is one in which firms continue to provide critical
financial services – a precondition for a healthy and successful economy.
The PRA makes forward-looking judgments on the risks posed by firms to its statutory
objectives. Those institutions and issues which pose the greatest risk to the stability of the
financial system are the focus of its work. The aim is to pre-empt risks before they crystallise.
A3A Threshold Conditions
The Threshold Conditions are the minimum requirements that firms must meet in order to be
permitted to carry out regulated activities. At a high level, the Threshold Conditions require:
• an insurer’s head office, and in particular its mind and management, to be in the UK if it is
incorporated in the UK;
• an insurer’s business to be conducted in a prudent manner, and in particular that the
insurer maintains appropriate financial and non-financial resources; and
• the insurer to be ‘fit and proper’, appropriately staffed, and the insurer and its group
capable of being effectively supervised.
The PRA wants to ensure that at the point of authorisation new insurers hold capital
sufficient to cover the risks they run. Once authorised, firms must continue to meet these
conditions at all times.
A3B Risk assessment framework
The PRA’s framework reflects its additional insurance objective to protect policyholders as
well as the financial system. It captures three elements:
1. The potential impact on policyholders and the financial system of a firm coming under
stress of failing.
2. How the macroeconomic and business risk context in which a firm operates might
affect the viability of its business model.
3. Mitigating factors, including risk management, governance, financial position (including
its solvency position), and resolvability.
Figure 1.2 depicts this framework.

Figure 1.2: The PRA’s risk framework

Gross risk Mitigating factors

Potential Structural
impact Risk context Operational mitigation Financial mitigation mitigation

Management Risk
Potential External Business and management
impact context risk Liquidity Capital Resolvability
governance and controls

Source: The Prudential Regulation Authority’s approach to insurance supervision.

Chapter 1 Regulation and legislation affecting the underwriting function 1/5

Chapter 1
On the Web
The PRA’s approach to insurance supervision: www.bankofengland.co.uk/prudential-
regulation/publication/2018/pra-approach-documents-2018

A4 The FCA
The FCA is a separate institution and not part of the Bank of England. Although it is
accountable to the Treasury, it operates independently of the Government and is funded by
the firms it regulates.
The FCA regulates over 56,000 firms.
• It is the regulator for both the prudential and conduct of business in respect of firms of
limited systemic importance, e.g. insurance intermediaries and asset managers. It also
regulates Lloyd’s members’ agents and Lloyd’s brokers.
• It regulates conduct of business issues for the systemically important firms that are
prudentially regulated by the PRA, e.g. insurers, banks, Lloyd’s, and Lloyd’s managing
agents.
• The FCA is also responsible for the Financial Ombudsman Service (FOS) and the
Financial Services Compensation Scheme (FSCS).
The Financial Services Act 2012 states that the FCA’s overarching strategic objective is to
‘ensure that the relevant markets function well’. Its operational objectives are to protect
consumers, ensure that the industry remains stable, and promote healthy competition
between financial services providers. This includes acting to prevent market abuse and
ensuring that consumers get a fair deal.
A4A The FOS
The FOS publishes decisions, comments and case studies relating to complaints handled.
Where complaints relate to the interpretation of policy cover, underwriting managers are well-
advised to pay heed to FOS decisions. Although the direct issues being addressed may
relate to sales, claims and complaints handling, underwriting may be impacted through the
requirement to pay claims which would otherwise have been declined and the need to
amend wordings to reflect the insurer’s intention more clearly.

On the Web
www.financial-ombudsman.org.uk/decisions-case-studies/case-studies. Search, for
example, for the FOS approach to ‘keys in cars’ cases.

A5 PRA Rulebook and FCA Handbook

Most of the provisions in the original FSA Handbook have now been incorporated into either
the PRA Rulebook or the FCA Handbook, or both, according to each regulator’s set of
responsibilities and objectives.
The PRA Rulebook contains rules and directions, or principles, made by the PRA that apply
to PRA-authorised firms.

On the Web
PRA Rulebook: www.prarulebook.co.uk
FCA Handbook: www.handbook.fca.org.uk/handbook

A5A Principles for Businesses (PRIN)

Refer to
Think back to M80 chapter 1, section C

You will be aware from your previous studies that the PRIN sourcebook, included in both the
FCA Handbook and PRA Rulebook, outlines the fundamental obligations of all firms under
the UK regulatory system. An underwriter should be mindful of all the principles, but when
Chapter 1 1/6 960/December 2020 Advanced underwriting

dealing with a proposer or an existing customer, those that refer to integrity, fairness, skill,
clarity of information and proper standards are particularly relevant.
A5B Training and competence sourcebook
The sourcebook relating to training and competence (TC), included in the FCA Handbook, is
relevant to underwriters. It also links to the second Principle: ‘a firm must conduct its
business with due skill, care and diligence’. The training of underwriters used to be a
combination of informal on-the-job training assisted by formal study. In recent years this has
changed substantially as companies have responded to the demands of increasingly
competitive markets. They recognise that the offer of structured training and related
remuneration is critical if they hope to retain the best staff. As stricter regulation in this area
has been introduced, insurers have had to accept that effective training must be offered to
staff across the company and maintain auditable records to evidence this.
A5C Fair treatment of customers

Refer to
Think back to M80 chapter 1, section C2

As you will know from your previous studies, the original treating customers fairly (TCF)
initiative imposed a duty on the management of a firm to ensure that the fair treatment of
customers principle was embedded into its values, culture, and the way it conducted its
business. The FCA continues to monitor whether this has been considered and delivered at
every level of the organisation, and that performance is regularly reviewed against the fair
treatment of customers obligation. Therefore, this theme is central to the role of the
underwriter in ensuring that the customer is given sound advice, and an understanding of the
fair treatment of customers and the six consumer outcomes is in the best interests of all
insurers particularly when creating new products for market.
The principles set by the FCA reflect the professional and ethical standards that should
guide those who work in insurance as they go about their day-to-day activities. However, it's
vitally important for an industry that relies on trust for customers to have confidence that they
are dealing with people who are putting their interests first; not because they have to, but
because they believe it's the right thing to do.
Organisations with a record of great customer service, treating every customer fairly and with
respect, build themselves a good reputation; those who don't won't be recommended to
other people.
The CII Code of Ethics provides members of the insurance and personal finance profession
with a framework in which to apply their role-specific technical knowledge in delivering
positive consumer outcomes. Under the fifth 'Core duty' within the Code, members are
required to: 'treat people fairly regardless of: age, disability, gender reassignment, marriage
and civil partnership, pregnancy and maternity, race, religion and belief, sex and sexual
orientation'.

A6 Authorising new insurers

It is the responsibility of the PRA to assess applicant insurers from a prudential perspective
and determine whether the applicant will meet the Threshold Conditions (outlined in
Threshold Conditions on page 1/4) at the point of authorisation and on an ongoing basis. At
the same time the FCA will assess applicants from a conduct perspective. The PRA leads
and manages a single administrative process and is responsible for coordination and
transmission of all formal notices and decisions to the applicant insurer.
The guidance notes for insurance companies demonstrate the scope and depth of
information required, including detailed financial projections and information about
management, staff, systems and controls. The review and evaluation of this mass of
information inevitably takes time: the regulators’ service standard states that they will make a
decision within six months of receiving a complete application. Clearly, more is involved in
gaining authorisation than merely providing financial projections.
Although the authorisation of the start-up company to write general insurance business is
recognised by all concerned as a necessary step, the PRA and the FCA will only consider
granting authorisation once the required information has all been assembled.
Chapter 1 Regulation and legislation affecting the underwriting function 1/7

Chapter 1
It has often been said that the requirements of the regulatory regime in the UK largely reflect
what good businesses would be doing in any case. By the time the start-up company has
gained authorisation, the underwriting manager would already have access to three- or five-
year forecast revenue accounts for each class of business (on a realistic and two pessimistic
bases), as required in the application. These forecasts (and their explanatory notes) form the
basis of the monitoring which must commence as soon as the business goes live; this
monitoring should extend encompass not only the overall financial results but also all the
assumptions used in the creation of the forecasts.

Research exercise
To appreciate what is involved in the case of applications for authorisation in the UK it is
well worth reviewing the guidance provided on the PRA’s and FCA’s websites:
www.bankofengland.co.uk/prudential-regulation and www.fca.org.uk.

B Capital and solvency requirements

Refer to
Think back to M80 chapter 2, section A

All businesses require capital in order to operate. The nature of the insurance business
means that insurance companies require substantial amounts of capital (in various forms) to
reflect its inherent nature – that of uncertainty.
The question of exactly how much capital to hold is a very difficult one. If an insurance
company holds enough to cover all possible future claims, this would tie up a huge sum of
capital. On the other hand, if they would rather free up capital for other uses, they would then
be vulnerable to large, unexpected claims. It therefore depends how much risk the company
wants to take; however, they have to bear in mind the minimum level set by regulators. We
will return to this link between an insurance company’s capital requirements and the attitude
to risk set by senior managers throughout this course.
Regulators recognise the need to deal with this uncertainty and set rules for insurers to
maintain levels of capital appropriate for their business activities. This also ensures that
consumers are protected and that the insurance market operates efficiently.

B1 Solvency regulation
Regulation relating to capital is a complex area and there is a large amount of information
available for further reading on this. The following provides a short synopsis of the current
position in the UK.
• Prior to 31 December 2015 UK insurers – and those from other EU (and related) states –
were subject to the EU Solvency I Directive, which specifies a minimum capital
requirement (MCR).
• The MCR is the higher of two amounts: the base capital requirement (a flat monetary
figure designed for very small insurers) and an amount that applies to the majority of
insurers, calculated from the volume and type of business. This is the general insurance
capital requirement (GICR) or, in the case of a life company, the long-term insurance
capital requirement (LTICR), plus an extra amount called the resilience capital
requirement (RCR) that protects life companies from market risk.
• All UK-regulated insurers legally had to have capital at least as large as their MCR.
• The Solvency II Directive, effective since January 2016, includes a Basel II-inspired risk-
based replacement for Solvency I. See Solvency II on page 1/8 for more details on
Solvency II.
Chapter 1 1/8 960/December 2020 Advanced underwriting

Basel II
Basel II is the second of the Basel Accords (now extended and effectively superseded by
Basel III), which are recommendations on banking laws and regulations issued by the
Basel Committee on Banking Supervision.
Initially published in June 2004, it was intended to create an international standard for
banking regulation to control how much capital banks need to put aside to guard against
the types of financial and operational risks banks (and the whole economy) face.

• After a series of legislative delays, it was agreed that Solvency II would be transposed
into law in Member States by 31 March 2015, prior to the Directive coming into effect for
insurers on 1 January 2016.
• In preparation for Solvency II, companies undertook some preliminary reporting during
2015 as a ‘dry run’ to test their preparedness and ability to produce reliable reporting.
• The FSA believed that MCR specified in Solvency I only represented about half as much
capital as is needed by an insurer in the UK marketplace. As it was not prepared to wait
for Solvency II, it decided to apply its own more stringent rules. These rules are based on
one of the Threshold Conditions for authorisation: that a UK insurer must have capital
resources that are ‘adequate having regard to the size and nature of its business’. Thus
capital adequacy enabled the FSA and subsequently the PRA to set capital requirements
in excess of the Solvency I limits.
• Since April 2013 an insurer’s capital adequacy and solvency has been regulated by
the PRA.
• As a result, UK authorised insurers were working to capital requirements that were about
twice the amount applicable for their EU counterparts, even those operating in the UK
market but authorised to do so by other EU states. This anomaly has stopped now that
the EU Solvency II Directive has come into force across the whole of the EU.

B2 Solvency II
Solvency II is the EU Directive covering the capital requirements and related supervision for
insurers. The key elements – the so-called framework – were adopted in 2009, originally with
a view to being implemented by EU Member States by 2012. As mentioned above, this was
then postponed and the Directive came into effect on 1 January 2016.
The main purpose of the new Directive is to ensure adequate policyholder protection in all
EU Member States with all insurers holding capital calculated using the same methodology.
It also takes into account current developments in insurance, risk management, financial
techniques, international financial reporting and prudential standards. It is intended to better
reflect the true range of risks faced by an insurer. Solvency II is also intended to recognise
the fundamental differences between the risks of insurance and banking.
The new regime applies to all insurers with gross premium income exceeding €5m or gross
technical provisions in excess of €25m. Some insurance firms will be out of scope depending
on the amount of premiums they write, the value of technical provisions or the type of
business written. Solvency II principles and rules apply to Lloyd’s syndicates in full.
Insurers in the London Market currently operate within the EU and are therefore subject to
regulations, treaties or directives issued in Europe, including Solvency II.
The UK left the EU on 31 January 2020 and will need its own system that mirrors Solvency II
when the transition period ends. This must be deemed 'equivalent' and fit for purpose to
allow ongoing trade with the EU. To this end, The Solvency 2 and Insurance (Amendment,
etc.) (EU Exit) Regulations 2019 have been created and came into force on 'exit day'. The
purpose of the regulations is to ensure that the existing EU law on Solvency II, which is now
part of UK law, continues to operate effectively following Brexit and will do so until a new UK-
specific framework is developed.
The Solvency II requirements are structured into three ‘pillars’. Each pillar consists of a
grouping of like concepts with the following main headings:
• Financial requirements.
• Governance and supervision.
• Reporting and disclosure.
Chapter 1 Regulation and legislation affecting the underwriting function 1/9

Chapter 1
Figure 1.3: The three-pillar approach

Three-pillar approach

PILLAR 1 PILLAR 2 PILLAR 3

Financial requirements Governance and Reporting and disclosure
• Minimum capital supervision • Disclosure of risks facing
requirement (MCR). • Governance, risk them, capital adequacy
• Solvency capital management and and risk management.
requirements (SCR). required functions. • Transparency.
• Own risk and solvency • Support of risk-based
assessment (ORSA). supervision through
• Supervisory review process. market mechanisms.

B2A Pillar 1 – Financial requirements

Solvency II requirements are more comprehensive than those in Solvency I, which
concentrated mainly on the liabilities side (i.e. insurance risks). Solvency II also takes
account of the asset-side risks creating a ‘total balance sheet’ type regime where all the
risks and their interactions are considered. This is more consistent with the economic
realities of insurance operations.
The Directive establishes economic valuation of assets and liabilities in all solvency
calculations. This means they should be valued at the level at which they could be
transferred (exchanged, settled) to a ‘knowledgeable willing party in an arm’s length
transaction’.

On the Web
European Commission guide to Solvency II: www.eiopa.europa.eu/browse/solvency-2_en

Minimum capital requirement

Like Solvency I, the regime specifies an MCR, a critical level of capital below which a firm
cannot be allowed to carry on its operations normally and stringent supervisory powers take
effect. The MCR in Solvency II is intended to be a fairly simple calculation that can be
undertaken and reported to the regulator on a quarterly basis.
The MCR is carried over from the Solvency I regime, but there is now an absolute floor of:
1. €2.2m for non-life insurers, including captives, except for certain risk classes where it
should not be less than €3.2m.
2. €3.2m for life insurers, including life insurance captives.
3. €3.2m for reinsurers, except for reinsurance captives where the MCR shall not be less
than €1m.
In addition, the MCR must not fall below 25%, nor exceed 45%, of the undertaking’s
solvency capital requirement (SCR).
Solvency capital requirement (SCR)
A key feature of the regime is a solvency standard for all firms known as the SCR. This must
be calculated at least once a year, reported to the regulator and published. The firm is
expected to continuously monitor its actual capital position against the SCR and also
recalculate its SCR if the risk profile of the firm changes significantly. The SCR has to be
covered by an equivalent amount of assets in excess of liabilities, subject to specific
eligibility and valuation rules. If the SCR is not covered the firm must submit a recovery plan
to the regulator.
Chapter 1 1/10 960/December 2020 Advanced underwriting

The SCR includes provision for the following risk categories:

• Insurance risk.
• Market risk.
• Credit risk.
• Liquidity risk.
• Counterparty risk.
• Operational risk.
• Group risk (where applicable).
Options for insurers
Insurers have a range of options, varying from the standardised through to much more
tailored calculations:
• Standard formula only.
• Standard formula with undertaking specific parameters (USPs) for certain categories of
risk (namely underwriting and reserving risk).
• Partial internal model (company’s own capital model for some risk categories, combined
with the standard formula for the remaining risk categories, combined with a
diversification credit).
• Full internal model – all risk categories are quantified using the model (statistically or
otherwise).
The standard formula is a factor-based method but it is very comprehensive and much
more complex to calculate than the ECR under Solvency I. The capital charge is calculated
for each risk category and then they are combined using a correlation matrix. Operational
risk is added at the end of the calculation.
A capital model is a company’s own mathematical model (or ‘calculation kernel’, as it is
often known) of their business that can be used to generate a range of outcomes, including
the required scenario for the SCR. It usually includes elements that are stochastically
modelled, which means it statistically generates many scenarios using selected distributions
and parameters.

Be aware
There is a distinction between the terms ‘internal model’ (which can be used to calculate
the capital requirements under Solvency II) and a ‘capital model’. Capital model is a
general term for any mathematical model that calculates capital requirements. Whereas
the internal model for Solvency II specifically refers to the insurer’s own specific capital
model, together with the additional processes and governance around it. See Capital
modelling on page 1/14 for more on generic capital modelling.

On the Web
www.lloyds.com/the-market/operating-at-lloyds/solvency-ii

Syndicates operating at Lloyd’s must use a full internal model, as outputs from this are used
to parameterise Lloyd’s own internal model for the whole market. Most large UK insurers
have introduced an internal model (full or partial) and this has created a large workload on
top of the demands of ‘business as usual’. Even though most already had models for the
purpose of producing an ICA – a pre-Solvency II requirement of the PRS – these were not at
all standardised and were of varying quality.
There were previously few requirements around model governance, data quality, methods,
calibration and validation, which are now important areas of focus under Solvency II.
Companies have improved their current models or in some cases started again from scratch.
It is an opportunity to select the optimal modelling platform and structure for the business to
get the most use out of the model. Companies have also redesigned processes to be more
efficient.
However, some companies are using the standard formula, particularly smaller companies
for whom an internal model would not be realistic given the time and cost implications.
Chapter 1 Regulation and legislation affecting the underwriting function 1/11

Chapter 1
For insurers to have their internal model approved for Solvency II it must satisfy a large
number of requirements. The regulator must be satisfied that it appropriately reflects their
risk profile and is embedded in the risk management framework. This is very onerous, but is
intended to produce models that are robust, well understood and used.
Essential features of internal models
To be approved by the regulator, an internal model must:
• provide an appropriate calculation of the SCR;
• be capable of being calibrated to 99.5% in one year, i.e. a 1 in 200 probability;
• be an integrated part of the insurer’s risk management process and systems of
governance; and
• satisfy the requirements set out in Articles 120–125 of the Solvency II Directive.
Article 120 relates to the Use Test: ‘Undertakings shall demonstrate that the internal model is
widely used in and plays an important role in their system of governance’. In the level 2
requirements, there is the following foundation principle:
The undertaking’s use of the internal model shall be sufficiently material to result in
pressure to improve the quality of the internal model.
In reality, this means that the internal model should be used as much as possible in the
running of the firm. This generates ideas and requests from senior management and the
board for more development in the following areas:
• Economic and solvency capital assessment, including calculation of SCR.
• Risk management processes; for example, by regular production of specified risk metrics.
• Management decisions, such as purchase of reinsurance, business planning, investment
decisions, product pricing, ALM, mergers and acquisitions.
• Capital allocation; for example, by calculating the capital charges to individual lines of
business. This aids management understanding of the true profitability of the business,
taking into account the cost of holding capital.
To satisfy this test, management must show tangible evidence of the model’s use. This could
take the form of model output documentation discussed at meetings, including those at
board level, and minutes showing the decisions that were taken as a result. To achieve this
usually involves providing some training for management, so that they understand the key
features and limitations of the model and can interpret the output. Typically this involves the
actuaries who build, parameterise and develop the model. In addition, it means producing
meaningful management information from the model.
Companies who had already used a model were at an advantage, as management were
already aware of it. Otherwise it needed a significant investment of time to fully adopt and
show genuine use. The PRA can ask to meet with management and so will expect a level of
explanation suitable to their role.
Articles 121–125 relate to more technical standards for the model.
• Statistical quality standards.
• Calibration standards.
• Profit and loss attribution.
• Validation standards.
• Documentation standards.
While these contain lengthy and detailed requirements, it is nevertheless intended that the
model is very much ‘live’ and run as frequently as required by the business, with transparent
and easy to use outputs. Balancing these needs is a challenge for companies and involves
embedded model change control processes and governance, robust statistical design and
live documentation.
Regulators have the power to impose a capital add-on regardless of the firm’s chosen
approach. The capital add-on might be used if the risk profile deviates significantly from the
assumptions underlying the SCR, or regulators are concerned about the governance or risk
management of the firm.
Chapter 1 1/12 960/December 2020 Advanced underwriting

B2B Pillar 2 – Governance and supervision

There are four ‘building blocks’ of governance that reflect the best practices that should
already exist within firms. These must be well integrated and clearly tie various aspects of
the ongoing governance of the business to risk and capital management. These ‘building
blocks’ are:
• own risk and solvency assessment (ORSA) and capital management;
• risk management system;
• policy, processes and procedures; and
• key functions.
What is an ORSA?

ORSA
The ORSA lies at the heart of Solvency II.
Source: The European Insurance and Occupational Pensions Authority (EIOPA)
The ORSA is a road map for a forward-looking assessment of capital and solvency
position across a wide range of risks and is designed to ensure that an organisation’s
solvency needs are met at all times. Since this is the organisation’s own view of economic
capital, the ORSA report also plays an important role in rating agencies’ financial strength
evaluations.
Source: Unlocking the ORSA, Ernst & Young, 2010

The ORSA is owned by the board and is a process. Activities that form part of the ORSA
take place on a ‘business as usual’ basis throughout the year. Therefore, the ORSA is a
living document and a key driver for the business, from the board down.
Solvency II requires every firm to produce a written report (the ORSA report) to the
regulator providing an economic view of the capital needed to run its business going forward,
independent of the regulatory requirements.

Be aware
Following the UK's departure from the EU, it is important to remember that the ORSA will
need to take account of the transitional regulations to ease movement from Solvency II to
a new UK-specific framework.

The ORSA represents good business practice but perhaps its most immediate value is to
convince the regulator that the board understands the firm and the risks and challenges it
faces, and the firm has adequate capital to achieve its strategic plans.
The ORSA requires a description of the risks based on the business model, assets and
liabilities with a strategic perspective, e.g. 3–5 years (compared with the twelve-month
horizon used for the SCR). The ORSA must be written from the perspective of the firm’s
board and cannot be outsourced.
The ORSA does not have a pre-defined format but it should include the:
• overall solvency in qualitative and quantitative terms (i.e. economic capital), including
stress testing and reverse stress testing;
• possible future scenarios;
• details and analysis of the strategy, business environment and business plan;
• assumptions used for the capital calculations, which must not be inconsistent with those
used to calculate the SCR;
• outline of how the firm intends to comply with the capital requirements on a
continuous basis – both with and without the use of matching volatility adjustments and
other transitional measures; and
• summary of changes to the internal model, its use and its validation; and
• control and governance policy.
Chapter 1 Regulation and legislation affecting the underwriting function 1/13

Chapter 1
The ORSA should evaluate all material risks to the firm that may impact its ability to meet its
obligations under insurance contracts (e.g. whether it has sufficient capital to continue in
business for the current year and over the strategic plan period). This includes allowing a
firm to take account of risk mitigation, including through the use of reinsurance. The ORSA
should:
• be reviewed regularly and approved by senior management and the board;
• be based on adequate measurement and assessment processes; and
• form an integral part of the firm’s management process and decision making.
Finally, the process and outcome should be internally documented and independently
assessed by the internal and external audit functions.

ORSA guidelines
Lloyd’s has produced a useful ORSA report template for its members in Solvency II Own
Risk and Solvency Assessment (ORSA) Guidance Notes (May 2012), which may be found
on the Lloyd’s website.
The PRA, however, has implied that it does not intend to publish specific guidelines to
firms on how to write an ORSA as these might be interpreted as a standard template and
thus inhibit boards’ thinking about risk.

Figure 1.4: Factors leading to ORSA

Why an ORSA?
• Regulators didn’t see AIG’s failure coming

• Regulators in Europe, USA and several other major markets realised that
traditionally imposed solvency rules had limited effect in insurance:
– Too short termist
– Didn’t reflect to company strategy
– Didn’t address all of the major risks
– Didn’t coincide with the firm’s own view of the real risks it faced and its
capital needs
– Didn’t reflect current Enterprise Risk Management practice

• They need to understand the economic capital needed to run the company
based on the risks and medium/long term strategy

Regulators therefore decided to ask for insurers’

Own Risk and Solvency Assessment (ORSA)

Source: © Reputability LLP www.reputability.co.uk

 
Chapter 1 1/14 960/December 2020 Advanced underwriting

Figure 1.5: The European Insurance and Occupational Pensions

Authority (EIOPA) perspective on ORSA

EIOPA’s view
ORSA is ….
• Forward-looking
• A top-down process owned by the Board
• Provides a comprehensive picture of the company’s risks
• Gives the supervisor insight into the level of quality of the
management and/or supervisory body’s risk
understanding
• Connects the full risk picture with risk management
system and internal control system
• Captures risks a long time before they can be quantified
• Uses unquantifiable knowledge about risk
Risks are based on the undertaking’s business model, assets and
liability within a perspective of 3 to 5 years

Source: © Reputability LLP www.reputability.co.uk

 
On the Web
Willis Towers Watson. (2013) Regulators worldwide are embracing the ORSA: A global
trend with multiple benefits. June 2013. Available from www.willistowerswatson.com/en-
ZA/Insights/all-insights.

B3 Capital modelling
As explained, with the implementation of Solvency II, it is intended that the extensive use of
internal (PRA-approved) capital models in decision-making, more rigorous approaches to
risk management and greater transparency in reporting will better reflect the true risks faced
by insurers. These will change both external perceptions and internal insurance company
behaviours, which involves members of the board and every underwriter with an authority to
accept risks. This has led to insurers developing internal capital models.
Inevitably it has also led to third parties creating their own software models for sale to the
insurer market. There is much debate surrounding uniform models and it is recommended
that a keen eye is focused on further developments. These capital models have involved
thousands of potential scenarios being produced to reflect a range of possible outcomes for
economic and insurance risks.
Within each of these scenarios the insurer revalues its balance sheet. The solvency capital
requirement is then set as to ensure solvency in all but a ‘one-in-a-200-year’ event.

B4 Industry response to Solvency II

Refer to
The industry is currently working under transitional arrangements during the adjustment
from Solvency II to a new UK-specific framework. For more on this, see Solvency II on
page 1/8.

The initial reactions to Solvency II were mixed. Everyone could see the benefit of having a
modern, risk-based regulatory system operating across the EU but the resulting complexity,
costs and delays brought criticisms. However, some firms that had invested time and money
Chapter 1 Regulation and legislation affecting the underwriting function 1/15

Chapter 1
in setting up their systems to comply with Solvency II did foresee some competitive
advantage being gained over those who had postponed their preparations.
The ABI suggested that Solvency II would bring the following benefits:
Consumers:
• Solvency II should reduce the risk of failure or default by an insurer, with improved
identification and monitoring of risk.
• A more consistent and open regulatory framework should make it easier for companies to
sell across different markets, promoting competition.
• A more sophisticated assessment of insurers’ capital should mean insurers are no longer
required to hold excess capital, which increases costs and makes insurance and
investment contracts more expensive than they need to be.
Insurers:
• The new regime will have a much greater focus on effective governance and risk
management which become hard, tightly defined regulatory requirements for the first
time, rather than fairly loosely defined obligations.
• Market consistent valuations of assets and liabilities will improve transparency and
enable both firms and regulators to better understand the underlying financial position of
the insurer.
• Solvency II will see a much greater role for firms’ own internal risk capital assessments,
including their own internal capital model to provide a significant input to the regulators’
assessment of the firm.
• A more streamlined and proportionate regulatory regime should reduce burdens on
insurers, reducing costs and increasing flexibility.
Regulators:
• Regulators will have a better understanding of the firms they are regulating. The
information they receive will more clearly identify the key risks in the business. This will
ensure that regulators can take earlier action where risks emerge.

On the Web
Visit www.abi.org.uk and search for ‘Solvency II’

The practical effect of Solvency II on underwriting

Underwriting managers have a better understanding of the capital required to run each class
of business. Some classes are more volatile than others and, therefore, require more capital
and will need to generate more profit to achieve the required return on capital (ROC). For
example, long-tail classes such as liability are more volatile than homogeneous portfolios
such as pet insurance.
Product design and use of technology have closer scrutiny to ensure delivery of required
returns on capital employed.

C Competition
One of the FCA’s main statutory objectives is to promote effective competition in the
interests of consumers. It also has a duty to promote effective competition when addressing
its consumer protection and market integrity objectives. This duty means that the FCA is
looking to achieve its desired outcomes using solutions that promote competition regardless
of which objective it is pursuing. This involves looking at several factors, such as:
• the needs of different consumers who may use those services, including their need for
information that helps them make informed choices;
• how easy it is for consumers to access those services, including consumers in areas
affected by social or economic deprivation;
• how easy it is for consumers to switch suppliers;
• how easily new businesses can enter the market; and
• how far competition is encouraging innovation.
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The FCA uses ‘thematic reviews and market studies’ as its main tools for examining
competition (and other conduct risk issues) where it believes ineffective competition is
leading to poor outcomes for consumers. Examples of studies already carried out include the
well-publicised PPI investigation and, more recently, general insurance add-on products
have gone under the spotlight, along with delegation of underwriting authority.
As the FCA moves forward with this programme, it is essential for underwriting managers to
be alert to the focus of FCA activities to ensure that they can assess the relevance to their
own organisation. This is not only to avoid punitive intervention, but – more importantly – to
manage their underwriting strategies, products, use of technology and distribution channels
in ways that place the consumer at the heart of their business models.

Research exercise
Each year the FCA produces a Risk Outlook report, which sets out their views on the main
drivers of risks to their statutory objectives as well as signalling the types of forward-
looking areas they will focus on. Find the most recent report, which is available from the
FCA website, and see which areas are likely to have an impact on insurers and
specifically the underwriting function.

Of particular interest is the work recently undertaken by the FCA in respect of broker
remuneration. The work began in 2017 and the study is assessing:
• whether any conflicts of interest arise; and
• how broker conduct affects competition.
Extensive data was requested from both insurers and brokers. The findings were published
in February 2019 and concluded that:

Overall, we have not found evidence of significant levels of harm to competition that merit
the introduction of intrusive remedies…
We have, however, identified some areas which warrant further action, in relation to
conflicts of interest, the information firms disclose to clients and certain specific
contractual agreements between brokers and insurers. These areas can be addressed
within our usual supervisory processes. Given the dynamic nature of the market, we will
continue to monitor developments in broker business models and the effectiveness of
competition.

On the Web
The full report is available on the FCA website at https://www.fca.org.uk/publications/
market-studies/ms17-2-wholesale-insurance-broker-market-study.

The FCA works closely with the Competition and Markets Authority (CMA).

Be aware
The Financial Services (Banking Reform) Act 2013 gave the FCA ‘concurrent
competition powers’ within the financial sector, effective from April 2015. This means the
FCA is able to enforce competition law in the financial sector in the same way, and with
the same sanctions and decision-making powers, as the CMA.

C1 Competition and Markets Authority (CMA)

As part of the Government’s reforms to the arrangements for competition, consumer
protection and consumer credit regulation, the Office of Fair Trading (OFT) closed on
31 March 2014.
Responsibility for competition and consumer protection was assumed by the CMA, which
brought together the Competition Commission (CC) and certain consumer functions of the
OFT in a single body. The CMA promotes competition, within and outside the UK, for the
benefit of consumers. It works with HM Treasury and the FCA as an independent public body
to ensure that competition between companies in the UK remains fair for the benefit of
business, consumers and the economy as a whole.
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Chapter 1
The CMA has responsibilities for:
• investigating mergers that could restrict competition;
• conducting market studies and investigations in markets where there may be competition
and consumer problems;
• investigating where there may be breaches of UK or EU prohibitions against anti-
competitive agreements and abuses of dominant positions;
• bringing criminal proceedings against individuals who commit the cartel offence;
• enforcing consumer protection legislation to tackle practices and market conditions that
make it difficult for consumers to exercise choice;
• cooperating with sector regulators and encouraging them to use their competition powers;
and
• considering regulatory references and appeals.
The CMA has five strategic goals:

Delivering effective to deter wrongdoing, protect consumers and educate businesses.

enforcement

Extending competition using the markets regime to improve the way competition works, in particular
frontiers within the regulated sectors.

Refocusing consumer working with its partners to promote compliance and understanding of the law,
protection and empowering consumers to make informed choices.

Achieving professional by managing every case efficiently, transparently and fairly, and ensuring all
excellence legal, economic and financial analysis is conducted to the highest international
standards.

Developing integrated through ensuring that all staff are brought together from different professional
performance backgrounds to form effective multi-disciplinary teams and provide a trusted
competition adviser across government.

On the Web
GOV.UK guide to the CMA: https://bit.ly/2RP4V6d

C2 Competition legislation
In the UK anti-competitive behaviour is prohibited in two main ways:
• Anti-competitive agreements (for example, cartels) between businesses are prohibited
by Chapter 1 of the Competition Act 1998 (CA 98) and Article 81 of the EC Treaty.
• Abuse of a dominant position in a market is prohibited by Chapter 11 of CA 98 and
Article 82 of the EC Treaty.
C2A Competition Act 1998
What is the objective of competition law?
Effective competition between businesses delivers open, dynamic markets and drives
productivity, innovation and value for consumers. The objective of competition law is to help
businesses provide these benefits by deterring them from engaging in anti-competitive
agreements or conduct.
What is prohibited by competition law?
The Competition Act 1998 (CA 98) comprises two prohibitions:
• The Chapter 1 prohibition: agreements between businesses that prevent, restrict or
distort competition to an appreciable extent in the UK.
• The Chapter 11 prohibition: conduct amounting to an abuse of a dominant position.
Chapter 1 1/18 960/December 2020 Advanced underwriting

What are anti-competitive agreements?

Examples include, but are not limited to, the following:
Price fixing an agreement between two or more businesses in which all parties agree to sell a
certain product or service at the same price.

Limiting production an agreement between two or more businesses which has the aim of limiting
production and output so that demand can be driven up allowing prices to rise.

Carving up markets an agreement between two or more businesses in which all parties agree to share a
market, whether it be by territory, type or size of customer.

Sharing commercially the exchange of information relating to the parties’ pricing policies or elements of
sensitive information them, such as discount levels or timing of planned price increases or decreases.
with one or more
competitors

It is important to understand that the above list is not exhaustive and that agreements can be
formal or informal, verbal or written.

Example 1.1
In 2010 the OFT investigated the exchange of broker pricing information between six
insurance companies in the motor insurance sector. This investigation identified an
increased risk of price coordination among these insurers through the use of a specialist
market analysis tool. The OFT warned the firms that as each of the insurers was able to
access their competitor’s future pricing intentions, there were concerns that the software
could be used to coordinate on price, which would be a potential breach of
competition law.

Example 1.2
In the London Market during the early 1990s, it was common for Lloyd’s syndicates not to
quote on a fellow syndicate’s business. There were similar agreements in the composite
insurer market. These were verbal, implicit agreements, which would now be seen as
infringements of CA 98.

What are cartels?

In short, they are agreements between businesses not to compete with each other. They are
often verbal and, therefore, difficult to uncover.
The Chapter 11 prohibition – abuse of a prominent position
Holding a dominant position is not unlawful but it is unlawful to abuse that position. The
prohibition therefore relates to the conduct of the company, not its position in the market.
When considering a complaint it is necessary to first establish whether a business holds a
dominant position, and if it does, determine if its actions amount to abuse.
What is a dominant position?
Assessment is not based solely on the size of the company. While market share is important
(a company is unlikely to be dominant if its market share is less than 40% of the market), it
does not determine on its own whether a company is dominant.
A business is only likely to hold a dominant position if it can behave independently of the
normal constraints imposed by competitors, suppliers and consumers.
What amounts to abuse of a dominant position?
Examples include:
• charging excessively high prices;
• offering different prices or terms to similar customers; and
• refusing to supply an existing or long-standing customer without good reason.
Insurance Block Exemption Regulation
On 31 March 2017, the European Commission’s Insurance Block Exemption Regulation
no. 267/2010 (IBER) expired and was not renewed. Under IBER specific types of agreement
commonly used within the insurance industry were exempted from normal competition laws
Chapter 1 Regulation and legislation affecting the underwriting function 1/19

Chapter 1
on the basis that cooperation in these areas increased efficiency and benefited consumers.
These types of cooperation now fall under the general rules of competition law.
• Agreements in relation to joint compilations, tables and studies
The Commission considered that while certain types of exchange of information remain
essential in the insurance sector, a block exemption regulation is no longer justified since
the guidelines on the applicability of Article 101, Treaty on the Functioning of the
European Union (TFEU) to horizontal cooperation agreements, published on 14 January
2011 (the ‘Horizontal guidelines’) offer guidance for the purpose of self-assessment which
are perfectly suited for these types of cooperation.
• The coverage of certain types of risks by co-insurance and co-reinsurance pools
The Commission concluded that prolonging IBER is no longer justified either, since its
applicability to these forms of cooperation was extremely limited. Furthermore, it is no
longer possible to presume with sufficient certainty that these types of cooperation satisfy
the conditions necessary to be compatible with the Internal Market. This does not mean
that the operation of coinsurance and co-reinsurance pools is now considered anti
competitive; rather all participants must self-assess to ensure that all such arrangements
they enter into fall within the current competition law.
All insurance company employees who have any contact with competitors, whether
professionally or socially, must be advised of the seriousness of breaching competition
legislation. Any discussion or exchange of current information on pricing (or on other similar
commercially or competitively sensitive subjects) is entirely unacceptable. Strict rules
surround the exchange of insurers’ historical data via independent bodies for presentation in
aggregate form and discussion of industry trends and current affairs are also limited.
Underwriters dealing with co-insured risks must be specifically advised regarding appropriate
behaviour, in order to ensure that customers have access to the most competitive terms and
other insurers have unrestricted access to the market.
The consequences of breaching CA 98 are severe and include the entity being fined up to
10% of its group global turnover, director disqualification and the possibility of criminal
proceedings being brought.

C3 Insurance Distribution Directive

The Insurance Distribution Directive (IDD) came into force on 22 February 2016 and
Member States, including the UK, had to transpose the Directive into their own legislation by
1 July 2018 (this was delayed from the original transposition date of 23 February 2018). The
requirements have applied to firms since 1 October 2018.
The IDD is a revision and replacement of the Insurance Mediation Directive 2002/92/EC
(IMD). The IDD’s aim is to make it easier for firms to trade across borders, strengthen
policyholder protection and provide a level playing field. It sets out consumer protection
provisions in insurance and the scope of regulation is increased to include all firms that sell,
advise on, or conclude insurance contracts and those who assist in administering and
performing them, including those that shortlist as part of a selection process (such as
aggregators), or introduce insurance. However, just providing general information about
insurance products, insurers or brokers without collecting such information has been
excluded, as is providing data on potential policyholders to insurers/brokers.
The key provisions of the Directive are:
• Professionalism. All firms engaged in any of the activities covered by the Directive must
possess appropriate knowledge and ability to complete their tasks and perform their
duties adequately, such as: the insurance market; applicable laws governing insurance
distribution; claims handling; complaints handling; assessing customer needs and
business ethics standards/conflict of interest management. Staff must complete at least
15 hours of professional training or development per year.
• Commission disclosure. Pre-contractual disclosure of the intermediary and the nature,
not amount, of their remuneration (whether commission, fee or other type of
arrangement). This would be waived for contracts involving large risks or for professional
customers. The pre-contract disclosure regime will be extended to insurance
undertakings. Firms must state what type of firm they are (intermediary or insurer) and
whether they provide a personal recommendation. Firms that sell insurance on a non-
advised basis must ensure that the products they are selling fulfil the customers most
fundamental needs.
Chapter 1 1/20 960/December 2020 Advanced underwriting

• Harmonisation. The IDD is a minimum harmonisation directive, allowing Member States

to set stricter requirements (‘gold plate’) if they deem this necessary. This allows the UK
to maintain its rules for retail investment advisers under the Retail Distribution Review
(RDR), for example.
• New product governance requirements, which are largely in line with the FCA’s
product governance requirements.
• A new category of insurance settler called Ancillary Insurance Intermediaries. This
includes connected travel insurance providers that don’t sell or introduce insurance as
their main business, but still do so and therefore are subject to selling rules.
• New duties applicable to insurance companies that are selling products through
companies that are not authorised by the FCA.
• A requirement for all general insurance firms in the retail and small corporate market to
provide customers with Insurance Product Information Documents. These are similar to
the Key Features Documents, currently used by insurers.

D Legal and regulatory constraints on scope

of cover
D1 The FCA product intervention strategy
A major feature of the FCA’s approach to regulating financial markets is product
intervention. It has developed a range of tools which it uses to ensure firms develop
products that are right for their consumers, and which allow it to directly intervene where it
sees potentially harmful products.
The FCA’s approach to product governance examines a firm’s strategy for bringing products
to market. It encompasses product design itself, and how the firm establishes a target
market for the product and selects routes to market (such as which intermediaries to use). It
also looks at how firms review their products to make sure that in practice they are not
reaching the wrong customers.
Where necessary, the FCA also uses product intervention rules. These interventions include
issuing warning about:
• risky products, banning or mandating certain features;
• restricting sales or marketing to certain groups of consumers; and
• for the most extreme cases, the possibility of outright product bans.
The FCA is keen to point out that product intervention does not equate to product pre-
approval, but it is clear that providers can expect more challenges on areas such as value for
money, the design of charging structures and how sales staff are remunerated. Underwriting
managers, along with other senior managers, will clearly have to focus their thoughts in
these areas at every stage of product design and marketing.
The FCA will be particularly alert to products that:
• meet the needs of intermediaries rather than the end users, which can result in retail
customers bearing an excessive amount of risk;
• are so complex that neither customers nor intermediaries can properly understand the
risks; and
• have such large fees attached, or are so unlikely to pay out on any claim, that customers
would be better off buying almost any other product, or no product at all.

On the Web
CII Policy and Public Affairs. (2013) ‘Product intervention in financial regulation: keeping
the customer’s interests at heart’, Think Piece 100, 18 September 2013, updated April
2014. www.cii.co.uk/27492
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Chapter 1
D2 Impact of legislation
In addition to the conditions implied by law that apply to all insurance contracts, significant
legislation, case law and regulations also apply with:
• legislation enacting requirements for compulsory insurance covers; and
• legislation and case law defining policy cover interpretation.
D2A Consumer Insurance (Disclosure and Representations) Act 2012

Refer to
Think back to M80 chapter 2, section C7

A general principle of insurance is that the proposer must disclose all material facts to the
insurer. The duty of utmost good faith has applied since the Marine Insurance Act 1906
(MIA 1906); this has now been replaced by the Insurance Act 2015 (see Insurance Act
2015 on page 1/21). The duty is to disclose voluntarily, and the proposer cannot withhold a
material fact because no specific question was asked at the proposal stage. The duty of
utmost good faith applied to commercial contracts up until 12 August 2016, but the Insurance
Act 2015 replaces this with a duty to make a fair presentation of risk. The duty of utmost
good faith ceased to apply to consumer contracts with the introduction of the Consumer
Insurance (Disclosure and Representations) Act 2012 (CIDRA), effective from 6 April
2013.
Underwriters must now ask specific questions about any material facts if they are to rely on
non-disclosure as a reason to repudiate a claim and/or avoid a policy. This switches the onus
from consumers having to volunteer the required information to the insurer having to ensure
that the right questions have been asked.
Under CIDRA, insurers can no longer avoid policies for honest or reasonable
misrepresentations, which must be honoured in full. Insurers have a compensatory remedy
for ‘careless’ misrepresentations based on what it would have done if the consumer had
answered with reasonable care. Insurers can avoid the policy altogether (and retain the
premium) if the misrepresentation qualifies as ‘deliberate or reckless’. In each case the
insurer must be able to show that it would have acted differently had there been no
misrepresentation. As a result of these changes, underwriters must ensure that question
sets, policy wordings, other documentation and processes offer them and the customer the
protection intended under CIDRA. On occasion these items may not be within the insurers’
control; for example, question sets on aggregator or other external systems there may be a
consideration of making changes to the pricing of products, i.e. where the likely impact may
be an increase in claims costs or re-evaluate the product offering.
Although it is said that CIDRA simply codifies existing market practice, the new provisions
have certainly created fertile ground for consequential disputes. The Act was the first new
measure arising from the Law Commission’s ongoing review of insurance contracts and it is
likely that there could be a further shift in the balance of power in favour of insureds.
D2B Insurance Act 2015
The Insurance Act 2015 (IA 2015) is the second piece of legislation arising from the joint
review by the Law Commission and the Scottish Law Commission on insurance contract law.
It came into force on 12 August 2016 and applies to contracts placed or varied after that
date. IA 2015 reforms:
• post-contractual issues for both consumer and non-consumer insurance contracts; and
• pre-contractual obligations on commercial policyholders.
These reforms represent what the UK Government has described as ‘the biggest reform to
insurance contract law in more than a century’ and are intended to bring the market into the
twenty-first century.
Chapter 1 1/22 960/December 2020 Advanced underwriting

The key provisions of IA 2015 relate to disclosure, warranties, conditions and fraud as
follows:
• Duty of disclosure and representation: the duty of disclosure is replaced by the wider
‘duty to make a fair presentation of the risk’. The duty is satisfied if either all material
circumstances are disclosed or sufficient information is provided to put the insurer on
notice to make further enquires. The term utmost good faith is replaced by ‘good faith’.
• Remedy for failing to make a fair presentation of the risk: if a business fails to make a
fair presentation of the risk, the insurer’s remedies must be proportionate – except where
non-disclosure of information is either fraudulent or reckless – and based on what the
insurer would have done if it had received a fair presentation of the risk.
• Basis of contract clauses (warranties): basis of contract clauses are abolished for all
classes of insurance. These are clauses that incorporate all statements made in the
proposal form as warranties in to the insurance policy. Where these existed prior to the
Act, insurers could avoid a claim if they found that any information on the proposal form
was inaccurate, regardless of materiality.
• Remedy for breach of warranty: All warranties can be remediated. If a business
breaches a warranty, the insurer’s liability is suspended only for the duration of the
breach. If the breach is remedied before the loss, the insurer is required to pay the claim.
Previously a breach of warranty could result in the policy being cancelled by the insurer
ab initio.
• Remedy for breach of terms designed to reduce particular risk types: Where an
insured breaches a term of an insurance policy that is designed to reduce the risk of a
particular type of loss, the insurer cannot refuse to pay the claim if the insured can
demonstrate that the breach did not increase the risk of the loss.
• Remedy for fraud: the option to avoid the policy ‘ab initio’ has been removed. Therefore,
the insurer is still on risk for claims made before the fraudulent act occurred. The insurer
has the option to terminate the policy from the date of the fraudulent act.

On the Web
Practical guides to IA 2015 for insurers:
BIBA/Mactavish implementation guide: https://bit.ly/2DD2ZuA
IUA/LMA quick reference guide: www.lmalloyds.com/act2015
Pinsent Masons: https://bit.ly/2ov2YR6

Activity
Investigate what actions were taken to comply with the Insurance Act 2015 in the
company where you work.

D2C Enterprise Act 2016

The Enterprise Act 2016 received Royal Assent in May 2016. The Act came into force on 4
May 2017 and contains clauses that were originally part of IA 2015 but were removed to
make that Act’s passage through Parliament less controversial.
From an insurance perspective the key provision of the Act introduces a contractual
requirement on insurers to pay sums due in respect of claims within a ‘reasonable time’.
Failure to do this may result in the insurer having to pay damages to the policyholder. For
consumer claims it is not possible to contract out of this requirement. However, parties to a
non-consumer contract may contract out, subject to meeting the transparency provisions in
IA 2015.
D2D Equality Act 2010
The primary purpose of the Equality Act 2010 was to codify the array of Acts and
Regulations which formed the basis of anti-discrimination law in the UK. The Equality Act
2015 was introduced from October 2010 but some aspects did not come into effect until
2013. The Act aims to ensure that all individuals have equal access to employment as well
as private and public services regardless of the protected characteristics: age, disability,
Chapter 1 Regulation and legislation affecting the underwriting function 1/23

Chapter 1
gender reassignment, pregnancy and maternity, marriage and civil partnership, race, religion
or belief, sex, and sexual orientation.
EU Gender Directive
Following a ruling made by the Court of Justice of the European Union (CJEU), insurers can
no longer use gender as a means of determining the premiums for all types of insurance.
This rule came into effect on 21 December 2012 and the terms were detailed in the Equality
Act 2010 (Amendment) Regulations 2012.
Prior to the Directive, motor insurance for females generally cost less than for their male
counterparts (especially for younger drivers). This is because, statistically, they are safer
behind the wheel – that is, they produce less claims costs. Government estimates at the time
of implementation suggested that females aged between 17 and 25 would pay between 15%
and 25% more for motor insurance once the Directive was in force. The implication for motor
insurers was that rating models needed to be changed in order to comply with the Directive.
Some insurers, for example those who specialised in providing policies for female drivers
only, had to rethink their underwriting strategy.
D2E Consumer Rights Act 2015
The Consumer Rights Act 2015 is a major piece of legislative reform that applies to
consumer insurance contracts. The majority of its provisions came into force on 1 October
2015. While many of the measures reflect much of the FCA best practice in terms of policy
wording and treating customers fairly, insurers should be aware of the following changes.
• The introduction of new rules to ensure that digital content is fit for purpose, e.g. the use
of apps and downloads.
• New laws for ancillary contracts, for example when travel insurance is sold alongside the
purchase of a holiday.
• Changes to consumer cancellation rights.
• The requirement to make all potentially onerous core terms ‘prominent’.
Underwriting managers should review their product and distribution strategies in the light of
these changes.

D3 Data protection
Data protection has been the subject of recent legislation to reflect increasing use of
technology in the way data is used and stored. The purpose of the legislation is to protect an
individual’s rights in the way their data is stored and used.
D3A General Data Protection Regulation (GDPR)
Who does the GDPR apply to? The GDPR applies to ‘controllers’ and ‘processors’. The
definitions are broadly the same as under the now superseded Data Protection Act 1998
(DPA 1998) – i.e. the controller says how and why personal data is processed and the
processor acts on the controller’s behalf.
The GDPR places specific legal obligations on processors; for example, firms are required to
maintain records of personal data and processing activities. A firm will have significantly
more legal liability if it is responsible for a breach. These obligations for processors are a
new requirement under the GDPR.
Controllers are not relieved of their obligations where a processor is involved – the GDPR
places further obligations on controllers to ensure their contracts with processors comply
with the GDPR.
What information does the GDPR apply to? The GDPR applies to personal data.
However, the GDPR’s definition is more detailed, reflecting changes in technology and in the
way in which information is collected. It makes it clear that information such as an online
identifier – e.g. an IP address – can be personal data.
The GDPR applies to both automated personal data and to manual filing systems where
personal data is accessible according to specific criteria. This is wider than the DPA 1998’s
definition and could include chronologically ordered sets of manual records containing
personal data. Personal data that has been anonymised – e.g. key-coded – can fall within
the scope of the GDPR depending on how difficult it is to attribute the pseudonym to a
particular individual.
Chapter 1 1/24 960/December 2020 Advanced underwriting

Sensitive personal data: The GDPR refers to sensitive personal data as ‘special categories
of personal data’. These categories include:
• race;
• ethnic origin;
• politics;
• religion;
• trade union membership;
• genetics;
• biometrics (where used for ID purposes);
• health;
• sex life; or
• sexual orientation.
Principles: Under the GDPR, the data protection principles set out the main responsibilities
for organisations. They are similar to those in the DPA 1998 with added detail. The most
significant addition is an accountability principle: the GDPR requires firms to show how they
comply with the principles – for example by documenting the decisions they take about a
processing activity.

Data Protection Principles

All personal data should be:
1. processed lawfully, fairly and in a transparent manner in relation to individuals;
2. collected for specified, explicit and legitimate purposes and not further processed in a
manner that is incompatible with those purposes;
3. adequate, relevant and limited to what is necessary in relation to the purposes for
which they are processed;
4. accurate and, where necessary, kept up-to-date;
5. kept in a form which permits identification of data subjects for no longer than is
necessary for the purposes for which the personal data is processed; and
6. processed in a manner that ensures appropriate security of the personal data,
including protection against unauthorised or unlawful processing and against
accidental loss, destruction or damage, using appropriate technical or organisational
measures.

Lawful processing: For processing to be lawful under the GDPR, firms need to identify a
lawful basis before they can process personal data and document it. This is significant
because this lawful basis has an effect on an individual’s rights: where a firm relies on
someone’s consent, the individual generally has stronger rights, for example to have their
data deleted.
Consent: Consent under the GDPR must be a freely given, specific, informed and
unambiguous indication of the individual’s wishes. There must be some form of positive opt-
in – consent cannot be inferred from silence, pre-ticked boxes or inactivity, and firms need to
make it simple for people to withdraw consent. Consent must also be separate from other
terms and conditions and be verifiable.
Firms can rely on other lawful bases apart from consent – for example, where processing is
necessary for the purposes of an organisation’s or a third party’s legitimate interests. They
are not required to automatically refresh all existing DPA consents in preparation for the
GDPR, but if a firm relies on individuals’ consent to process their data, it must make sure it
will meet the GDPR standard. If not, firms must either alter the consent mechanisms and
seek fresh GDPR-compliant consent or find an alternative to consent.
Chapter 1 Regulation and legislation affecting the underwriting function 1/25

Chapter 1
Rights: The GDPR creates some new rights for individuals and strengthens some of those
that existed under the DPA. These are:
• The right to be informed.
• The right of access.
• The right to rectification.
• The right to erasure.
• The right to restrict processing.
• The right to data portability.
• The right to object.
• Rights in relation to automated decision making and profiling.
Accountability and governance: Accountability and transparency are more significant
under the GDPR. Firms are expected to put into place comprehensive but proportionate
governance measures. Good practice tools such as privacy impact assessments and privacy
by design are now legally required in certain circumstances. Practically, this is likely to mean
more policies and procedures for organisations, although many will already have good
governance measures in place.
Breach notification: The GDPR introduces a duty on all organisations to report certain
types of data breach to the relevant supervisory authority, and in some cases to the
individuals affected.
Transfers of personal data to third countries or international organisations: The GDPR
imposes restrictions on the transfer of personal data outside the European Union, to third
countries or international organisations, in order to ensure that the level of protection of
individuals afforded by the GDPR is not undermined.
D3B Data Protection Act 2018
The Data Protection Act 2018 (DPA 2018) came into effect in May 2018, to coincide with
the implementation of the General Data Protection Regulation (GDPR) and the Law
Enforcement Directive (LED). It aims to modernise data protection laws to ensure they are
effective in the years to come.
Although the GDPR has direct effect across all EU Member States and organisations have to
comply with it, it does allow Member States limited opportunities to make provisions for how
it applies in their country. In the UK these have been included as part of the DPA 2018. It is
therefore important the GDPR and the DPA 2018 are read side by side.
The main elements of the DPA 2018 include the following:
General data processing
• Implement GDPR standards across all general data processing.
• Provide clarity on the definitions used in the GDPR in the UK context.
• Ensure that sensitive health, social care and education data can continue to be
processed to ensure continued confidentiality in health and safeguarding situations can
be maintained.
• Provide appropriate restrictions to rights to access and delete data to allow certain
processing currently undertaken to continue where there is a strong public policy
justification, including for national security purposes.
• Set the age from which parental consent is not needed to process data online at age 13,
supported by a new age-appropriate design code enforced by the Information
Commissioner.
Regulation and enforcement
• Enact additional powers for the Information Commissioner who will continue to regulate
and enforce data protection laws.
• Allow the Commissioner to levy higher administrative fines on data controllers and
processors for the most serious data breaches; being up to £17m (€20m) or 4% of global
turnover.
• Empower the Commissioner to bring criminal proceedings for offences where a data
controller or processor alters records with intent to prevent disclosure following a subject
access request.
Chapter 1 1/26 960/December 2020 Advanced underwriting

Conclusion
The main ideas covered by this chapter can be summarised as follows:
• The Threshold Conditions are the minimum requirement that firms must meet in order to
be permitted to carry out regulated activities.
• It is the responsibility of the PRA to assess insurers from a prudential perspective and
determine whether they will meet the Threshold Conditions. The FCA will assess
applicants from a conduct perspective.
• Solvency II is the EU Directive covering the capital requirements and related supervision
for insurers.
• The Solvency II requirements are structured into three ‘pillars’: capital requirements,
systems of governance, and supervisory reporting and public disclosure.
• Solvency II implementation with its extensive use of capital models in decision-making,
more rigorous approaches to risk management and greater transparency in reporting,
means that the true risks faced by insurers are better understood and addressed.
• The FCA uses thematic reviews and market studies as its main tools for examining
competition and other conduct issues where it believes ineffective competition is leading
to poor outcomes for consumers. The FCA works closely with the CMA.
• In the UK, two main types of anti-competitive behaviour are prohibited: anti-competitive
agreements and abuse of a dominant position.
• The Insurance Act 2015 has introduced major changes to the obligations of insurers and
policyholders. It has been described as ‘the biggest reform to insurance contract law in
more than a century’.
• In addition to the conditions implied by law that apply to all insurance contracts,
significant legislation, case law and regulations also apply with:
– legislation enacting requirements for compulsory insurance covers, and
– legislation and case law defining policy cover interpretation.
• Data protection has been the subject of recent legislation to reflect increasing use of
technology in the way data is used and stored. The purpose of the legislation is to protect
an individual’s rights in the way their data is stored and used.

Additional reading
Baker, B. (2013) Recent development in Solvency II, 29 April 2013. CII Fact File.
Collins, S. (2012) The regulatory framework, 6 August 2012. CII Fact File.
Davies, H. and Green, D. (2008) Global financial regulation: the essential guide.
Cambridge: Polity.
Doff, R. (2015) Risk management for insurers: risk control, economic capital and
Solvency II (3rd edition). London: Risk Books.
The Insurance Act: Bringing Commercial Insurance into the Twenty-First Century,
21 April 2015. CII Policy briefing. www.cii.co.uk/media/6087127/
cii_policy_briefing_insurance_act_2015_21apr2015.pdf.
 Chapter 1 Regulation and legislation affecting the underwriting function 1/27

Chapter 1
Self-test questions
1. What are the three statutory objectives of the PRA?

2. What are the essential components of the ORSA policy?

3. Name the three pillars of Solvency II.

4. What are the CMA's five strategic goals?

5. What are cartels?

6. What are the main changes introduced by the Insurance Act 2015?
You will find the answers at the back of the book
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 2

Chapter 2
Start-up scenario
Contents Syllabus learning
outcomes
Introduction
A Business plan 5.1
B An underwriting perspective 1.2, 2.5, 2.8
C Investors 1.2
D Financial projections 1.2
E Risk management 2.8, 4.3
F Reinsurers 2.1, 4.3
G Risk appetite 2.8
H Go-live 2.1
I Start-ups versus established insurers 2.5
Conclusion
Self-test questions

Learning objectives
This chapter relates to syllabus sections 1, 2, 4 and 5.
On completion of this chapter and private research, you should be able to:
• identify an underwriting director’s key responsibilities and relationships; and
• identify the source of underwriting authority within a general insurance company and
explain how the extent of that authority is determined.
 2/2 960/December 2020 Advanced underwriting

Introduction
Chapter 2

Throughout most of this unit, the context is that of an established general insurance
company. In this chapter the issues of underwriting authority and strategy, as well as key
responsibilities and relationships, are introduced in a context uncomplicated by decades of
corporate history and culture, namely, that of a business start-up.
This provides a common starting point for the discussion of the unit's syllabus topics in the
context of an industry based on a very wide range of existing (and changing) business
models. The start-up scenario also places emphasis on the source of an insurer's
underwriting authority; an emphasis which is not only appropriate but necessary, following
the implementation of Solvency II.

Many insurance professionals would be attracted, almost instinctively, to the thought of

working in a new, start-up insurance company. Their motivation might spring from a range of
desires: to introduce a new product; to achieve better results by avoiding the perceived
errors of existing companies; to exploit new technology or distribution channels; to utilise
specialist knowledge to provide a more tailored service or to take advantage of a particular
stage of the underwriting cycle. These are only a few of the possible reasons why a group of
senior professionals might agree to develop a business plan and seek support from investors
to establish a new insurance company.

Consider this…
Think of other possible reasons why an insurance professional would want to be part of a
start-up insurance company or department.

Fundamental to all such initiatives is the identification of the means by which the proposed
business will produce/source, sell and service a product valued by its intended target market.
The aim would be to generate sufficient profit to gain the support of investors and the
regulators’ authorisation to commence business. In other words, what’s the plan?

Key terms
This chapter features explanations of the following terms and concepts:

Authority Complaints Regulatory Reinsurance

procedure requirements
Risk appetite Statement of risk Target operating Underwriting audit
appetite model (TOM)

A Business plan
A great deal of research and other development work may already have gone into the
formulation of the business idea and plan; a core team may have already been formed and
potential investors identified. A basic plan with key set-up costs and a draft revenue account
may have been drawn up to help form an outline business case. Even if these documents
are in a very rudimentary state, they will already include key assumptions (possibly implicitly)
about the business – notably its target customers, products, method of operation, assumed
growth prospects, capital required and profitability – that are critical to the evaluation of the
proposed business from an underwriting perspective. There will also have been
consideration of the target operating model (TOM) that the business will use, and how
underwriting and portfolio management will be part of that.
An operating model provides a high-level view of how processes, people and systems
interact to support the business. A target operating model describes how those processes,
people and systems could be arranged to achieve optimum efficiency for the future business
and identifies where to prioritise change activity to achieve the greatest benefits.
Chapter 2 Start-up scenario 2/3

On the Web
KPMG. (2016) Empowered for the future: Insurance Reinvented, KPMG International.

Chapter 2
https://assets.kpmg/content/dam/kpmg/pdf/2016/06/empower-for-the-future-insurance-
reinvented.pdf

This is not the appropriate place to discuss the evaluation of business ideas and general
methods of business planning. As an experienced professional you will undoubtedly have
views about the desirability and viability of many aspects of the proposition but your focus
will be on those aspects which have a direct bearing on underwriting.
In this instance, let us assume that you are considering the opportunity to act as the
underwriting director in the start-up team.

Consider this…
What information is needed to convince you that the business proposition is sound and
that it can deliver a sustainable underwriting result?

B An underwriting perspective
As prospective underwriting director, here are some of the questions you might ask the
originators of the business proposition – or reflect on after the initial discussion.

Products • What are the intended insurance product(s) and any associated services?
• Is this a well-established existing product, a standard product with some novel
features or a radically different product? Are the risks that the product addresses
well-known or emerging?
• Are any aspects of the product and its associated services to be provided by third
parties? What are their costs and requirements?
• Is there a draft prospectus (providing information on maximum sums insured,
limits of indemnity, benefits and standard excesses) and a policy wording?
• How do these fit with the current risk appetite?

Target customers • What are their characteristics and requirements? What has been done to validate
assumptions about customer requirements?
• How well can target customers be identified and enumerated?
• How and from whom do they currently purchase insurance? What will persuade
them to change insurer?
• What do you know about their claims experience? High frequency/predictable
average cost or low frequency/unpredictable average cost?
• What level of premiums do you expect to be able to charge? Without historical
data, how will the company know what to charge?

The competition • Has a ‘gap’ in the market been identified or is it an area with lots of competition?
What’s happening to current pricing levels?
• How will the new company differentiate its offering? How easily can this
differentiation be copied?

Environment and timing • The business proposition does not exist in a vacuum: external issues will affect its
viability/attractiveness at different times. Is the timing right – the economy,
expected rate of return on investment, stage of the underwriting cycle?

Delivery and service • What type of service do the target customers require? Highly impersonal/
automated or highly bespoke/expert?
• Will sales be direct or intermediated (agent, broker, affinity group, other)?
• Will the underwriting be delegated to a coverholder? What is their expertise?
• Type of advertising: specific or brand awareness; which media?
• Serviced through a branch network, call centres, internet or mix?
• Technology support to staff: automated, highly functional or basic with a high
degree of manual intervention?
 2/4 960/December 2020 Advanced underwriting

Projections • What are the sales projections for the first three to five years? Beyond that, what
are the new company’s medium- to long-term objectives?
• Are there ways in which a critical mass may be achieved more quickly (for
Chapter 2

example, targeting affinity schemes or through acquisition of existing businesses)?

• Will the type of business written in the first few years be representative of the
‘mature’ business or will the early business be skewed in some way?
• How quickly will the business break even and then produce a profit?

People • How credible are the senior members of the team and what relevant qualifications
do they hold? Will they be considered acceptable by the regulators?
• Does their explanation of the business proposition make sense?
• Do they appear to place an appropriate emphasis on the role of underwriting?
• How confident are you that your professional advice, as underwriting director, will
be valued?
• What are the values of the business in terms of ethics and treating customers
fairly?
• How will capability be developed? For example, through setting up an underwriting
and pricing academy to advance learning and development.

Regulation • Are there any regulatory or legislative issues affecting the writing of the business?
• Is regulation in this area of business likely to become more stringent in the future?
• Are there any opportunities which a new entrant would benefit from?

Capital • How much capital is required?

• Who are the investors and how secure are they?
• What is the planned return on capital?
• How is the return on capital factored into the premium?

It is highly likely that the underwriting director, once appointed, would be responsible for
formulating answers to many of these questions and/or developing more detailed answers.
The evaluation of the proposition from an underwriting point of view is not simply about your
decision whether or not to accept the role: many others will also evaluate the proposition
from an underwriting perspective and will ask the same or similar questions. Potential
investors (which may include existing insurance companies) will seek the advice of
underwriters. If the new business is a managing general agency (MGA), potential carriers will
be advised by underwriters, as will reinsurers and the Financial Conduct Authority, when
they become involved.

Refer to
Refer to chapter 3 for more on MGAs

Remember that, as underwriting director, you will be responsible for forecasting

performance, determining pricing and underwriting guidelines, formulating reinsurance
strategy, recruiting and supporting underwriters and – along with other members of the
management team – achieving the financial plan. What other questions would you ask?
Chapter 2 Start-up scenario 2/5

Does the proposition stack-up What standards are you using

from an underwriting to make your decision?
perspective?

Chapter 2
Are the key elements of the Will the target customers
proposition well-aligned? What do be attracted to the product
you think? and the proposed means of
delivery?

And can the cost of this Does the proposition involve a

delivery method be well-established, relatively
accommodated within the predictable type of insurance
proposed premium/ pricing risk or is the insurance risk a
levels? source of significant
uncertainty?

The underwriting director is a key member of any start-up team: focusing on all of the issues
affecting underwriting but also heavily engaged in supporting other members of the team as
they develop and refine the overall proposition. They will be highly influential in discussion
with other stakeholders (particularly reinsurers and potential underwriting staff).

C Investors
The start-up team is preparing to make formal presentations to different groups of potential
investors. As well as ensuring that the business proposition can be articulated clearly and
that the financial projections are credible, the team has to think about the different
capabilities and preferences of the potential investors.
As well as providing start-up and ongoing capital investment, some of the investors may be
able to offer technical assistance (from the experience of other companies already owned by
them) which could prove invaluable, particularly in the early days of the new company. In
order to balance their own portfolios, some investors may favour certain classes of insurance
business over others (for example, long- or short-tail) and a particular combination of
investors may be required to provide the specific backing the new company needs. The
start-up team might have to think again and reformulate their proposition in order to achieve
a viable balance between the proposed business and willing investors.

Figure 2.1: The business proposition

Proposition Investors

Reformulate Capabilities

Preferences
 2/6 960/December 2020 Advanced underwriting

D Financial projections
Although actuarial and finance colleagues (on the team or acting as professional advisers)
will be primarily responsible for creating the financial plans, determining capital requirements
Chapter 2

and considering issues around cash flow and investment returns, they need the underwriting
director’s input. As underwriting director, you have to check that the exposure and premium
income projections and the assumed split in the income for different classes of business are
credible and fit with everything else you know about the proposition.

Be aware
Inevitably you will be using many assumptions as you assess the projections: it is
essential that you record your assumptions, their source and your rationale.

Similarly, as the projected loss ratios are critical to the viability of the proposition, your careful
consideration and validation are required when populating the plan. You will need to consider
how the loss ratios are broken down between attritional, large and catastrophe losses. Is the
split that which you'd expect? Bear in mind that a new business stream cannot rely on
possible, historical releases on outstanding claims to ‘smooth’ the first-year loss ratio.

D1 Assessing costs
After claims costs, the largest business costs generally relate to staff, reinsurance and ICT.
You will be directly involved in agreeing those costs relating to the service that underwriters
will provide and the governance of that service. The type of service required (potentially
servicing intermediaries as well as target customers) and the agreed delivery mechanisms
will dictate how the service is to be established (levels of expertise, location and type of
systems-support) and the appropriate type of control mechanisms (for example, automated
monitoring and/or auditing of individual underwriting files).
The type of product(s) and the characteristics of the customers will also influence other
costs, such as those associated with risk control. Your claims colleagues will ask you to
predict the number, cost and type of claims which will be received during the first year and
thereafter, to enable them to estimate the appropriate number and type of claims handlers
required, and to cost and establish appropriate loss adjusting and solicitors’ contracts. In
addition to assessing these costs, you will need to review the expense base and allocation of
expenses by line of business and understand the commission mix. The commission will
include any profit commissions payable, based on the performance of the business.

D2 Capital requirements
All of this information, and much besides, needs to be fed into the projections that will
indicate how much capital the start-up business needs to secure from investors:
• what the new company needs to spend before it even starts to trade;
• what it will cost to trade for the first few years before a profit can be generated; plus
• that level of additional capital, specified by the Prudential Regulation Authority (PRA) and
if appropriate Llloyd's Corporation, required to ensure the insurer’s solvency.
As you will know from your previous studies and chapter 1, the PRA requires all UK insurers
to take an increasingly sophisticated approach to assessing their own solvency
requirements. Although not simply the result of the application of a standard formula, in
broad terms the capital requirement is based on premium income projections, adjusted for all
the perceived risks associated with running a business, including how the risks interact. The
capital requirement may also be adjusted to reflect the amount and type of reinsurance
purchased (see Reinsurers on page 2/8).
A critical assumption made by the start-up team is that the required amount of capital can be
raised at a cost (the required annual return on the investment) the proposed business can
support and that investors will continue to support the business with their capital through its
early, unprofitable years. Securing the correct amount of capital is important: too little capital
will constrain growth and could undermine the new company’s position in the market; too
much capital will increase the amount of profit required in order to provide the necessary
return to investors and could make the company’s products uncompetitive. Bearing in mind
Chapter 2 Start-up scenario 2/7

the significant level of expenditure required to establish a general insurance business, any
new venture is unlikely to achieve break even in less than two or three years.

Chapter 2
Consider this…
How soon will the level of profit achieved provide adequate overall recompense for the
investors’ faith in the new business?

Clearly the more novel or innovative the business plan, the more difficult it may be to provide
acceptable projections (due to lack of precedents/experience) and thus to gain support.
Investors may demand a higher return for what they perceive to be a riskier investment.
While the issues around the financial projections and the required capital investment can be
complex, it is clear that the accuracy of the underwriting assumptions (exposures, level of
income, mix of business, claims ratios) and the actual achievement of the plan are
fundamental to the ability of the business to gain and maintain investor support. Underwriters
in established businesses can fail to appreciate that their authority is underpinned and
therefore constrained by assumptions and requirements relating to the business’s continued
access to capital. By contrast, the requirement to match actual results to planned exposure,
income, business mix and underwriting result will never be far from the consciousness of
underwriters in a start-up company.

E Risk management
In any sector, investors in a new business will want to be assured of the start-up team’s
grasp of the risks around the venture. In an uncertain business such as general insurance,
potential investors (as well as reinsurers and regulators) will require specific information
about the start-up team’s assessment of risk and how consideration of risk and its
management has been built into the business plan and the financial projections.

Consider this…
From an underwriting perspective, what risks might apply to a new business? And, if you
are responsible for monitoring these risks, what might be suitable courses of action?

Common risk examples:

• Claims projections prove inaccurate.
• Adverse economic conditions occur.
• Court judgments impact typical level of claims settlements in respect of bodily injury.
• Poor-quality business is written.
• Management information is corrupted.
• Business flows from delegated authority brokers prove intermittent.
• Recruitment targets for underwriters are not achieved.
• The business experiences exceptional weather-related losses in the first year.
• Rates rise more steeply than expected: capital inadequate to write available, targeted
exposures.
• Rates decrease more steeply than expected and volumes or margins cannot be
achieved.
• Pricing models are based on incorrect assumption: for example, rates of inflation.
• Inability to change ICT systems in a timely manner.
If they occur, these risks might prove to have limited applicability or impact. Alternatively,
they might significantly undermine the performance of the business in its first year and
thereafter. None of the risks mentioned are far-fetched and investors would expect these and
many other risks to be monitored, evaluated and managed on an ongoing basis.
Some risks, once identified, can be avoided altogether and others may be accepted as
inherent to the particular business. Generally, however, management teams are expected to
lessen, control and/or transfer risks in accordance with the stated risk appetite of the
individual business.
 2/8 960/December 2020 Advanced underwriting

As insurance is itself a risk transfer mechanism, it is not surprising that insurance companies
utilise reinsurance as a key means of transferring and controlling certain risks. Reinsurance
is especially vital to the operation of small and/or young insurance businesses where a run of
Chapter 2

large claims over a short period of time or higher than anticipated total claims costs could
undermine the business. As previously mentioned, the purchase of reinsurance can reduce
the amount of capital required so, while potential investors consider the business
proposition, the start-up team has to turn their minds to the topic of reinsurance purchase.

F Reinsurers
How much reinsurance should the new business purchase? How much risk will reinsurers be
willing to accept in return for a reasonable premium?

Consider this…
The purchase of reinsurance can reduce the capital requirement for solvency but at what
price does the cost of increased levels of reinsurance outweigh the cost of additional
capital?

Figure 2.2: Retention levels: reaching agreement

A new business would probably want to purchase

excess of loss reinsurance with as low a retention
as possible in order to smooth out the impact of
any large losses on the fledgling account.

Reinsurers will not wish to sell their covers with too

low a retention: they do not want to be involved in
too many claims (increasing their claims handling
expenses); they will look to establish a level of
retention which ensures the reinsured continues to
have a proper interest in maintaining good
standards of risk acceptance – ‘skin in the game’.

In respect of any excess of loss reinsurance, the lower the retention, the higher the cost will
be to the reinsured (insurer). Similar considerations would apply to proportional and other
forms of reinsurance protection.
A new start-up may decide to partner with a reinsurer on a proportional basis to smooth
potential losses and utilise the expertise of the reinsurer.

F1 Limits – how high?

What limits of liability and total sums insured per risk fit the business proposition? It may
impress brokers if underwriters can offer high limits but is the feel-good factor worth the extra
cost? What do the target customers typically require? Does the business want to cater for
the 5% of customers who need unusually high limits? Would the cost of the higher limits be
spread across all policyholders? How would that affect the competitiveness of the company’s
pricing? How are you going to control the use of higher limits (the reinsurers will definitely
want to know) and are the underwriters qualified to handle these limits? Will they see enough
cases with higher limits to develop/maintain their personal competence?
Together with acknowledging these questions, full consideration will need to be taken of the
market requirements for limits under the policies. During the development of the strategy, the
insurer will need to consider whether to target a particular niche, such as younger drivers, or
to be a balanced provider of insurance products. This understanding of the target market will
need to be clear to reinsurers so that they can price their covers.
Chapter 2 Start-up scenario 2/9

Be aware
The reinsurers will want to steer a start-up insurer away from what they regard as higher-
hazard or low-priced areas of the market and agreeing the treaty exclusions will involve

Chapter 2
extensive negotiation.

The purchase of catastrophe reinsurance also needs careful consideration and significant
input is required from the company’s actuaries and the reinsurance brokers’ catastrophe
modellers. The development of an insurer’s reinsurance programme will be discussed in
chapter 8.

F2 Board approval
As reinsurance purchase is a critical area, which involves a great deal of money and is
fundamental to the survival of the business, decisions will be authorised at board level.
Finance, actuarial and underwriting will work together on recommendations for the board’s
approval and, as underwriting manager, you can expect to have many meetings with your
company’s reinsurance brokers and with many prospective reinsurers who may wish to
accept a share of one or more of the proposed reinsurance treaties.
As with any prospective reinsured, you want to paint a positive picture of the risk the start-up
company wishes to pass to the reinsurers by describing how you and your colleagues will
select and handle risks with expertise and discernment, the controls that are in place and
why, in return, this business deserves to attract the confidence of the reinsurers: this
confidence reflected in their willingness to offer broad covers, few exclusions, high limits and
low prices!

F3 What will the reinsurers want to know?

The reinsurers need to understand the business proposition thoroughly: the details and the
big picture. As underwriting director, you will typically have very regular contact with the
reinsurers and will therefore need to demonstrate a broad understanding of the business
proposition: your professional expertise needs to extend beyond the technicalities of
underwriting to the whole insurance business. The reinsurers will also want to understand
your own capabilities and level of understanding, as they will be particularly interested in the
underwriting standards and controls which will be established under your direction.
Typical reinsurer questions:

Strategy • How would you describe the company’s underwriting strategy?

• Do you plan to delegate underwriting authority?
• How do you see your product/service offering in comparison with those of your competitors?

Plans • Describe the typical risks the company intends to write and provide a profile of the business
you plan to accept in the first year (for example, by property sum insured or limit of liability).
• What is your estimated premium income for each of the four quarters of the year?
• What is the seasonality of the business and its claims?
• What do you think about the current level of pricing in the market (for the business you plan to
write)?
• What is your target loss ratio? What allowance have you made for large claims, bad
weather…?
• What is your survey strategy?
• What is your flood strategy?
• What risks will you not accept?
• What lines of business will you not write or accommodate for a particular customer or
distribution partner?
• Will you accept exposures outside the UK? In which areas/territories?
• What will be the maximum and average exposures (MD & BI)?
• What is your definition of a risk?
• Will your company become a member of Pool Re?
• How will you establish your technical rates?
• What discounts are you planning to use?
• Are your policy wordings finalised and may we see them?
 2/10 960/December 2020 Advanced underwriting

Control • Who will write the underwriting guide? May we see it?
• What authority limits do you, personally, have and how do you plan to control risk
acceptance?
Chapter 2

• What proportion of risks do you expect to be referred to you?

• How are you proposing to select (recruit) underwriters and measure their competence?
• Who will manage claims?
• What MI do you have access to or is planned?
• What support/constraints does the system provide to underwriters?
• Can individual underwriters amend policy wordings?
• Who can sign-off endorsements?
• How will you monitor exposures?
• How do you plan to measure aggregations?

This is, of course, not a comprehensive list.

F4 Building sustainable relationships

Although the reinsurance treaties finalised and subscribed at the end of this process of
discussion and negotiation are typically lengthy, detailed and contract certain, they should
not be regarded as the only end-product of the process, as all of the information provided
and discussed is valued and relied upon by the reinsurers. The quality of the information
provided will influence the relationship between reinsurers and new reinsured, as well as the
cost of the reinsurance cover.
Just as with potential investors, the start-up company’s objective is to secure the long-term
support of those reinsurers whose appetite for risk easily encompasses that of the new start-
up and whose terms, prices and credit ratings are most acceptable. It is important to
establish the relationship on a sound footing by providing as much quality information as
possible, being open with regard to any problems you face and paying attention to the
reinsurers’ requirements and preferences.
When the new business matures and requires higher limits or different forms of reinsurance
in order to pursue further profitable growth, the company will want to have its choice of the
most advantageous reinsurance partners: building a good reputation and securing
reinsurers’ interest and commitment begins at start-up.

G Risk appetite
By this stage, the senior members of the start-up team – board members of the new
company – have reached agreement with the investors regarding the funding of the business
(the capital requirements, required rates of return and reinsurance purchase), its financial
and business objectives and its approach: in other words, the corporate strategy.

The board is responsible for determining the nature and extent of the risks it is willing to
take in achieving its strategic objectives.
(UK Corporate Governance Code)

Key aspects of this agreement will be recorded in a statement of risk appetite, signed by
the board. From an underwriting perspective, this statement summarises:
• the risks which are or are not acceptable;
• maximum limits for individual risks and aggregate limits of exposure;
• maximum income limits; and
• maximum net retentions.
The statement of risk appetite will become, once the company is authorised to commence
business, the basis of your own underwriting authority as underwriting director.
Chapter 2 Start-up scenario 2/11

Be aware
As a commercially sensitive document, you may not be able to distribute copies of the
statement of risk appetite to the underwriters within your control. However, you must

Chapter 2
ensure that the underwriting strategy, all guidance to staff, levels of authority, licences and
delegated authorities fit within the scope of the risk appetite statement.

H Go-live
By focusing on the interaction of the new company with its investors, reinsurers and
regulators, the impression may have been given that starting-up a general insurance
company primarily involves financial calculations, documentation of plans and meetings. It
does involve those activities but that’s not what it will look like to most of the people (staff
and professional advisers) involved. Most people will be working hard to recruit and train
other staff, furnish premises and install ICT, introduce accounting systems, and a mass of
other necessary tasks. Establishing a general insurance company requires a huge,
collaborative effort.
You also need to be aware of how your competitors view a new player forcing its way into the
market. They may feel threatened and resentful and could try to make business life difficult.
It is therefore important to stay focused on the business objectives.

Be aware
The necessary authority to conduct any of these tasks stems from the documented
agreements described above: between the board of the new company and its investors,
reinsurers and regulators. Each person with authority within the new company must be
guided by corporate strategy including the statement of risk appetite which summarises
the key features relating to risk acceptance and management (not only insurance risk).

Of prime importance to everyone involved in the management of underwriting will be the

establishment of the underwriting strategy, along with underwriting guidance and
governance, as well as matters relating to products, pricing, financial plans/budgets, systems
and management information (MI).

H1 Underwriting strategy
The underwriting, product, distribution and marketing strategies of the new company must
support one another as closely as possible. If the distribution strategy focuses on groups of
brokers with little or no interest in the defined target customers, or if the product strategy
requires limits which the reinsurers are unwilling to provide, it is clear that the new company
will probably fail to achieve its objectives.
The underwriting strategy has to inform both underwriting and sales staff about the core
business the company is seeking to write and what limits apply. It should explain the agreed
approach towards both individual risks and features of the overall account. For example, the
capital funding of the business may only support a particular mix of business: possibly
general liability may not exceed a certain proportion of total premium income. Consistent
communication of the underwriting strategy to all concerned – with the necessary
explanations – is a particularly vital task when staff from other companies are being recruited
and brought into the company. When asked the question ‘What kind of business does
your company want to write?’, all underwriting and sales staff should be able to articulate
a consistent, accurate answer.

Be aware
It will need to be clear to underwriting staff why the risk strategy has been set to target a
particular market. Only through discussion and appropriate explanation will it become
apparent to the new underwriters that the company has carefully balanced the cost of
capital and reinsurance with the new business’s capability to attract targeted risks at the
price necessary to produce sufficient profit in the required time frame, and that the result
of this complex set of considerations is summarised in the underwriting strategy.
Underwriters and sales staff need to understand this background if they are to promote
their new company and its underwriting strategy with confidence.
 2/12 960/December 2020 Advanced underwriting

H2 Underwriting guidance
The underwriting director will have prime responsibility for ensuring that the following
are ready:
Chapter 2

• Underwriting guidance (on paper/intranet or incorporated into automated systems),

including acceptance criteria, reinsurance exclusions, base rates, loadings and discounts,
policy commentaries, standard endorsements and survey strategy.
• Facilities for credit-checking and other databases relating to flood, subsidence and
catastrophe exposures.
• Facultative reinsurance arrangements, if necessary.
Along with the company secretary/legal department, the underwriting director will have
checked that the new company has specific regulatory authorisation for all of the necessary
classes of business.

H3 Products
Whether under their direct control or not, the underwriting director’s agreement to the
following will be required:
• Base rates and rating routines (with actuarial input).
• Cost of extensions (with actuarial input).
• Policy wordings (with legal and claims input).
• Prospectuses (with compliance input).
• Proposals/statements of fact (with compliance and claims input).
• Third-party arrangements (with legal input).

H4 Plans and budgets

Although the underwriting director has access to the top-level plans and budgets which have
been agreed with the investors and the regulator, it is necessary to break these down to the
levels at which units (product/branch/region) and staff will be targeted. This work may be led
by operations with the input of underwriting, sales and finance.

H5 Systems and management information (MI)

The underwriting director will be anxious to confirm that underwriters have the necessary
functional support to accomplish their work. They will also want to ensure that the rating
routines accurately reflect the agreed approach; that base rates have been loaded correctly
and that the data warehousing facility is operational and will capture the necessary data in
the appropriate format. The format and content of many types of MI have to be specified in
order to monitor and manage products, underwriting, claims and financial results.

H6 Governance
The underwriting director will have agreed with the human resources function how the
recruitment of underwriters is to be approached. Role profiles, terms and conditions will have
been agreed and an interview and assessment process determined. As well as indicating
whether suitable for the role of underwriter in the new company, the recruitment process
should provide the information necessary to determine the new underwriter’s initial level of
underwriting authority, which will be documented in their underwriting licence. The
recruitment process may also indicate training needs which will have to be addressed.
The operation of an insurance company as a whole will need to be monitored and UK
regulators are keen to ensure that methods are adequate. It is likely that the company will be
overseen by a board of directors and it is their job to monitor the activities carried out by
executive management. It is important to note that the structure and actual responsibilities of
boards vary slightly with the type of company and the jurisdictions in which they operate.
Integral to a board’s supervisory functions are two duties:
• Shareholder interests.
• Risk management.
Chapter 2 Start-up scenario 2/13

Refer to
Refer to 990, chapter 2, sections A and B

Chapter 2
In a plc, board meetings usually occur on a monthly basis. Meetings of sub-committees of
the board – audit, remuneration, underwriting, risk and compliance committees, for example
– are also held regularly and report to the board.
H6A Corporate governance

Refer to
Think back to M92, chapter 4, section A1

Corporate governance is defined as ‘the set of processes and organisational structures

through which the board and senior executives manage a company at the highest level’. This
may also be referred to as the system of governance.
All organisations need to put down in writing the key methods they use in carrying out and
managing their business. Corporate governance practices give structure and provide clarity
over the roles, responsibilities and authorities of senior management.
In the UK, the Financial Reporting Council publishes the UK Corporate Governance Code
and any firm listed on the London Stock Exchange is required to demonstrate in their annual
report how they have applied the Code. The UK Corporate Governance Code sets the
expectation that the board should maintain sound risk management and internal control
systems, which should be reviewed on a regular basis (at least annually). Key principles
from the Code have been incorporated into the FCA Handbook and must be applied by all
regulated firms.

On the Web
Financial Reporting Council: www.frc.org.uk
PRA approach to insurance supervision: www.bankofengland.co.uk/prudential-regulation/
publication/2018/pra-approach-documents-2018
FCA approach to supervision and enforcement: www.fca.org.uk

H7 Underwriting audit
The underwriting audit process will, month by month, build up a picture of relative
competencies, training needs and general issues which require attention. In the early years
of trading, underwriting audit (and the specific discussions which flow from it) will provide an
excellent means of achieving the required commonality of approach between different
underwriters and units, as well as confirming to the board that underwriting strategy is being
observed correctly.

Be aware
If underwriting authority has been delegated outside the company (to scheme brokers,
coverholders or MGAs, for example) appropriate audit procedures have to be devised and
in place for go-live, also.

Along with operations, the underwriting director needs to monitor underwriters’ compliance
with contract certainty and other regulatory requirements, such as those concerning
money laundering, data protection and the fair treatment of customers. The establishment of
a robust complaints procedure is also essential from the outset.
Effective collaboration is key to the business’s success and the management team will
establish a schedule of regular meetings to review specific topics (such as ‘pricing’ with
representatives from underwriting, products and actuarial or ‘audit’ with representatives from
underwriting and operations) as well as more general monthly meetings involving all areas.
 2/14 960/December 2020 Advanced underwriting

Be aware
All areas will be required to support the company’s risk management processes.
Chapter 2

I Start-ups versus established insurers

If your current company is long-established, you would be correct in assuming that it
probably did not follow the start-up process outlined above, which reflects current practice.
However, in order to comply with regulatory requirements, all companies are obliged to
develop clear structures of governance and sound risk management processes; new
companies, as described above, should have these from the outset. Sometimes it is more
difficult to adapt to new requirements than to start afresh: the challenge facing older, larger
general insurance companies to meet all regulatory requirements should not be
underestimated.
Given the regulators’ principles-based approach to regulation, implementation approaches
between even new companies will not be identical. There is also considerable variety in the
ways in which longer-established companies may choose to fulfil their regulatory obligations.
To understand the approach of any given company (or division of a company), you will have
to consider the relevant Principles and then evaluate the company’s practice in that light.
Underwriters can fail to appreciate how their own company operates when they work for a
large, established company with many different classes of business, products and
distribution channels and where everything appears to work like clockwork, year after year.
These arrangements, ways of working and understandings have been built up over many
years and are backed up by a wealth of historical data and analysis. It is for this reason that
this study text has commenced with a far more stark example of underwriting management
in action: in order to consider what is involved in developing a coherent, profitable approach
to general insurance underwriting when starting from scratch.
Your own first challenge in underwriting management is not likely to be the creation of the
underwriting strategy for a start-up insurer but almost all of the considerations in this chapter
would apply if you were responsible for developing a new area of business.

Be aware
In an industry where change is constant, this is not a remote possibility.

Research exercise
Cyber insurance
The number of high-profile cyber security attacks continue to make the headlines, the
costs of which can be huge and materially impact the balance sheet of any business.
There is also the reputational impact to consider. However, the take-up of cyber insurance
is low. A 2017 UK Government cyber security survey found that only 33% of UK
businesses have a cyber security risks policy and only 11% have a cyber security incident
management plan. In addition, the General Data Protection Regulation (GDPR) and
Data Protection Act 2018 (DPA 2018) place an additional burden on business relating to
the protection of personal data.
As an underwriting manager you are investigating business opportunities. What actions
would you need to take to launch a new product to provide cyber insurance? Please pay
particular attention to:
• the perils covered by the product;
• the target customers;
• risk selection criteria;
• how the product would be priced;
• the impact on your risk appetite; and
• the reinsurance required.
Chapter 2 Start-up scenario 2/15

Conclusion
The main ideas covered by this chapter can be summarised as follows:

Chapter 2
• There are a number of questions that an underwriting director might ask the originators of
the business proposition, which fit within the following categories: products, target
customers, competition, environment and timing, delivery and service, projections, people
and regulation.
• As well as providing start-up and ongoing capital investment, some investors may be able
to offer technical assistance which could prove invaluable, particularly in the early days of
a new company.
• After claims costs, the largest business costs generally relate to staff, reinsurance,
commission and ICT.
• In an uncertain business such as general insurance, potential investors, regulators and
reinsurers will require specific information about the start-up team’s assessment of risk
and how consideration of risk and its management has been built into the business plan
and the financial projections.
• The statement of risk appetite summarises the risks which are not acceptable, maximum
limits for individual risks and aggregate limits of exposure, maximum income limits and
maximum net retentions.
• The underwriting, product, distribution and marketing strategies of a new company must
support one another as closely as possible.
• In order to comply with regulatory requirements, all companies are obliged to develop
clear structures of governance and sound risk management processes.

Additional reading
IRM. (2011) Risk appetite and tolerance. Executive summary. Available from: https://
theirm.org/what-we-say/thought-leadership/risk-appetite-and-tolerance/.
 2/16 960/December 2020 Advanced underwriting

Self-test questions
Chapter 2

1. Why might an insurance professional wish to be involved in a start-up operation?

2. What are the main business costs involved in running an insurance underwriting
department?

3. What questions would you expect reinsurers to ask to assess whether they wished to
offer cover for a start-up underwriting operation?

4. What information does a statement of risk appetite include? What is its purpose?

5. What is the purpose of an underwriting audit?

You will find the answers at the back of the book
 Strategy
3

Chapter 3
Contents Syllabus learning
outcomes
Introduction
A Corporate strategy 1.2, 2.1, 2.5, 5.1
B Multinational business 1.3
C Marketing 2.4, 2.8, 3.4
D Distribution 2.2, 2.3
E Operations 5.5
F Core elements of an underwriting strategy 2.1
G Scenario 3.1
H Scenario 3.2
Conclusion

Learning objectives
This chapter relates to syllabus sections 1, 2, 3 and 5.
On completion of this chapter and private research, you should be able to:
• explain those corporate, functional and strategic business unit strategies which relate
most directly to underwriting;
• examine the issues and implications of underwriting business internationally;
• select appropriate criteria to evaluate options when considering the underwriting response
to other strategies;
• explain the benefits and risks of using delegated authority arrangements; and
• develop documented underwriting strategies which include the essential information.
 3/2 960/December 2020 Advanced underwriting

Introduction
Although this chapter focuses on the creation and application of underwriting strategy, it is
important to understand how underwriting strategy at its highest level is derived from
corporate strategy and how it has to work alongside a number of other strategies in order to
be effective.
As underwriting director of a start-up insurer, you are responsible for expressing the will of
the board regarding risk acceptance and terms to all other underwriting managers and staff.
This will be driven primarily by the definition of risk appetite. There can be many levels of
Chapter 3

underwriting strategy and within a single insurer there may be strategies applicable to
different divisions, product sets, schemes, distribution channels or countries of operation. As
underwriting manager for any of these areas, you may be responsible for updating the
relevant underwriting strategy and for negotiating changes with reinsurers and colleagues
(for example, those responsible for distribution and marketing). In order to do this effectively
and within your authority, you must understand how underwriting strategy has been derived
within your company and how the company’s other strategies impact on underwriting and
vice versa.
What can be stated with certainty is that all underwriting managers are responsible for
interpreting underwriting strategy when faced with the reality and complexity of customers’
risks and for ensuring that the full meaning and significance of the company’s underwriting
strategy is conveyed to staff reporting to them. Accurate interpretation and meaningful
explanation require an understanding of not only the company’s underwriting strategy, but
also its other strategies, particularly those relating to marketing, distribution and
operations. Indeed, in your own company, you may regard certain strategies relating to
marketing, distribution or operations as integral to your own strategy. Firstly, however, we will
look briefly at corporate strategy.

Key terms
This chapter features explanations of the following terms and concepts:

Aggregator Broker consolidation Commoditisation Company culture

Competitive Corporate strategy Customer Differentiator
advantage segmentation
Hygiene factor Insurance Managing general Market dominance
(underwriting) cycle agency
Premium pricing Risk acceptance Risk appetite Strategic business
limits unit (SBU)
Underwriting
governance

A Corporate strategy
Corporate strategy states, at the highest level, which markets the company is focused on,
the value it intends to generate for shareholders, staff and customers, and how the
company’s approach will achieve this in the current environment. Further strategies at
strategic business unit (SBU) and functional levels will explain ‘what’, ‘why’ and ‘how’, in
respect of those units’ and functions’ contributions to the achievement of corporate strategy.

Research exercise
It is worth reading the corporate strategies of a number of companies with similar business
interests, for example, general insurance (www.zurich.com, www.aviva.com,
www.axa.com, www.iag.com.au).
Is it possible to discern different priorities and approaches? Read the half-yearly and
annual results statements (particularly the summaries reported in the insurance press) for
a number of different companies: what long- or short-term issues do they focus on?
Chapter 3 Strategy 3/3

It is important to remember that published corporate strategies are primarily aimed at market
analysts and shareholders. For employees, corporate strategies are generally at too high a
level to provide guidance but for senior managers, in particular, the overall intent and
direction expressed in their company’s corporate strategy needs to be understood and
reflected in their own units’ or functions’ strategies and plans.
What guidance do insurers’ corporate strategies provide for underwriting managers?
Most corporate strategies will include specific financial and non-financial targets that will help
to shape the underwriting strategy. For example, a return on capital (ROC) target is a
financial target that can apply across many different lines of business. The organisation may

Chapter 3
wish to be in a top-three position in a chosen market or be a niche player, building its
underwriting strategy around customer research.
In their published format, there is usually little of specific relevance regarding underwriting;
however, not every aspect of corporate strategy is made public. One of the most important
elements of corporate strategy, which is commercially sensitive and thus generally
confidential, is the company’s risk appetite.

Be aware
You should take care to note that the company’s risk appetite deals with more than
insurance risk alone: it includes investment risk (how should the company’s assets be
invested?), counter-party or credit risk (how should the company manage the risk of a
reinsurer failing?), reputational risk (how should the company manage adverse publicity
to protect its share price?) and every other significant risk the company faces. When we
discuss the company’s risk appetite (insurance risk) in this unit, this is definitively the
company’s maximum acceptance which only the board can amend.

Below board level, all underwriting managers and underwriters operate within an
‘underwriting strategy’, a ‘gross acceptance policy’ or a ‘risk appetite’, which may at times be
exceeded by reference to someone with a higher level of underwriting authority. At no time
may this exceed the company’s risk appetite (insurance risk) as signed off by the board. All
of a company’s gross acceptance policies are derived from the company’s risk appetite
(insurance risk).
In the creation or development of an underwriting strategy, knowledge of the company’s risk
appetite is necessary but not sufficient. As stated in the introduction, it is also necessary to
refer to other functional strategies (such as marketing, distribution and operations) and to
those of distinct SBUs (which may be defined by product, customer and/or country). It is
likely that each SBU will require its own specific underwriting strategy, which must sit
comfortably within the company’s overall risk appetite.

Example 3.1
‘UK Commercial’ might be an SBU of a company with two other SBUs in the UK, ‘UK
Personal’ and ‘UK Life’, or the other SBUs might be commercial insurance operations in
France and Japan.

A1 Competition for capital

Refer to
Think back to M80, chapter 3, section A

While all functional and SBU strategies must comply with the requirements and intent of
corporate strategy, there will always be competition for resources within a company – the
fundamental (and limited) resource being capital. Just as each insurer must have adequate
capital resources in line with its size and the nature of the business it undertakes, insurers
must also evaluate the capital required by different SBUs and classes of business within the
company. This is a regulatory requirement, as well as an appropriate input to decisions about
how companies should conduct business.
Within an insurance company, at any given point in time, it is likely that a number of SBUs
will be looking to grow their premium incomes. Each of these requests for capital investment
 3/4 960/December 2020 Advanced underwriting

has to be evaluated separately and the capital required will be measured against the SBU’s
profit potential (and that of each class of business written) using projected combined
operating ratio (COR) and return on capital employed (ROCE). Different types of
business have varying capital requirements in order to write the business and this has an
effect on the ROCE.

Example 3.2
Let us assume that for every £100 of UK motor premium written, £50 of capital is required,
and for every £100 of UK casualty premium, £100 of capital is required. Let us also
Chapter 3

assume that both the motor and casualty books make a 5% profit margin on the business
written and that investment income on both books is nothing. ROCE on casualty will be
5% but on motor it will be 10%.

The evaluation will also consider the anticipated state of the market: are prices rising or
falling? A softer market (falling prices) implies that loss ratios will deteriorate, putting
pressure on profitability; while a hard market (rising prices) will improve profitability but put
pressure on capital (higher average premiums, even on a static book of business, will
increase the capital requirement). The Solvency II regulatory regime has led to an enhanced
focus on the allocation of capital between lines of business.

Be aware
As discussed in chapter 2, the purchase of reinsurance can reduce an insurer’s capital
requirement. Decisions about what to buy and how much will vary considerably from
insurer to insurer based on the insurer’s size and maturity, the spread and mix of
business, and its performance (gross loss ratio). As well as evaluating the trade-off
between the cost of capital and the net cost of reinsurance, corporate risk appetite will
shape the company’s approach to the purchase of reinsurance. We shall consider
reinsurance in more depth in chapter 8.

How can the company balance its short-, medium- and long-term objectives with the
need to meet its annual ROCE target?
A longer-term outlook may mean that a small but growing account, which generates a poor
short-term return on investment, will continue to be supported in anticipation of acceptable
returns in future. A large account, producing similarly poor returns, may be faced with a more
stark response from the board: capital investment in increased premium income is
unsupportable and immediate action is required to bring the COR to an acceptable level.
When a return to profitability cannot be anticipated in a reasonable timeframe, the company
must consider exiting the account.
Of course, an insurer has other opportunities for the investment of capital beyond the funding
of the underwriting function. Investments in infrastructure (such as buildings and ICT) and
projects (such as customer research) must also be considered and evaluated on a financial
basis. If a prolonged soft market is anticipated, insurers may choose to divert some of their
capital resource to new infrastructure and projects rather than allowing low-margin or
unprofitable accounts to expand.
The decisions made regarding the allocation of risk capital and the purchase of reinsurance
(in other words, the company’s ‘capacity’) are reflected in the underwriting strategies, plans
and budgets which state an individual account’s planned premium income for the
forthcoming year, as well as its target COR and ROCE. An insurer’s finance department will
be as concerned about an account which appears to be exceeding its planned premium
income as one which is failing to reach its target. Overall, minor variations may be absorbed
within a company as some accounts exceed target by a small amount while others fail to
quite reach their targets. However, no company wishes to be in the position of having to turn
away potentially profitable business due to lack of capital (see chapter 5 on planning).
Chapter 3 Strategy 3/5

Be aware
The requirements of Solvency II mean underwriting managers are increasingly involved in
the assessment of capital requirements, which must more closely reflect actual risk
assessment under the regulations. The emphasis on more accurate risk and capital
assessments focuses insurers’ attention on the effective use of capital, as well as its
overall adequacy.

Refer to

Chapter 3
For more information on the effect of Brexit on Solvency II, please see Solvency II on
page 1/8.

Underwriting management decision: capital requirements

If Account A grows by 20% (gross written premium (GWP)) next year, how will any change
of mix affect its capital requirement?

As noted above, the process of allocating risk capital within a company will include decisions
regarding entering new classes or markets or exiting existing ones.

A2 Entering and exiting

Entering a new class or market shares a number of features with a start-up situation,
described earlier. While the scale of the entry project can range from a household insurer
entering the market for pet insurance to the decision to establish a new operation in a
different country (see Multinational business on page 3/6), there are a number of common
considerations:
• Costs versus anticipated returns.
• Regulatory requirements.
• Expertise.
• Timing.
• Capability.
• Balance of a class of business on the overall risk mix of the portfolio.
The cost of capital (risk capital and investment in infrastructure) has been discussed above:
whatever the scale of the entry project, all of the costs must be evaluated against the
prospects for profitable returns. All new ventures in insurance are costly to establish, not
least due to the requirement to hold sufficient capital to cover the solvency capital
requirement (SCR), and it would be unusual for a new venture to produce a profit in less
than two or three years of operation.

Be aware
The SCR must be covered by an equivalent amount of capital (assets in excess of
liabilities, subject to specific eligibility, and valuation rules).
Think back to Capital and solvency requirements on page 1/7 for a more detailed
discussion of SCR.

In order to ensure that sufficient profit will be generated, the opportunity presented by the
new class or market must be evaluated carefully. How much demand exists? How much
competition is there for this new business and how effective is it? How volatile are the results
likely to be?
The regulation of insurance companies varies around the world and, in general, observance
of regulatory requirements can be a costly and time-consuming process. Even when an
established UK insurer applies for authorisation in a new class of business, the regulator
takes time to evaluate its plans for the class and queries its expertise in the new area.
Capital and specific expertise can both be expensive to obtain but both are required to
establish the credibility of the new venture in the eyes of customers, intermediaries,
reinsurers and credit rating agencies (as well as regulators).
 3/6 960/December 2020 Advanced underwriting

Timing can play a significant part in the success of a new venture: the ideal time is when a
hardening of the market is anticipated or is under way (see The insurance (or underwriting)
cycle on page 3/11). In these circumstances, intermediaries and customers welcome
increased competition and, as long as prices continue to rise, other insurers may not react
adversely. However, entry to a new market or class when the market is softening could lead
some existing insurers to indulge in a bout of price discounting, compounding a deteriorating
position. The new entrant could be forced to lower prices below an economic rate (in order to
gain a foothold in the market) and thus push the prospects of profit beyond their planned
time frame. The existing players hope to encourage the new entrant to exit quickly before
they also lose too much money: their objective is to reduce competition and moderate the
Chapter 3

overall decline in prices.

Be aware
The decision to exit a class of business or market is not taken lightly. Irrespective of the
circumstances, the decision will leave customers and intermediaries inconvenienced and
disappointed, and internal staff upset and possibly redundant. The decision could
represent a serious reputational risk to the insurer and its announcement will need careful
handling.

On the Web
PwC. (2016) Unlocking value in run-off. A survey of discontinued insurance business in
Europe. Tenth edition. September 2016. https://pwc.to/2q2O0RD.

In some instances an insurer may exit at the optimal point before returns fall below an
acceptable level and losses are incurred. While exiting a class of business or market is a last
resort for an insurer, underwriters have an ongoing requirement to produce sustainable
positive returns on the capital deployed; therefore, in some circumstances, it is unavoidable
and the correct decision. It may be apparent that demand for a particular class of business is
diminishing rapidly or that the prospects of an economic sector or country are poor. Insurers
can therefore anticipate the need to change their approach or exit. More commonly, losses
will have been incurred while attempts were made to bring the class or account back to
profitability. It may not be possible to redeploy the buildings, systems and other infrastructure
used for the administration of the business and their disposal will lead to further losses, in
addition to the cost of redundancies.
Even if the business is sold, the original insurer’s liability for the run-off must be considered.
Should the company handle the run-off itself (potentially for many years) or pay for the run-
off to be transferred to another insurer?
These costs and difficulties need to be measured against the damage done to the company
by continuing to engage in unprofitable or underperforming business – financial and
reputational damage – which could ultimately threaten the company’s survival.

On the Web
'Tokio Marine Group put UK insurer into run-off', https://www.insurancejournal.com/news/
international/2019/06/25/530223.htm.

B Multinational business
Even those general insurers with no strategic interest in writing foreign business have
existing customers who require cover for minor exposures abroad and wish to include these
exposures in their existing insurances. It is convenient and reassuring for the customer (and
their broker) and it should be cost-effective, in that the additional premium should be less
than the cost of buying new, separate insurances for the foreign exposures.

Example 3.3
UK businesses with warehouses in continental Europe or the Republic of Ireland or the
requirement of UK drivers for motor insurance while driving in continental Europe on
holiday.
Chapter 3 Strategy 3/7

Refer to
Refer to M92, chapter 1, section B

Insurance and international trade and development are closely related and, as domestic
businesses of all types expand their operations abroad and/or acquire foreign businesses,
the insurance industry responds to serve these multinational companies. In the UK, the
London Market (see Global insurance programmes on page 3/8) is the focus of this type
of activity, devising and servicing global insurance programmes. Although the impetus for
this global business originated in the desire of insurers to satisfy the requirements of

Chapter 3
domestic businesses as they grew and diversified, the multinational businesses serviced by
London Market and other UK-based international insurers no longer need to have a
connection with the UK.
Some insurance companies have themselves become multinationals, by acquisition and
expansion, offering insurance to the private citizens, businesses and governments of many
countries around the world. The motivations behind these insurers’ strategies relate to:
• the search for a better return on capital and utilising excess capital (reflecting limited
scope for equally profitable growth in existing markets);
• exploiting innovations more widely (product/system/approach/brand); and
• spreading risk (through the location of exposures and timing of different economic
cycles).

Be aware
International business is when an insured is based outside the domicile of the insurer.
Multinational business is when insurance is required in more than one territory.

B1 Issues to overcome
There are several pitfalls and obstacles inherent in writing multinational business that the
underwriting strategy needs to address. The strategy should:
• be very explicit regarding which foreign exposures are or are not acceptable;
• provide clear guidance regarding from whom underwriters should obtain advice about:
– risk acceptance (including authorisation),
– regulatory and taxation issues, and
– specific local requirements;
• explain the correct approach to processing such business and producing acceptable
documentation.
A number of immediate questions arise:
1. Is the insurer authorised to write the business in question? Has the insurer been granted
the necessary cross-border licence?
2. What are the regulatory issues of operating in the country/countries in question?
3. Is it clear (to the underwriter, broker and client) what servicing capabilities the insurer has
in the relevant location? Does the insurer rely upon third parties? Precisely what happens
in the event of a claim?
4. Who will survey the risk and provide local technical advice?
5. If the cover requested by the customer includes motor, worker’s compensation, general
and products liability or professional indemnity, is it acceptable for these covers to be
written from abroad? Many countries, especially in Europe, have minimum legal
requirements for these types of policy and any policy issued must comply with such
requirements.
6. Does the insurer’s reinsurance protection extend to foreign risks?
7. Are the covers requested normally available in the relevant foreign country? For example,
earthquake and flood covers are not readily available in many countries and may not be
covered by reinsurance.
8. Are there covers which can only be placed with local or state insurers?
 3/8 960/December 2020 Advanced underwriting

9. Are there any local taxes and how do they operate?

10.How will the insurer treat currency fluctuations (affecting exposures, deductibles,
premiums and claims payments)?
11.Are there any political risks?
12.How will the portfolios be monitored? For example, from a distance or locally?

Be aware
It should, therefore, be apparent that for domestic insurers to accept occasional foreign
exposures is typically a time-consuming task which brings an additional degree of risk to
Chapter 3

the insurer through the lack of local knowledge of the risk and potential challenges to
service standards.

B2 Global insurance programmes

The creation of global insurance programmes is a key feature of the work of London Market.
Although London Market underwriters are well aware of the complexities outlined above and
have the expertise to deal with all of these issues, they too can be under tremendous
pressure due to the scale and diversity of the enterprises they are dealing with and the tight
timescales in which they often must respond: for example, in order to incept cover on a
newly acquired business for an existing client. Servicing businesses in many different
locations, whether directly or via third parties, remains a challenge.
Even multinational insurers will struggle to be authorised in every country where their
customers have exposures. (See Multinational insurers on page 3/8.) In the recent past, a
multinational company would have accepted that the insurer of their global programme is
non-admitted in a particular country. However, many organisations are now encountering an
increased local concern regarding the extent of protection offered by global non-admitted
policies and their regulatory and compliance implications.
Penalties for legal, regulatory and compliance breaches can be harsh and companies failing
to comply may be faced with fines, cancellation of cover, imposition of sanctions and – in
exceptional cases – imprisonment of personnel. As a result there is a growing demand for
fully-compliant global programmes.

Definition of non-admitted cover

‘Non-admitted’ cover is a policy that is issued by an insurance company that is not
licensed in the territory or country in which the insured and/or the risk is domiciled.

Refer to
Refer to M81, chapter 7, section B4 on DIC/DIL coverage

Global programmes are increasingly popular with insureds as they provide certainty
regarding the extent of cover purchased, avoid duplication of cover and should provide good
value in return for the scale of their purchase. An alternative approach would focus on the
coordinated purchase of local covers with an additional difference in conditions/difference in
limits (DIC/DIL) cover arranged centrally, bringing all the local covers up to a common level.

On the Web
Guyatt, C. (2009) 'Going Global', Canadian Underwriter, December 2009.
www.canadianunderwriter.ca/features/going-global.

B3 Multinational insurers
Multinational insurers may not want to underwrite risks outside the country in which they are
based. Their corporate strategies may in fact require the businesses in different countries to
focus solely on their domestic markets. They may also have quite different insurance
operations in different countries: direct personal lines in one country, intermediated
commercial in a second, and marine and aviation only in a third, for example. However,
those multinational insurers dealing extensively with commercial insurance will often have
Chapter 3 Strategy 3/9

developed internal capabilities to assist large clients, even if they do not specialise in global
programmes.
Multinational insurers will utilise different entry strategies and structures in their businesses
around the world. In the early stages of development common approaches include joint
ventures with local companies and the acquisition of local insurers. Access to customers,
knowledge of risk features and familiarity with local regulatory/business regimes are
important potential advantages derived from these approaches.
In some countries foreign insurers will have no option other than to enter into a joint venture,
often with a State insurance company. From an underwriting perspective it is worth

Chapter 3
remembering that the company’s degree of control and access to data may be diminished
under such an arrangement. Entry into a new country via acquisition of a local insurer poses
other potential issues, including establishing common understandings and practices in
underwriting and claims handling and extracting compatible management information.
Of course, establishing a completely new subsidiary company in a foreign country could be a
costly and high-risk approach: hence the frequency with which the other approaches are
utilised. The scope to share expertise and specific innovations between group companies
and regions (and thereby derive enhanced profits and/or market share) often features
prominently in the corporate strategies of multinational insurers. For example, innovations in
distribution are often shared around the world:

On the Web
Anker, G (2004) 'Direct Line pulls plug on venture', Post Online, 13 May 2004.
www.postonline.co.uk/personal/1246248/direct-line-pulls-plug-on-venture.
'RBS mourns Direct Line Spain sale', Post Online, 23 April 2009. www.postonline.co.uk/
insurer/1208480/rbs-mourns-direct-line-spain-sale.
'AIG's Talbot to shut Australian and Lloyd's China offices', Intelligent Insurer, 28 May 2019.

Attempts to introduce different approaches to insurance marketing and distribution may or

may not be successful but prime attention must be paid to the typical claims experience of
different markets and local regulatory attitudes.

On the Web
Denton, S. (2010) 'Italian insurance regulator to act on high motor premiums', Post Online,
30 July 2010. https://bit.ly/2zRjsXA.

Opportunities to share more general expertise and knowledge are possibly of most interest
to underwriters working for multinational insurers. While it would be unusual for a product
developed in one country to be entirely acceptable, unaltered, in another country, there will
be much to interest and inform underwriters in the general underwriting considerations and
long-term claims experience associated with a product or risk new to their domestic market.
As well as the wide range of insurance approaches and traditions prevalent around the
world, general consumer attitudes and the requirements of industry and commerce differ
considerably over time and location.

Example 3.4
Some years ago, the only insureds and insurers interested in large-scale viniculture, the
cultivation of vines, were located in continental Europe. Today this industry is of major
significance in many more locations around the world (for example, South Africa,
Australia, New Zealand and California) and underwriters in those countries wish to learn
from the experience of their colleagues in Europe: gaining, for example, a long-term
perspective on the causes and incidence of crop failure. Of course, European experience
in the twentieth century is not necessarily applicable to Australia in the twenty-first century
but consideration of current challenges, such as climate change, to the viniculture industry
around the world can only benefit from the most comprehensive evaluation enabled
through the sharing of data, information and knowledge by underwriters.
 3/10 960/December 2020 Advanced underwriting

Research exercise
The referendum in June 2016 determined that the UK would leave the European Union.
As a result the way in which insurers transact business in the EU will change. Investigate
how different insurance companies and Lloyd’s are planning to write business once the
UK leaves the EU. What are the implications for your particular employer?

C Marketing
Chapter 3

In general terms, the objective of marketing is the creation of sustainable competitive

advantage. Many types of activity can contribute to this overall objective, including:
• the identification of target market segments;
• the development of products and their promotion;
• pricing and distribution;
• customer research;
• branding;
• competitor analysis;
• data analysis;
• environmental monitoring; and
• the allocation of resources.
In the context of general insurance, it is apparent that a number of functional areas, including
underwriting, collaborate to accomplish marketing work and, therefore, this is not the
description of the typical responsibilities of a marketing department in a general insurance
company.
Competitive advantage is most effectively and sustainably achieved when a company’s
internal capabilities are tailored to address and continue to adapt to specific external
opportunities. Typically, a new insurer will build the capability to exploit identified external
opportunities; an existing insurer will look for further external opportunities in order to utilise
existing capabilities before investing in new internal capabilities. Before discussing some of
the capabilities which can contribute to competitive advantage, we need to turn our attention
to the opportunities presented by the external environment.

C1 The external environment and the demand for

insurance
Some environments are more conducive to the successful growth and profitable operation of
general insurers than others. Those conducive attributes (such as stable political, legal and
judicial systems) will also support general economic growth and thus the demand for
insurance. General instability, by contrast, will undermine economic growth but may, in some
instances, increase the demand for insurance. Insurers have to evaluate the overall cost and
risk of doing business in each specific environment open to them against the expected
returns.

On the Web
Of course, the demand for general insurance is not a simple function of economic
development, prosperity or degree of risk: general insurance expenditure as a proportion
of GDP varies from 7.5% in the Netherlands, 2.3% in the UK and 3.4% in Taiwan to 0.5%
in Indonesia (source: sigma No 3/2019 ‘World insurance: the great pivot east continues’,
www.swissre.com/sigma).
Particularly in an international context, it is evident that history and cultural attitudes, as
well as relative affluence, are influential in determining attitudes towards the use of
insurance.

Underwriting management decision: evaluating the opportunity

Is this a positive environment in which to offer insurance or, at least, one where the
inherent risks are understood and where there is a sufficient demand for insurance?
Chapter 3 Strategy 3/11

Other much more specific external influences affect demand for insurance, such as changes
in public perception (the requirement that polluters should pay for the remediation of polluted
land and waterways); technological innovation (the extensive use of communication
satellites); and public policy (the level of funding for health care). Of course, insurers do not
necessarily respond to every new demand or to the extent desired by potential customers.
Climate change might well increase the demand for insurance, but insurers and reinsurers
may not be able to respond in every instance, just as flood and earthquake cover are already
not generally available in many countries. Insurance against acts of terrorism has in recent
years required the intervention of governments to support insurance and reinsurance
markets. Concern over the extensive use of asbestos and emerging claims costs have led to

Chapter 3
restrictions in primary and reinsurance covers. The main constraint in these instances is the
combination of significant uncertainty and potential scale measured against insurers’
capital reserves.

Underwriting management decision: evaluating the opportunity

Are you satisfied that the cover required and/or the risks presented will not threaten the
survival of the company? in other words, is it within the risk appetite of the company? Do
you have the expertise to handle new covers/risks or can you develop or acquire it?

C2 The insurance (or underwriting) cycle

Refer to
Think back to M80, chapter 2, section D and refer to 990, chapter 10, section A3

For many years the external environment has affected general insurance through the
operation of the insurance (underwriting) cycle. While certain internal aspects of the
insurance market influence the precise path of the cycle (intense competition or the lack of it
can affect the amplitude of the cycle and significant claims events can influence timing), the
fundamental influence behind the cycle is the flow of capital seeking optimal returns.
Following a peak in 1994/95 and a trough of ‘dismal’ results between 1998 and 2001, prices
and profitability grew rapidly to another peak in 2003/04. The economic downturn that
followed the 2008 financial crisis also impacted the cycle, with consumers and businesses
affected in terms of their financial spending power. There are also clear signs of different
cycles between commercial and personal insurance, and with product lines within these
areas. Some insurers choose to exit a market rather than wait for an upturn in pricing levels,
while others develop alternative business models to create more non-risk income from their
customer bases.
Despite the fact that a ‘cycle’ by its nature repeats itself, insurers and underwriters can never
be sure where their business is on the cycle at any current point in time. This is only
apparent after the event, once the cycle has turned. The only predictable aspect of the
insurance/underwriting cycle is that it continues to impact the insurance market as powerfully
as ever.
Insurers continually strive to adopt and refine strategies to shield their businesses from the
full impact of the cycle. They may target areas of the market where there is less competition
due to the highly specialist nature of the risks or client requirements. Many will seek to
achieve a dominant position in their main markets, in the belief that they will have more
opportunity to influence prices and compete successfully on non-price-related issues.
Although most insurers would not choose to enter and exit markets in line with the cycle (due
to the costs and disruption caused), many will expand and contract the capital available to
support underwriting in line with the cycle. This strategy is most effective for insurers with low
fixed costs, as reduced volumes and income – while prices are low and loss ratios poor – will
not necessarily lead to unacceptable expense ratios. However, as most insurers have
relatively high fixed costs, their scope to reduce volumes and premium income while
maintaining acceptable expense ratios is limited.
For those insurers who might choose to follow the cycle (allowing their prices to rise and fall
in line with the general trend), it should be noted that there is no guarantee that ‘peak’ profits
will cover ‘trough’ losses.
 3/12 960/December 2020 Advanced underwriting

Impact on underwriting strategy

An important part of any insurer’s underwriting strategy is how they intend to manage the
cycle. Different approaches may be adopted for different parts of an insurer’s portfolio. This
may relate to the:
• relative market position of the insurer for different classes;
• ratio of variable to fixed expenses for certain classes or units;
• degree of competition in different parts of the market; and/or
• scope for non-price-related competition.
Chapter 3

Underwriting management decision: managing the insurance cycle

Where is the relevant insurance class or market on the cycle? Does the company have
the ability to survive the troughs and exploit the peaks? Is there a point on the downswing
when the company cannot afford to write more business (too unprofitable)? Is there a
point on the upswing when the company cannot write any more business (lack of capital)?
How well are competing insurers managing the cycle? What are our strategies for cycle
management?

Research exercise
For a product or market you are familiar with, consider how your own company and its
main competitors have sought to manage performance through the last insurance/
underwriting cycle (peak-to-peak or trough-to-trough). It may be worth discussing this
question with colleagues in order to capture a range of views. Which approaches appear
to have been most or least successful?

While competition for capital is the ultimate driver of the insurance or underwriting cycle,
competition among insurers, reinsurers and intermediaries for business drives the
competition underwriters are most familiar with on a daily basis.

Research exercise
After a prolonged period of soft market conditions many insurers expected the market to
harden significantly following two years of serious hurricane losses in 2017 and 2018.
Investigate what happened and what were the reasons for this.

C3 Competition
The market for general insurance in the UK is highly competitive. Despite the fact that
insurers have consolidated and the market exists to provide significant competition and
choice for consumers and businesses, none of the large insurers alone can dictate terms
(attempts to do so result in an unpalatable loss of GWP and increased expense ratios) and
there appears to be no shortage of capital to support smaller companies and start-ups.

Be aware
Any evidence of monopolistic pricing or other form of anti-competitive behaviour would
attract UK Government and/or EU intervention via competition legislation (see chapter 1).

Underwriting management decision: competitors

Who are the main competitors in each segment of the market in which your company
operates? Are there any emerging competitors worth watching? What are they doing?

Sometimes competition will not arise directly from other insurers but indirectly through:
• changes in distribution (for example, through broker consolidation and the rationalisation
of insurer panels);
• the use of technology in new ways (for example, the growth of aggregators); or
• from non-insurers (for example, large consumer brands).
Chapter 3 Strategy 3/13

In response to competition, general insurers typically seek to differentiate themselves and

create competitive advantage through the effective management of:
• brand;
• products;
• distribution;
• customer service; and
• price.

Chapter 3
Underwriting management decision: competitors
What are our competitors good at? How does our company choose to compete for
customers?

C3A Brand
While every general insurer is concerned to create and maintain a good public image (not
least due to the intangible nature of insurance) and therefore positive associations with its
brand or brands, some companies invest far more heavily than others in brand management.
However, insurers generally enjoy low recognition, particularly amongst the public and the
small business owners.

On the Web
Jackson, L. (2010) 'Lloyd's named UK's strongest insurance brand', Post Online, 24
February 2010. https://bit.ly/2zKy6jl.

In this way, big consumer brands, whether acting as intermediaries or insurers, can have a
significant competitive advantage in some sectors of the market.

Example 3.5
Part of this trend, Tesco has been able to leverage its significant customer base and
reputation for providing good value products and services.

C3B Products
Much effort is devoted to the differentiation of insurance products throughout the market.
Some insurers look to develop offerings that maximise cover and service; others look to
provide ‘lowest common denominator’ products. This is clearly an area of heavy involvement
by underwriting, which will be discussed later in this study text (see Establishing cover and
terms on page 4/10). Regarding the creation of sustainable competitive advantage
however, it is accepted that products are usually easy to copy, and innovative covers, if they
prove popular, can quickly become the norm.
C3C Distribution
As distribution controls access to customers, the relative effectiveness of an insurer’s chosen
method or methods of distribution is a very important determinant of competitive advantage
(see Distribution on page 3/19). A key consideration for an insurer is channel mix and
whether there is channel conflict. This is particularly relevant where an insurer provides
products directly to consumers, as well as through intermediaries or strategic partners.
C3D Customer service
Many insurers highlight their focus on customer service but customer service which
consistently excels and becomes a true source of competitive advantage is not the norm.
Good (but not consistently excellent) customer service is appreciated but it does not
necessarily influence future purchasing decisions. The nature and quality of a company’s
customer service depends upon the operational capabilities of the insurer as well as its
marketing strategy.

Refer to
Operations are discussed more fully in Operations on page 3/28.
 3/14 960/December 2020 Advanced underwriting

Insurers are under considerable pressure to find more cost-effective ways of operating and
this can create discrepancies between an insurer’s perception of good customer service and
an individual customer’s expectations (intermediary or end-customer). Taking decisions
around the nature of and level of investment in customer service initiatives is a particularly
difficult area in general insurance because reliable cost-benefit cases are difficult to
construct. For example, efforts to manage claims costs (by reducing claims leakage and
pursuing bulk purchasing initiatives) can severely irritate customers, despite the fact that
such initiatives are in the best interests of all honest policyholders.
The use of overseas call centres has been controversial and not universally welcomed but
Chapter 3

have customers ‘voted with their feet’? Have competitors who advertise that none of their call
centres are overseas benefited? It is difficult to evaluate the true impact of any one factor in
a relatively complex purchasing decision and even more difficult to project what the impact
might be of proposed changes in customer service delivery.
Many professional intermediaries state that they favour those insurers who continue to
support branch networks and provide known contacts but the same intermediaries regularly
place business with other insurers (without expensive branch networks) because they are
cheaper!

Be aware
Only in respect of claims service might a broad generalisation be regarded as valid:
namely, that a poor reputation in respect of claims service will adversely affect an insurer’s
reputation. However, a good reputation for claims service does not guarantee insurers
significant competitive advantage.

All of these features or capabilities – brand, products, distribution and customer service –
can be approached in many different ways. The features chosen need to work well together;
in other words, the marketing strategy must be coherent. This may seem obvious but there
are instances of insurers attempting to widen their product or customer base without
recognising that the existing brand or distribution method was not suitable for the new
product or did not provide sufficient access to the targeted customers. The marketing
strategy adopted must also be well-balanced: there is little point in investing heavily in
innovative products if there is insufficient brand awareness to support their sale.
To ensure that marketing expenditure is justified (i.e. will generate the expected return), it is
essential that each insurer understands which features or capabilities are true
‘differentiators’ or, in other words, have the potential to generate competitive advantage. It
could be argued that some of the aforementioned features are really ‘hygiene factors’
rather than differentiators; that is, features which are expected as standard. A good claims
handling service might therefore be regarded as a hygiene factor: all insurers need one and
while poor service will drive customers away, an excellent service will not necessarily attract
significantly more customers or make higher premiums acceptable.

Refer to
Refer to discussion of what customers value in What does the customer value? on page 3/
17

For every insurer, depending upon their chosen marketing strategy, there is a point at which
spending more money improving certain features or capabilities (which are already regarded
as ‘acceptable’ by customers) becomes ineffective. Increased expenditure will not result in a
more-than-equivalent increase in income. This can be a difficult conclusion for staff to
understand. Only by ensuring that front-line staff clearly understand the quality and style of
customer service to be delivered – and its rationale – can management hope to achieve the
intended level of customer satisfaction within planned budgets.

On the Web
The FCA’s then Director of Supervision, Clive Anderson, made a speech in November
2013 entitled ‘Trust and confidence – ensuring firms’ ethics are built around their
customers’. The transcript is available at: www.fca.org.uk/news/speeches/trust-and-
confidence-ensuring-firms’-ethics-are-built-around-their-customers
Chapter 3 Strategy 3/15

C3E Price
So far in this discussion of marketing strategy, the focus has been on features (brand,
products, distribution and customer service) that take time and money to develop and refine
in the search for sustainable competitive advantage. In what ways might a focus on price
contribute to the creation of such an advantage?
In some parts of the general insurance market, it is recognised that features other than price
have relatively little influence on the purchasing decision. Such products, which have
become less and less differentiated, are described as commoditised. These products are
not entirely undifferentiated but, as price is the key feature, competition is fierce and profit

Chapter 3
margins are low, reinforcing the undifferentiated nature of the competition. Motor insurance is
a good example of a highly commoditised market.
In other areas of the market, where the opportunity to differentiate between insurers (using
brand, products, distribution and/or customer service) still exists, price remains a major
factor. An underwriting manager may have as much difficulty persuading underwriters to
focus on all the benefits a product offers, rather than simply its price, as convincing brokers
or end-customers of the product’s merits. Of course, competition based on price may be
appropriate if the lower price is based on reduced expenses, greater efficiency or lower risk
premiums.

Refer to
Refer back to the discussion of the insurance/underwriting cycle in The insurance (or
underwriting) cycle on page 3/11

Be aware
Any significant sustainable reduction in internal costs and/or commission could provide
an advantage that may be hard for other insurers to replicate in the short-term. An insurer
whose risk selection process produces consistently lower-than-average claims costs has a
major advantage over competitors. Although rating structures can be copied, access to
internal databases and knowledge is restricted. Competition on the basis of risk selection
has the potential to create long-term advantage.

Underwriting management decision: competitors

Do we really understand our competitors’ marketing strategies? Can we evaluate each of
the main features and understand their overall approach to target customers?

Consider this…
Are the features your company intends to promote (compete on) true differentiators? Do
they work well together? For how long can any competitive advantage be sustained?

It is hard to predict which competitive features or innovations will generate lasting advantage
for the first insurer to adopt them or which will rapidly become ‘the way things are done’. In
the UK motor market in the 1980s, Direct Line generated a very significant ‘first mover’
advantage for themselves, which existing insurers found difficult and expensive to challenge.
By contrast, the collaboration of insurers with broker software houses (to improve brokers’
access to competitive products with easily updated rates), requires a sufficiency of insurers
to participate in order to secure brokers’ wholehearted support for these systems. Once
enough insurers agree to participate, such an arrangement may resemble a hygiene factor
rather than a differentiator.

On the Web
Ellis, A. (2010) 'Aviva teams up with SSP', Post Online, 25 February 2010.
www.postonline.co.uk/broker/1593690/aviva-teams-up-with-ssp.

C3F Sustainable competitive advantage

In the economy as a whole, ‘market dominance’ and the ability to command ‘premium
pricing’ are used as indicators of the achievement of a sustainable competitive advantage.
 3/16 960/December 2020 Advanced underwriting

Be aware
‘Market dominance’ does not necessarily imply being the single largest company in the
market: ‘dominance’ refers more to the degree of influence a company exercises, rather
than size alone. ‘Premium pricing’ is when one company can successfully charge a higher
price than others for a broadly similar product.

It may seem odd even to mention ‘premium pricing’ in the context of general insurance when
so much of the talk in the market is about commoditisation, which might appear to be its
antithesis. Although the search for ‘premium pricing’ can be obscured by the operation of the
Chapter 3

insurance or underwriting cycle, whose swings can lead to extreme price movements,
successful insurers (those creating and exploiting sustainable competitive advantage)
optimise their overall premium against anticipated claims costs year after year by
determining clearly their risk acceptance/pricing matrix and flexing it appropriately. This
applies throughout the market, from the commoditised mass markets for motor and home
insurance through to the markets for specialist products and/or corporate clients at the other
end of the scale, where underwriting expertise is applied on an individual basis.
As insurers seek to achieve ‘premium pricing’ for portfolios or accounts, rather than for each
individual risk, the actual differentiator is risk acceptance rather than pricing. Thus two
insurers could use identical rating tables and apply them consistently but if each insurer had
a different risk acceptance policy, the end result could be two quite different books of
business, different mixes of business and different loss ratios.
The opportunity to take advantage of ‘premium pricing’ does not happen by accident.
Sufficient suitable customers, whether mass market consumers, SME businesses or
corporate customers, must be attracted to the insurer in the first place. An insurer wishing to
take advantage of ‘premium pricing’ for any particular group of customers must be in or
approaching a position of dominance for that group. This will only happen if the other key
features are also right: brand, products, distribution and customer service.

C4 Customer segmentation
In mass markets insurers have literally millions of opportunities to test different permutations
of competitive features on consumers and assess the outcome. In specialist markets,
insurers, intermediaries and corporate clients speak directly to one another and insurers can
shape their offerings accordingly. Whether consciously or not, the search for greater
understanding of customer needs and preferences is part of a customer segmentation
exercise.
The focus on customer segmentation has grown in recent decades as even the largest of
insurers has discovered how difficult it is to be ‘all things to all people’ (and operate
profitably), particularly in a world where customer expectations, distribution methods and
risks change rapidly. Understanding has grown that different parts of the market require not
just different marketing strategies but quite different operations, leadership and culture.
Smaller companies, which cannot reasonably hope to dominate a whole market, have
discovered the benefits of narrowing their focus and achieving a dominance (and thus good
returns) in a more specific part of the market. Large insurers are also following this path by
being more selective in their choice of target markets and developing a range of operating
models and marketing strategies, as required.

Refer to
See Operations on page 3/28 on operations

C4A External research

Customer segmentation starts in the external environment where researchers look at
different ways of segmenting or categorising customers by their characteristics, needs,
preferences and behaviours. A range of specialists, including underwriters, using a wide
variety of sources, can contribute to such an exercise. Economists provide insights regarding
the anticipated growth or decline of different sectors in economies around the world, while
information on major external risks such as the anticipated geographical impact of climate
change may be provided by reinsurers. Marketing specialists can examine demographic and
Chapter 3 Strategy 3/17

lifestyle data purchased from firms such as CACI and the mass of government statistics now
readily accessible on the internet.

On the Web
CACI: www.caci.co.uk
GOV.UK statistics release calendar: https://bit.ly/2RlJZTK – includes business, economy,
crime, population, price indices, earnings etc.

Chapter 3
With this background information, more detailed customer or sector research may be
commissioned in order to identify the characteristics which most influence behaviours related
to the purchase and use of insurance.
How are customer needs and preferences addressed by other insurers? Do they consciously
target specific customer segments? How successful are they? Viewed from a customer’s
viewpoint, what are the competing products or alternatives? In the market for corporate
insurance it is obvious that self-insurance and captives form viable alternatives and thus
compete with conventional product/service offerings. The level of welfare, health and social
security provision in a country will clearly affect the willingness of its citizens to purchase
private insurance protection.
C4B Internal data and its limitations
Underwriters and actuaries can work together to review internal data relating to the claims
experiences of different groups and subgroups of customers, their projected exposures and
the cost and attractiveness of possible cover variations. Although many insurers have
implemented comprehensive data warehousing strategies for their current business, the use
of data mining software enables insurers to explore internal databases in different, revealing
ways. Even though existing internal data may not have been fully exploited, it can only take
an insurer so far. In many insurance companies, current data and systems are based on the
assumptions and practices common 20 years (or more) ago. Although newer insurers may
have more up-to-date systems and better-organised data, they do not have internal data
covering a long period of time. For all insurers, therefore, a comprehensive and current
understanding of customer segmentation requires the use of as much relevant external data
as possible, as well as focused customer research.
C4C What does the customer value?
Efforts should be made to obtain customers’ views of their needs and preferences, not
limited by their conventional expectations of what insurers can or cannot offer. In the same
vein, insurers’ assumptions about what customers (former, current and potential) need or
prefer should be challenged rigorously and evidence sought to justify such assumptions. In
particular, researchers must pursue the issue of ‘value’: how highly do customers value the
various elements of insurers’ product and service offerings? Which elements are customers
willing to pay for or change insurer to obtain and which might be described as merely ‘nice to
have’? Any assessment of customer satisfaction has to be underpinned by a clear
understanding of the extent to which customers value the various elements of the product/
service offering. The aim must be to achieve high levels of customer satisfaction with the
elements which represent most value to customers (their perception, not that of insurers).

On the Web
Aubert, N. (2014) 'Insurer: Aiming for happy customers', Post Online, 17 June 2014.
www.postonline.co.uk/2349346/c-suite-insurer-aiming-for-happy-customers.

C4D The insurer’s choice

Having identified groups of customers whose typical exposures and claims experiences are
within corporate risk appetite and sought out customers’ views, the segmentation exercise
proceeds to identify sectors and segments of customers whose needs and preferences may
be satisfied by the insurer’s internal capabilities and capacity in a cost-effective manner.
The exercise may reveal that customers in certain sectors are perfectly satisfied with existing
products but have certain service requirements that, if fulfilled, would give an insurer a
significant advantage. Other sectors/segments may be identified that are attractive but
require the development of new internal capabilities: this could relate to brand development
 3/18 960/December 2020 Advanced underwriting

or new distribution channels. On the other hand, the conclusion may be reached that
customer requirements are currently well-satisfied by existing providers and the company
should look elsewhere for sectors in which to differentiate itself and gain competitive
advantage. This latter conclusion may be reached about a sector in which the insurer
already has a presence.

Consider this…
In the latter circumstances, is it better to maintain a presence without devoting significant
resources (including capital) to the sector or segment or to exit? Refer back to Entering
Chapter 3

and exiting on page 3/5.

C4E Success in customer segmentation

In order to turn a well-chosen target group and specifically tailored product/service offering
into a commercial success, a high proportion of all customers in the target group must feel
compelled to seek a quote from that insurer. Once an insurer is approaching or has achieved
this level of dominance – the opportunity to quote for a high proportion of the target group’s
insurances – the insurer’s underwriters have ongoing access to the best possible information
about the target group as a whole and, with this perspective, can exercise their powers of
discrimination in terms of acceptable risks and suitable terms, in order to build a book which
is balanced/optimised to achieve the desired underwriting result. Once achieved, this level of
advantage is far harder for other insurers to challenge because it is self-reinforcing: it can be
described as a sustainable competitive advantage.

Research exercise
Thinking about a familiar product or market, you identify the customer characteristics that
influence:
• the ways in which insurance is purchased (including distribution channel and method,
typical retention periods, pricing objectives and product feature preferences); and
• typical claims experience.
How do these characteristics, preferences and behaviours influence your company’s
approach to this particular product or market?

C4F SME businesses

Although customer segmentation takes place in all parts of the market, in recent years
segmentation has been a particular focus among insurers of SME businesses in the UK. The
reasons behind this increased focus may include more intense competition in this part of the
market (among intermediaries as well as insurers), expectations of more sophisticated
analyses based on data captured in expensive computer systems and success stories
emanating from the USA. There are also some long-standing examples of sustainable
competitive advantage gained through successful customer segmentation in the UK, notably
NFU Mutual’s farmers and General Accident’s (now Aviva) motor traders.
A critical issue in customer segmentation, which impacts the market for SME insurance in
the UK, is that of scale. The difficulties which underwriters confront in attempting to build
reliable rating matrices for specific trades and small businesses due to small sample size,
also impact the broader picture of customer segmentation. SME business owners might
appreciate different types of product, service and distribution options but can they be
provided in a cost-effective manner if even a 100% share of the target group represents only
one or two thousand risks?
Chapter 3 Strategy 3/19

Be aware
In 2019 there were 5.9 million enterprises in the UK, an increase of £200,000 on 2018.
Over 99% of these enterprises had 0–249 employees, comprising the micro, small and
medium businesses. These were broken down as follows:
• 'micro' (0–9 employees) – 5.6 million, or 96% of enterprises;
• ‘small’ (10–49 employees) – 211,000, or 4% of enterprises;
• ‘medium’ (50–249 employees) – 36,000, or 1% of enterprises; and
• ‘large’ (250+ employees) – 8000, or les than1% of enterprises.

Chapter 3
Despite their lower numbers, ‘large’ enterprises accounted for 48% of total turnover and
40% of employment.
Source: House of Commons Library Business statistics briefing paper, 31 July 2020.
commonslibrary.parliament.uk/research-briefings/sn06152/.
By way of comparison, there are approximately 38.4 million vehicles on UK roads whose
drivers are required to be insured, as of June 2020 (RAC Foundation).

C4G Fraud
New fraud continues to be a major issue for the industry and the value of fraud detected is at
a record level. ABI figures from 2019 show that insurers detected 107,000 fraudulent
insurance claims valued at £1.2 billion.
As part of their underwriting strategy, insurers must make significant efforts to combat the
risk of insurance fraud. Insurers must develop sufficient screening tools to prevent the
introduction of fraudulent customers onto their portfolios. Such customers intend to make
false claims and ease the impact of opportunistic misrepresentation of risk to obtain cheaper
premiums. Underwriters must work closely with claims teams to understand the overall
counter-fraud activity that is undertaken.

On the Web
Marriner, K. (2014) 'Industry welcomes government fraud action', Post Online, 7 June
2014. www.postonline.co.uk/insurer/2348828/industry-welcomes-government-fraud-action.
Association of British Insurers News release 2813/87/20195. www.abi.org.uk.

D Distribution
Refer to
Think back to M80, chapter 3, sections E and F

Distribution has always been highly influential in shaping insurance markets and every
insurer’s distribution strategy is central to its business. As distribution methods and customer
preferences can be subject to considerable change, this is undoubtedly one of the most
challenging strategic areas in general insurance – one which presents both opportunities and
threats.
Some insurers focus on a single distribution channel, such as:
• direct;
• the use of agents; or
• professional intermediaries.
Different methods can be used within a single channel, for example, a direct insurer could
transact business by telephone and/or the internet through contact centres or could adopt a
purely internet-based service. There is also considerable scope for direct insurers to utilise
different media for advertising purposes, as well as the possibility of white-labelling their
products on behalf of well-known consumer brands.
 3/20 960/December 2020 Advanced underwriting

On price comparison/aggregator websites participating insurers can include direct insurers,

despite the fact that the aggregator takes a commission. Some direct insurers choose not to
participate on such sites.
Similarly, insurers using the professional intermediary channel use a variety of distribution
methods which are also subject to change. While most professional intermediaries in the UK
are now keen to use internet-based quotation facilities for small commercial business, some
years ago the same business was often being dealt with by on-site underwriters in brokers’
offices.
Many large insurers favour a multi-channel distribution strategy, utilising many different
Chapter 3

distribution methods.

D1 Delegated authority arrangements

One important aspect of an insurer’s strategic mindset is the possibility of using delegated
authority arrangements to attract business. These arrangements take several forms, namely
binding authorities, lineslips, coverholders, consortia, group/affinity programmes and master
covers. Detailed coverage of the technicalities of delegated authority is beyond the scope of
this syllabus. We will consider binding authority arrangements in this study text, which are
contracts whereby an insurer/underwriter authorises a third party – such as a broker or
managing general agent (MGA) – to act on their behalf.
Binding authority arrangements offer a number of advantages to the insurer, including:
• access to businesses in local markets that would not normally come into their sphere;
• cost-effectiveness of writing high volume/low value business that would be too expensive
to write individually in the open market;
• lower operating costs;
• access to knowledge, experience and reputation of the coverholder;
• a more cost-effective way of trying out a new class of business without employing a new
set of underwriters, on a follow basis;
• access to more data for pricing and insight; and
• localised and efficient claims handling which enhances the insurer’s reputation.
There are, however, various disadvantages, which include:
• loss of control;
• failure of coverholder to report adequately;
• premiums not adequately accounted for or paid;
• local legislative/regulatory rules which may not be complied with;
• impact of poor claims service on the insurer’s reputation;
• mismanagement of funds;
• accepting a lead share on risks for a class of business in which the insurer has little or no
expertise;
• anti-selection where the coverholder has several binding arrangements in place with
different insurers for similar risks; and
• unauthorised sub-delegation.
Binding authorities can be a cost-effective way of writing risk which an insurer may not have
access otherwise to write. In light of the potential disadvantages, it is apparent that an
insurer should take great care in choosing a coverholder and they should ensure that a
detailed due diligence exercise is completed before authority is granted. Some of the
questions they should be asking include:
• Does the coverholder have the necessary knowledge and experience? Does the
individual(s) named in the binding authority agreement have suitable experience to make
decisions?
• Does the coverholder hold binders with other insurers? Does it have a reputation for
correct management of these binders?
• Are the necessary controls in place?
• Is the coverholder aware of the local regulatory environment and does it have processes
in place to pay local taxes etc.?
Chapter 3 Strategy 3/21

• What is the coverholder’s ICT capability? Will it be able to produce bordereau in a timely
and accurate manner with the information required by the insurer?
As well as exercising due diligence, the insurer should have a stringent audit system to
ensure the coverholder is adhering to the rules and regulations set out in the binding
authority agreement.

Research exercise
Have a look at some of the binding authority contracts that you have access to. See if they
have specific guidelines relating to underwriting within them. What level of detail is

Chapter 3
provided? How is compliance with the guidelines checked?

Be aware
In addition to the UK-specific regulatory requirements imposed on insurers and
coverholders based in the UK, there are also Lloyd’s-specific requirements for those
operating in the Lloyd’s market. These are outlined here: https://bit.ly/2SRpe49.
Lloyd’s publishes a Code of Practice, which serves as an introduction to delegated
authority in the Lloyd’s market. There are also Minimum Standards which all Lloyd's
business must comply with.
The FCA conducted a thematic review of delegated authority in the general insurance
market. The review, published in July 2015, highlighted that improvements are needed in
the due diligence undertaken and the consideration of their regulatory obligations.
https://bit.ly/2yXVAUy

D2 Market facilities
In recent years large brokers have taken delegated authorities a step further by introducing
market facilities.
A market facility can be defined as a structure whereby a broker bundles its account, or
significant portions of its account, and places it in the market as a block of business at the
terms and conditions agreed with the lead underwriter. The participants to the facility must
accept risks across the whole block of business rather than being able to underwrite
individual risks. The facility underwriter(s) may have some discretion on the scope of the
facility but there is no level of discretion on each risk underwritten. The facility may include
both direct and reinsurance business.
These are also often called ‘full-follow’ or ‘blind underwriting’ facilities. Insurers pay an
enhanced commission to participate is these facilities.
Opinion is divided as to whether this commoditisation of the insurance market has gone
too far.

Critical reflection
Think of and investigate the advantages and disadvantages of participating in market
facilities from an underwriting manager’s point of view.

D3 Access to customers
Within an overall marketing strategy which has identified key products and target customers,
those responsible for distribution must identify the channel and methods of distribution which
will provide best access to the target customers. By focusing on access to customers, well-
aligned distribution strategies will help the insurer achieve its sales targets in the most
effective manner, namely achieving the highest volume of sales for the lowest acquisition
cost per policy or per premium.
In the past, there was a tendency for specific customer groups to be strongly aligned with
particular distribution channels and methods. In the UK it is evident that this tendency is now
less marked, with even the role of professional intermediaries in the market for SME
commercial business under apparent threat.
 3/22 960/December 2020 Advanced underwriting

On the Web
Swift, J. (2010) 'QBE: shock findings show a third of SMEs would go direct', Post Online, 1
February 2010. https://bit.ly/2JJ2qjc.

The use of line slips and the coinsurance of large commercial risks remains a very effective
way for insurers to access these particular customers and still achieve a spread of risk.
Intermediaries who can offer both access to the most appropriate insurers and other forms of
advice and support (for example, broader risk management or the management of captives)
will clearly represent the most effective channel accessing this significant customer group.
Chapter 3

For some customer groups, the distribution method may be highly influential in the choice of
insurer. For example, direct-only companies and those using tied agents seek out customers
who wish to deal in these ways and those who might be persuaded to do so.

D4 Knowledge of risks
As well as providing access to customers, insurers’ distribution strategies and methods
provide underwriters with knowledge of customers and their risks.

Be aware
Different distribution strategies and methods affect the volume and quality of risk
information available to underwriters and the opportunities they may have to differentiate
acceptance criteria and terms. Distribution therefore has a very significant impact upon
underwriting and upon the approaches, or strategies, underwriting areas can adopt.

To assess the impact a distribution strategy (and/or method) has on the understanding and
selection of risks and the application of appropriate terms, in the following example please
consider the extent to which each option offers:
• quality knowledge of target customers and risks (characteristics, behaviours, preferences,
claims experience);
• opportunities for underwriters to develop and apply detailed acceptance criteria and
differentiated terms (including risk premiums); and
• direct decision-making for the insurer’s underwriters, with the ability to consider unusual
risks and adjust standard terms.
Chapter 3 Strategy 3/23

Example 3.6
An insurer currently has a relatively small book of personal lines motor business. Market
research suggests that the following three approaches would be equally effective in
acquiring the desired volume of new business:

Option 1 Option 2 Option 3

Provision of a dedicated contact An advertising campaign in a Exclusive marketing to the

centre for selected brokers, all number of daily newspapers, members of an over-50s
based in provincial towns. supported by direct internet organisation, with the membership

Chapter 3
fulfilment. organisation holding delegated
underwriting authority.

Evaluation of options
Option 1
• The brokers are already known to the insurer and the underwriters may assume that
new business from these sources will fit a particular socioeconomic and geographic
profile. (They need to check to what extent the brokers deal out-of-area.)
• Brokers generally pride themselves on their ability to attract and retain clients who will
be profitable for both broker and insurer. They are less likely to wish to deal with a
client who has a poor claims experience as such a client will cost the broker more in
handling charges and could undermine the broker’s relationship with the insurer. ‘Local
knowledge’ may enhance the broker’s client selection. It may therefore be assumed
that the new business will generally be of average or above-average quality.
• This option could provide the insurer with a reasonably diverse book of personal motor
business. As the brokers were specifically targeted by the insurer, the underwriters can
compare the new business (quoted/incepted) with the assumed profile.
• As the business will be processed on the insurer’s system, the underwriters will have
full access to all relevant management information. In due course, this data could
provide the basis for refinement of acceptance criteria and risk premiums.
• The contact centre will need to be staffed by underwriters who can satisfy the
requirements of professional intermediaries and they will expect the staff to have some
degree of authority to amend terms and premiums. All risks will be underwritten by the
insurer’s own staff, operating under licence.
Option 2
• Based on the newspapers selected (local, provincial or national), the broad profile of
the readership will be known. However, mass advertising is a fairly indiscriminate
approach to the acquisition of potential customers. It might be assumed that the overall
claims experience of those responding to the advertisements may be poorer than that
of customers acquired under Option 1. However, in view of the general decrease in
customer loyalty/inertia, it would be wrong to assume that the only readers responding
to such advertisements would be those with a higher-than-average propensity to claim.
• Nonetheless, the typical underwriting response to such a broad potential customer
base would be to draw up tight acceptance criteria in the first instance. The
underwriters will have the opportunity to review all quote data on the system and
amend general criteria and terms as they wish. They will have to be alert to the impact
of other rival offers from competitors which at any point could distort response levels.
As the profile of the business develops, the option to target other socioeconomic or
geographic groups, by advertising in different newspapers can be considered.
• As contact with customers is internet-only, there will be very limited opportunities, if
any, for underwriters to consider waiving acceptance criteria or amending terms on
individual risks. The success of this approach will largely depend upon the quality of
the acceptance criteria and rating structures built into the system and the degree of
refinement which can be applied over time.
Option 3
• As the membership of the organisation is known and the historical claims experience
may also be available, the opportunity exists to shape the product offering, acceptance
 3/24 960/December 2020 Advanced underwriting

criteria and terms to best mutual advantage. The fact that the customer segment is
very specific (drivers aged over 50) may, from an underwriting perspective, provide
welcome balance to the insurer’s existing motor book or it may confirm an existing
bias. The important point is that the profile of the new business is known before even a
single quote is issued.
• With appropriate limits applied to the delegated underwriting authority and referral and
audit processes implemented, this option could produce the most predictable result
(sales and loss ratios) of the three examined. The downside to this arrangement is that
much of the knowledge of the target customers and specific expertise in underwriting is
Chapter 3

retained by the delegated authority holder. Although there will be some interaction with
referral underwriters, the nature of the arrangement precludes overly-frequent referral.
The management information obtained by the insurer’s underwriters may be quite
limited, especially if bordereaux are used. This option may therefore provide limited
development opportunities for the insurer.
Summary of evaluation
Based on the three criteria outlined earlier, each option has advantages and
disadvantages, depending upon the objectives of the insurer and the insurer’s current
capabilities. There isn’t a ‘best’ option but rather a ‘best-fit’ option depending upon the
individual insurer’s circumstances and ambitions.
Option 1
• Provides the most scope to build an understanding of a diverse selection of customer
requirements and risk experience and the best opportunities to respond by amending
general acceptance and rating structures, as well as on an individual basis.
• Through direct communication with the brokers, it would be possible to influence the
profile of new proposers quite quickly (for example, the insurer wants more or fewer
young drivers).
Option 2
• Makes sense for an insurer wishing to build a direct business while highlighting the
precision with which the advertising media need to be selected and the time it may
take to build the desired profile of business.
Option 3
• Potentially provides the best knowledge of a specific segment of target customers.
• Offers an insurer with the desire to work in niche areas the opportunity to build a book
at relatively low fixed cost.

Be aware
The ‘knowledge and scope-for-action’ criteria described in this chapter are not designed to
encourage underwriters to veto distribution options which do not maximise these features:
they are intended to help underwriters respond to such options by evaluating potential
opportunities and limitations and, on that basis, devise appropriate responses which
enable insurers to achieve their targets.

Additional points
Costs – would any of the three options outlined above be costlier than another?
The following are general observations on the relative costs of systems, intermediary
remuneration (commission), advertising and underwriting staff:
• Systems. Always costly to build, amend and operate; the actual cost would depend upon
what systems capabilities the insurer already had. Options 1 and 2 could be costly;
Option 3 could be cheaper depending upon the actual division of work between the
insurer and the delegated authority holder.
• Commission. Option 3 (enhanced commission) more costly than Option 1; Option 2, nil
commission.
• Advertising. Option 2 very costly.
• Underwriting staff. Option 1 most costly; Options 2 and 3 less costly.
Chapter 3 Strategy 3/25

As the cost of advertising could equal the cost of standard intermediary commission, there is
possibly little overall difference in the cost of the three options. The cost of systems (new
build or adaptation) could represent the most significant difference between the options.

Consider this…
Quotation success rates – if the amount of new business obtained by each of these
three options is the same, do you think that the rate at which quotes are converted into
new business would be the same or differ? What does this imply about the volumes of
quotes which must be generated?

Chapter 3
Renewal retention – another important element in the cost equation. Which options would
typically retain most and least business at renewal, in your opinion?
The example above involved a personal motor product. In considering the relationship
between distribution and underwriting strategies, the scale of the potential customer base is
a critical feature. Due to the size of the personal motor market, not only can substantial
expenditure on advertising be justified but the scale of the customer and claims databases
associated with personal motor enables sophisticated rating structures to be developed
which cannot be emulated in other areas of the market. Thus in the personal motor market
there are sufficient potential customers and reliable data for many insurers to pursue
subgroups, such as drivers aged over 50, with good prospects of success.
By contrast, the challenge represented by SME commercial business in the UK is becoming
increasingly apparent as insurers and intermediaries experiment with different distribution
channels and methods with the objective of securing worthwhile market shares at
reasonable cost. Although professional intermediaries continue to handle a considerable
amount of SME business, innovative approaches including direct sales, white-labelling, the
use of price comparison sites and a range of different MGA approaches are increasingly
prevalent. However, many of these approaches present a far greater challenge to
underwriters in the SME market than in a mass market such as personal motor.
As mentioned in SME businesses on page 3/18 of this chapter, the SME market lacks the
scale of the personal motor market and this is further compounded by the lack of
homogeneity in SME business and its lower claim frequency. It is therefore more difficult to
build up data and knowledge on which reliable, highly differentiated rating structures can be
based.
The pressure on insurers and intermediaries to find cheaper ways to handle SME business
is understandable: SME premiums are relatively low and underwriters’ and brokers’ salaries
are relatively expensive. There have therefore been a number of different initiatives involving
the use of electronic communication to speed up routine administration and eliminate
duplication between brokers and insurers. Many of these initiatives have also sought to
standardise and reduce insurers’ question sets.
D4A The cost of (not) asking questions
Underwriters naturally want to know as much as possible about the risks proposed to them,
but in today’s insurance markets they might be constrained from asking all the questions
they would like to ask.
In mass markets, such as UK personal home and motor, the number of questions asked of
new proposers has been reduced and the questions themselves have become increasingly
standardised. Limited numbers of standardised questions are cheaper to process on
computer systems and make the work of price comparison sites simpler. Insurers have
adapted policy covers to avoid having to ask questions which could be perceived as difficult
to answer accurately or which might put the insured at a disadvantage when they make
a claim.

Example 3.7
Bedroom-rated household policies avoid the need for specific valuations, as does the
trend for maximum valuations (such as ‘Buildings Sum Insured £1m maximum’).

This approach supports those customers who wish to ‘shop around’ and serves to reinforce
the predominant focus on price in UK personal lines insurance. This has had an inevitable
 3/26 960/December 2020 Advanced underwriting

impact on product design, with fewer significantly differentiated product and service offerings
widely available.

Commoditisation
The process by which products become less differentiated and buyers care less about
which company they buy from: price is the main deciding factor.

Fewer questions and fewer options also support cheaper, non-advised sales – another
feature of the UK personal lines market. It could be said that a certain equilibrium now exists
Chapter 3

within this market as proposal questions, acceptance criteria, rating structures and products
have adjusted to the new distribution methods introduced over the last 30 years.
This process is still at an early stage in the SME market. Underwriters realise that reduced
question sets (and/or poorly phrased questions) can lead to the insurer being selected
against and there is a tension between those who favour simpler rating structures (cheaper
and faster to use) and those favouring more complex rating structures (which can
discriminate to a greater extent between high-, low- and average-hazard risks). It remains to
be seen whether the increasingly common use of statements of fact rather than proposal
forms will affect the general quality of information available to underwriters and their ability to
manage loss ratios.
Any trend towards the lowest common denominator in SME product design is hindered by
the continued, substantial involvement of professional intermediaries in this class of
business. Brokers want to be able to differentiate their offerings (and gain competitive
advantage) but they also feel the pressure of mounting costs and are narrowing down the
range of contracts they are prepared to offer, particularly for smaller business clients.
Insurers too are considering carefully the cost of additional benefits and value-added
services against customer requirements and the need to be price-competitive.
In non-advised sales to SME businesses, the drive for price-competitiveness could benefit
those insurers whose products offer lower limits of indemnity (for example, £1m rather than
£2m for public liability cover) which may or may not be appropriate for individual businesses.
As a matter of underwriting strategy and the fair treatment of customers requirement,
insurers involved in non-advised sales must address the suitability of their products in
respect of their essential features.

Sufficient information
Under the Insurance Act 2015, effective since August 2016, the burden is on the insurer
to ensure it has sufficient information to underwrite a risk. See Insurance Act 2015 on
page 1/21 for more information on the Insurance Act 2015 and its effect.

D5 Differential pricing
As noted above, different distribution channels and methods will have different costs
attaching to them: different up-front costs (for example, expenditure on systems) and
ongoing costs (commission, advertising, underwriter support etc.). Later in this study text we
will discuss the assessment of risk premiums and the other elements which make up the
final premium to the customer.
In an ideal world the calculation of general insurance premiums would be on a ‘risk premium
plus’ basis (that is, risk premium plus all other attributable costs). Often, particularly in the
most competitive areas of the business, a more complex approach is required in order to
achieve a specific target premium through the optimal selection of:
• product/service benefits;
• target customers and acceptance criteria;
• distribution channel and methods; and
• insurer administration.
One of the biggest challenges in general insurance is not necessarily the identification of
attractive market segments but rather identifying the best means of accessing particular
segments cost-effectively and understanding the implications of that choice. As previously
Chapter 3 Strategy 3/27

mentioned, some low-cost methods of distribution can over time reduce the insurer’s
knowledge of customers and risks and thus reduce their own capability.
Many distribution arrangements are based on a different allocation of administrative
responsibilities and costs between insurers and intermediaries. For example, some
intermediaries undertake to issue policy documents on behalf of the insurer and this may
reduce the overall premium. For the same risk, some direct insurers will be able to charge
less than insurers using intermediaries, if advertising costs are lower than commission costs.
As well as acquisition costs, insurers might also consider how different retention rates or
ability to cross sell affect the costs attributable to different distribution options.

Chapter 3
Example 3.8
Retention rates on business acquired through price comparison websites are likely to be
lower than average, increasing the cost of simply maintaining a static level of total
premium income.

Consider this…
Would underwriters developing a rating structure for a particular group of risks be justified
in adjusting the risk premium based on the distribution method or channel?

Most intermediaries, particularly those focusing on clients in a geographical area or involved

in a particular type of business, will claim that they bring superior discernment to the
selection and management of clients, to the benefit of the insurer’s claims experience.
Typically, such intermediaries will still be offered the insurer’s standard open-market
premiums, however, some have started to offer better screen rates to certain intermediaries
or enhanced commission. Intermediaries may be given access to underwriters with the ability
to offer higher than standard discounts and they may also participate in some form of profit-
share scheme, reflecting the overall profitability of their book of business.
Some intermediaries who have specialised in serving the needs of particular groups of
customers will argue that they not only select clients well but that their long experience
enables them to underwrite these risks more effectively than the insurer. This is the basis for
many delegated authority arrangements, such as schemes and MGAs. An insurer wishing to
target an unfamiliar group of customers or a group which they have difficulty in gaining
adequate access to, may consider such an arrangement.
The insurer may amend the standard base premiums and discounts available to the
delegated authority holder: the intermediary may have long-established expertise backed-up
by excellent claims data which justifies such amendment. Even if the base rates and
discounts are issued unaltered, there is every chance that their application in the hands of
the delegated authority intermediary will vary to some degree.
A challenge often arises fairly soon after differential pricing has been agreed: when internal
underwriters and/or other intermediaries realise that a scheme broker or MGA has more
advantageous rates for the same risk-types and the differential cannot be wholly attributed to
administration/commission. Technically, there may be a justifiable argument for differential
risk pricing.

Be aware
Appropriate justification for differential risk pricing depends upon scale and knowledge,
namely the size of the sample of risks, the degree of understanding and thus the
predictability of the claims experience. Any set of risk premiums assumes a certain mix of
risks: if the mix is significantly different, the risk premiums should reflect this. This is an
issue which will be dealt with later in the study text but it is fundamental when considering
risk pricing across different distribution options.

Differential risk premiums required?

Until now the discussion has focused on insurers either starting up or, as in the example
above, wishing to grow a small existing book. Insurers with substantial existing books of
business, when asked to consider the appropriate risk premiums for a new distribution
arrangement, might fail to consider biases inherent in their current book of business. These
biases, if long-standing, will be catered for within the existing rating structure (through cross-
 3/28 960/December 2020 Advanced underwriting

subsidies to a greater or lesser extent) but if the mix of business derived from the new
arrangement does not mirror the existing account, the use of the existing risk premiums may
not produce the predicted result. This problem is more likely to arise in areas such as SME
than in personal motor, due once again to the issues relating to lack of scale and
homogeneity; this restricts insurers’ ability to develop reliable, multi-factorial risk premiums.

D6 When things change

Change affects all insurers, even those who want to continue to do the same things in the
same way: the environment and markets in which insurers operate make change inevitable.
Chapter 3

As an underwriting manager, you have to be alert to changes in distribution channels and

methods which may impact your company’s underwriting strategy and results. Insurers using
the intermediary channel in the UK will be very aware of the changes associated with broker
consolidation over the last decade, most noticeably the prevalence of higher commission
levels in commercial insurance. (The consolidators have built large businesses from the
acquisition of many smaller intermediary firms.) Consolidation may also have disrupted
relationships between underwriters and intermediaries and changed the type and quality of
business offered by particular intermediary offices. The assumptions which underpinned the
underwriters’ approach to business generated by the intermediary have to be re-validated.
The advance of technology, specifically the ability of some insurers to amend rates every
day if they wish, and to set automatic acceptance quotas for certain types of risk, provides
significant opportunities in respect of underwriting strategy for these companies. These
developments create immense challenges for other insurers without similarly sophisticated
systems.

Critical reflection
How can insurers without sophisticated systems amend their underwriting strategies and
procedures to ensure that they do not acquire by default a disproportionate share of less-
desirable business?

Currently, there is debate surrounding dual pricing by motor and home insurers. This is in the
form of charging different rates for the same risk depending on whether it is new business or
a renewal or on the distribution channel. In September 2018, the FCA announced it would
investigate the practice of dual pricing following a super complaint by Citizens Advice.

On the Web
In July 2014, the FCA published its review of price comparison websites in the general
insurance sector. The report (TR14/11) is available from the FCA website: www.fca.org.uk/
your-fca/documents/thematic-reviews/tr14-11.
'FCA to launch investigation after dual pricing super-complaint'. Insurance Times. 28
September 2018. https://bit.ly/2yTxFDM.
In March 2019 Lloyd's launched The Future at Lloyd's programme, which was
subsequently updated in January 2020. A number of the proposals in the prospectus
necessitate increased use of technology and changes to the distribution strategy of how
products are delivered. See futureat.lloyds.com/blueprint-one/blueprint-one-update.

E Operations
An insurer’s operational strategy will be largely determined by the company’s marketing and
distribution strategies. This is not to imply that only one operational strategy best fits any
particular combination of products, target customers and distribution channel but that, in
order to be effective, an insurer’s operational strategy must be well-aligned to these
strategies in particular. For insurers wishing to deal effectively and profitably with a range of
customer groups, different operational structures, technologies and styles of operation may
be appropriate for different units within a single company.
Chapter 3 Strategy 3/29

Customers and intermediaries may prefer to interact with insurers:

• face-to-face;
• online or by email;
• by telephone; and/or
• by mail.
Underwriters require data in order to manage risk acceptance: the costs and relative
advantages of different types of operational structure and technology will influence how
insurers respond to these preferences and requirements.

Chapter 3
The advance of information and communications technology (ICT) has encouraged a
centralising trend in general insurance in the UK. Large networks of branch offices have
become far less common and the centralisation of certain functions, such as document
production and dispatch, has changed the work that once went on in those branch offices.
As well as managing costs, insurers are also looking to achieve greater consistency in the
service provided and improved risk management by operating out of a smaller number of
larger offices.
While for some insurers this trend may have resulted in a smaller number of larger regional
offices, with separate claims centres in two or three locations and a central document
production and dispatch unit, for others the majority of staff now operate out of very much
larger offices, split by function (such as underwriting, claims and accounts) rather than
geographical area, with their own dedicated call-centres. Some insurers make extensive use
of home-based workers and overseas back-office and call-centre units.
Managing change
In the last few decades there has been a great deal of experimentation with different
operational structures and technologies, and this continues. It is apparent that, as operations
are generally centralising, those customers and intermediaries who have a strong preference
for individual, relationship-based service may be disappointed by the options offered by
many insurers.

Consider this…
What impact have the changes in operational structures and ICT had on insurance
company staff?

While the impact on customer service tends to be the main focus in any discussion of
changes in operational structure, process or technology, how those delivering the customer
service are themselves served is a particularly relevant topic for those involved in
underwriting management.
Thirty years ago insurers published detailed books of personal motor rates (which were
typically updated every six months or annually) for use by branch staff and intermediaries,
whereas for the same business today the rates are held in computer databases and may be
updated daily. Customer service staff in call centres have online scripts and access to
answers for frequently-asked questions, as well as the ability to request assistance from
supervisors and underwriters. Some insurers dealing with commercial business falling within
the micro/small category may operate in a similar way to the typical personal lines call
centre. For business conducted in this way, underwriters typically work behind the scenes
supporting the customer service staff and their supervisors and/or they work with actuaries
monitoring claims experience, take-up and retention rates, and developing rating structures
and products.
In many ways less has changed for underwriters dealing with commercial (other than those
noted above) and more specialist business. Underwriters may access rates and underwriting
guides online and they have the ability to refer to more senior colleagues by email, as well as
by telephone. They are often now required to process business in its entirety, which in the
past underwriters may have handed over to more junior members of the team. Whether in a
local, regional or head office, underwriters have access to the internet and often to their own
company’s intranet. The availability of detailed, monthly information about the performance
of specific accounts and greater access to management information might be regarded as
the most welcome innovation for these underwriters.
 3/30 960/December 2020 Advanced underwriting

Underwriters continue to work in a range of roles requiring varying levels of underwriting skill
and knowledge, along with customer service, project management and supervisory skills.
From an underwriting management perspective, while the basic requirements have not
changed, each aspect of the management of the underwriting function has to be considered
with care.

Underwriting management decision: assessing operational

underwriting capability
Does the number of underwriters, their skills, authority levels, supervision, referral
Chapter 3

capability and supporting technology meet the requirements of:

• the relevant marketing and distribution strategies?
• the relevant underwriting strategy?
– Can risk acceptance be managed within agreed limits?
– Are the approaches to monitoring and auditing appropriate and effective?
• the regulator’s training and competence policy?

Underwriters are, of course, costly to employ. Increasing costs have encouraged insurers to
look to new technology to handle increasing volumes of business with less and less human
intervention. Clearly the optimal balance between automation and human interaction (from
both the customer’s and company’s perspectives) will vary between customer groups and
products and will vary over time.
One of the costs arising out of increased automation is, ironically, the cost of skilled
underwriters due to their relative scarcity. Older operational structures (typically branch
networks handling both personal and commercial business) provided a broad training for
staff wishing to pursue a career in underwriting (whether branch, specialist division or head
office). Newer structures tend to be more specialist and the opportunities to pursue a career
in underwriting are less apparent to many staff. This is an industry issue and one which, as
an underwriting manager, you will face. Does the industry:
• attract skilled underwriters by paying higher salaries?
• invest heavily in training those with lower skill levels?
• understand where the senior underwriters of tomorrow are coming from?
• invest in more technology support?

Be aware
This latter option is not necessarily the easy answer. The adoption of new technology in
commercial insurance has been complex and costly, and few commercial underwriters
express total satisfaction with their own company’s current systems. This dissatisfaction
reflects a fundamental dilemma which remains to be resolved in many companies: to the
extent that commercial underwriting requires a degree of individual judgment, the
implementation of highly automated systems could be counter-productive as well as very
costly (to cater for all or a high proportion of necessary variations). At the same time
insurers are looking for cost savings, better information, consistency and risk management
which improved systems can provide. Each insurer has to determine the extent to which
the development and use of computer systems represents a hygiene factor or source of
competitive advantage and they then need to decide how to achieve the necessary trade-
off between cost, timeliness and functionality in the development of their systems.

Company culture and leadership styles

For the purposes of this brief discussion of operational strategy we have considered
operational structures and technologies, how they are changing and how the delivery of
customer service and staff roles have been impacted. The focus now shifts from physical
structures and supporting technologies to company culture and styles of leadership.
Company culture reflects ‘the ways things are done’ and influences the development of
important organisational capabilities, such as communication, decision-making and
performance management (all critical in underwriting and customer service). Culture also
influences how a company’s management and staff approach issues such as change
Chapter 3 Strategy 3/31

management and, in this and many other ways, these organisational capabilities can
become significant sources of competitive advantage.
Many companies try to articulate key aspects of their desired culture within corporate
strategy and will make links to issues such as remuneration (pay and benefits), staff
retention and development opportunities. In reality, much of what makes up a company
culture is commonly understood but not explicit and therefore difficult for the company to
influence directly.
The most effective way of influencing culture is through leadership. Many roles include
leadership accountabilities and no one style of leadership is uniquely suited to underwriting

Chapter 3
management. As different customer and internal functional groups have different service
requirements, the units which service those groups require different styles of leader who can
appropriately influence staff actions and behaviours.
Most large companies, with a diversity of customer groups and internal functions, will seek to
develop a common underlying culture with the necessary, appropriate variations at unit level.
The appropriate ‘tuning’ of culture requires an awareness and sensitivity which individual unit
leaders are best placed to provide. How leaders spend their time indicates most clearly to
staff what is valued in the organisation.

F Core elements of an underwriting strategy

You may have heard the truism about asking a number of underwriters to evaluate the same
risk – yes, they all come up with different answers. The same holds true when describing the
content of underwriting strategies. We have therefore spent a significant amount of this
chapter discussing those elements of corporate strategy (particularly risk appetite and
marketing, distribution and operational strategies) which not only impact upon underwriting
strategy but are often regarded as integral to it.
In order to address this variation in approach, we have dealt with each area in turn and will
now focus on what might be regarded as the core elements of underwriting strategy,
common to all. These core elements will be examined in greater detail in subsequent
chapters of this unit.

Be aware
What appears in a written underwriting strategy and which responsibilities are allocated to
an underwriting department, its staff and managers vary considerably between insurers.

Rather than underwriting strategy, it might be more accurate to refer to underwriting

strategies, in the plural. As noted earlier, each SBU within an insurance company is likely to
have its own underwriting strategy and it may apply differently to different distribution
channels or deals. Documented strategies will be designed for particular audiences: they
may be for the board, reinsurers, internal staff or brokers. They may be written in rather terse
technical terms or more descriptively, aiming to educate and inform. Subsets of underwriting
strategy, describing ‘target markets’, will be produced for internal and external use.
If a documented underwriting strategy is used as the key point of reference for an
underwriter’s licence, it must be as explicit as possible. That said, it is impossible to
anticipate every eventuality and the effectiveness of any underwriting team will be greatly
influenced by its ability to share implicit understandings regarding risk acceptance (the
means by which underwriters identify unattractive risks that fall within the company’s stated
underwriting strategy, for example). However, as compliance can only be assessed against
the explicit requirements of underwriting strategy or policy, you may find that the auditors
(internal/external) object to an approach which relies heavily upon implicit understandings
(see chapter 9).

Research exercise
Based upon the underwriting strategy which currently operates within your unit and/or the
documentary basis of your personal underwriting authority, list which aspects are explicit
(fully documented/referenced) and which are implicit (understood but not documented).
Would you recommend any changes?
 3/32 960/December 2020 Advanced underwriting

F1 Risk acceptance
The one topic which every underwriting strategy must deal with is the management of risk
acceptance.
In its simplest form this comprises:
• the risk acceptance limits which apply; and
• how risk acceptance is controlled (known as underwriting governance).
The risk acceptance limits are derived from, but do not necessarily match, the limits specified
Chapter 3

in the statement of corporate risk appetite: an underwriting strategy for personal or

commercial lines, for distinct SBUs or for a specific scheme or MGA will only contain the
limits appropriate to that business. In some underwriting strategies, the limits applying in
relevant reinsurance treaties may be referenced (see chapter 8).
As well as individual limits (for example, sums insured and limits of indemnity), the risk
acceptance limits will include:
• the definition of a single risk;
• exposure accumulation limits;
• maximum income limits;
• acceptable classes of business; and
• geographic limits.
Information regarding the availability of additional reinsurance facilities, such as facultative
arrangements, and advice relating to significant categories of unacceptable business should
be included. Other subsidiary strategies, such as those relating to flood or subsidence as
well as survey strategies, should be included or referenced. As well as describing which risks
may be accepted, the source or means of determining appropriate premiums for acceptable
risks should be indicated.
An insurer’s system of underwriting governance usually relies on a number of different
controls. Insurers using highly automated systems depend on the accuracy of rating
routines, tables and the personal profiles of customer service staff and underwriters. At the
other extreme, the legitimate scope of underwriters with limited or no systems support is
defined by their personal underwriting authorities or licences. Irrespective of the nature of the
insurance operation, all underwriting activity must be monitored and audited in such a way
as to ensure that the relevant underwriting strategy is being applied and corporate risk
appetite has not been exceeded (see chapter 9).
With the implementation of Solvency II, greater emphasis is placed on the ability of
underwriting managers to project and work within specified risk profiles and this requirement
has to be translated into day-to-day risk acceptance processes as well as underwriting
governance.

F2 Additional underwriting targets

While risk acceptance is clearly the key responsibility of the underwriting function, most of
what follows is shared to some extent with other functional areas, such as, sales,
distribution, marketing, claims and operations but will typically be included in underwriting
strategy.
• Targets relating to loss ratios/COR may be expressed as the desire to achieve a COR of
X% ‘over the cycle’ or may reflect the targets for the current period only.
• Other financial measures, such as GWP and commission ratio.
• Guidance relating to the state of the market (the insurance/underwriting cycle) and how
the company wishes to tackle the challenges this presents.
• Business development focus:
– which accounts are targeted for growth;
– particular types of customer or product;
– particular types of distribution channel or deal; and
– desired mix of business (relevant to risk profile, also).
Chapter 3 Strategy 3/33

F3 Service
As underwriting strategy includes the management of risk acceptance, a documented
underwriting strategy may be used to share important operational information about the
underwriting function, such as the following:
• The service standards that apply:
– responses to internal referrals or external business propositions; and
– the handling of complaints and indemnity issues.
• How authorities/licences are granted, reviewed and updated.

Chapter 3
• Auditing: how frequently branches/units will be audited and in what ways.
• Internal communication issues: where to go for information (intranet, circulars etc.), head
office and branch contacts, specialist referral points. Links to survey and claims
departments.
• Other services: seminars, training, development opportunities.

F4 For restricted circulation

Aspects of underwriting strategy that are commercially sensitive and thus confidential will not
be widely available. These could be, for example, considerations relating to:
• entering/exiting markets;
• reinsurance purchase and retention levels; and
• cycle management: timing of rate rises, tolerance of losses within risk appetite, etc.

F5 From strategy to practice

As we have illustrated, there are many inputs to any underwriting strategy. Having examined
the influence of corporate and other functional strategies, subsequent sections of this unit
will examine how underwriting strategy is translated into policy and practice, and how
practice might, in turn, suggest changes in strategy.
All underwriting strategies are subject to change: to respond to changes in corporate or other
functional strategies; to rectify underperformance; in anticipation of changes in exposure to
risk or to manage the cycle more effectively. All such changes must be communicated
effectively.

Underwriting management decision: communication of strategy

Has the communication been effective? Are reminders required? Have the target
audience fully understood the strategy and what they need to do in order to comply with
it? Have they had a chance to ask questions? Are they following the strategy?
Have other interested parties received and understood the strategy (surveyors, reinsurers,
intermediaries, for example)? Have you checked?
How do you plan to monitor whether the new strategy is achieving its intended aims?

Part of our examination of underwriting policy and practice in the next chapter will include
thinking about how to monitor performance long before the final results (such as fully
developed loss ratios and customer satisfaction scores) are available. Similarly, when
underwriting strategies are in the process of development or change, you need to establish
how their application and effectiveness will be monitored from the day of their
implementation, in order to ensure that the intended objectives are fully met, benefits
achieved and nasty surprises avoided.
 3/34 960/December 2020 Advanced underwriting

G Scenario 3.1
G1 Question
As underwriting manager, you are about to introduce a new senior underwriter (previously
employed by another company) to your department. Your new colleague has already had an
opportunity to read the relevant underwriting strategy and an initial underwriting licence level
has been agreed.
In order to ensure that the new underwriter fully understands the underwriting strategy (as
Chapter 3

well as how it supports and is supported by the company's other key strategies), what
information would you plan to include in this discussion and what questions might you ask?
You may choose to illustrate your points using either a personal or commercial point of view
but not a more specialised/narrow focus. Please remember that this is not intended as a test
of product knowledge.

G2 How to approach your answer

Aim
This scenario tests your understanding of the source of underwriting authority in a general
insurance company, the other strategies that relate most directly to underwriting and the
essential elements of an underwriting strategy.
Key points of content
You should aim to include the following key points of content in your answer:
• Brief personal introductions: your role and background/experience; ask about new
underwriter's background/experience, unless already well-acquainted through recruitment
process.
• Wider company perspective: objectives, strategies, plans and, particularly, risk appetite.
Relevant marketing and distribution perspectives, plus operational strategy (including
ICT/systems) and general implications for underwriting.
• Walk through the department's underwriting strategy, make the links to what you have
already discussed (for example, your own department's risk acceptance limits in relation
to the company's risk appetite) and encourage new underwriter to ask questions
(effectively comparing and contrasting with previous company). Acknowledge what is
similar but emphasise aspects which are distinctive.
• Illustrate key points by going into more detail regarding underwriting policy. Advise new
underwriter where information on detailed underwriting policy and practice can be found
and who should be consulted, if in doubt detailed information regarding acceptable risks
under reinsurance treaties, for example). Identify current issues such as state of market/
position on underwriting cycle and department's approach.
• Review agreed underwriting licence and link to issues already discussed. Reflect on any
important implicit understandings not documented. Confirm referral procedures. Describe
company's approach to underwriting governance and customer service expectations
(whether customer- or colleague-facing role). Explain how underwriters communicate with
claims and risk control functions.
• Ensure new underwriter has ample opportunity to ask questions.
Chapter 3 Strategy 3/35

H Scenario 3.2
H1 Question
Your competitor, Insurer A, has launched a new product set specifically designed to meet the
needs of Customer Group X. There has been a great deal of favourable comment in the
insurance press and there has even been some discussion of the products and its approach
in the national press.
This certainly looks like a good idea and most of the elements of Insurer A's approach could

Chapter 3
be replicated quite easily. A project team has been asked to consider the merits, implications
and costs of your company adopting a similar approach and launching a rival set of products
for Customer Group X.
As underwriting manager and one of the eventual decision-makers, what issues would you
expect the project team to consider?

H2 How to approach your answer

Aim
This scenario reflects a typical marketing dilemma which requires you to consider and
respond to the issues raised from an underwriting point of view.
Key points of content
You should aim to include the following key points of content in your answer:
More information about Insurer A's initiative:
• Evidence of sales of new product set to Customer Group X.
• Size and potential value of Customer Group X.
• Other insurers already active (or thought to be preparing to be active) in this segment –
their existing market share (and this company's share).
• Details about Insurer A's product offering.
Internal information on Customer Group X:
• If already underwritten by this company – general claims experience of our Customer
Group X risks; if subdivided, are there more/less attractive subsets?
• How different is our product offering for Customer Group X, compared with Insurer A's?
• What would be required to match or better the cover provided by Insurer A? If we did so,
would it fit within current strategy (including reinsurance coverage)? What else could we
do to differentiate our offering for Customer Group X?
Prioritisation:
• What's in our current product development plan already? What evidence do we have that
any of the options discussed re Customer Group X could prove more rewarding than the
product development work already planned?
• For the options under consideration, what would the product development work cost and
how long would it take to complete? Do we have the resources? Do we understand all of
the issues and risks involved in pursuing any of these options?
External perception/reaction:
• How will customers (and brokers) react? Would it look like a 'me too' approach that could
undermine our brand image or such a good idea that our company's entry will be
welcomed? Might our Customer Group X initiative drive prices down?
 3/36 960/December 2020 Advanced underwriting

Conclusion
The main ideas covered by this chapter can be summarised as follows:
• Corporate strategy states, at the highest level, which markets the company is focused on,
the value it intends to generate for shareholders, staff and customers, and how the
company's approach will achieve this in the current environment.
• Most corporate strategies will include specific financial and non-financial targets that will
help to shape the underwriting strategy.
• The underwriting strategy for domestic insurers should be explicit regarding which foreign
Chapter 3

exposures are/are not acceptable.

• Multinational insurers will utilise different entry strategies and structures in their
businesses around the world.
• The objective of marketing is the creation of a sustainable competitive advantage.
• For many years the external environment has affected general insurance through the
operation of the insurance or underwriting cycle. While certain aspects of the insurance
market influence the precise path of the cycle, the fundamental influence behind the cycle
is the flow of capital seeking optimal returns.
• Distribution is highly influential in shaping insurance markets and every insurer's
distribution strategy is central to its business. As distribution methods and customer
preferences can be subject to considerable change, this is undoubtedly one of the most
challenging strategic areas in general insurance: one which presents both opportunities
and threats.
• An insurer's operational strategy will be largely determined by the company's marketing
and distribution strategies.
• Every underwriting strategy must deal with the management of risk acceptance, i.e. the
limits and how it is controlled.

Additional reading
Airmic. (2014) 'Understand clients' business models to stay relevant, Airmic tells
underwriters', 28 October 2014. https://bit.ly/2JUKsKq.
Chorn, N. and Hunter, T. (2004) Strategic Alignment. Richmond Ventures Pty Limited.
CII and Ernst & Young. (2007) The future of distribution in SME commercial general
insurance: the impact on underwriting and the underwriter of the 21st century. 1 May
2007. https://www.thepfs.org/learning-index/articles/the-future-of-distribution-in-sme-
commercial-general-insurance-the-impact-on-underwriting-and-the-underwriter-of-
the-21st-century/9878*.
Hughes, J. (2010) 'Performance – shareholder returns: cut to the core', Post Online, 19
May 2010. https://bit.ly/2RSlIWd.
Lafley, A.G. and Martin, R.L. (2013) Playing to win: how strategy really works. Boston,
Massachusetts: Harvard Business Review Press.
Marriner, K. (2014) 'MGAs hear Lloyd's plans for delegated authority business', Post
Online, 11 February 2014. https://bit.ly/2PRBva9.
Nurala, R. (2014) 'Big data analytics – the solution to insurance fraud?', Post Online, 13
June 2014. https://bit.ly/2JWwpUF.
Rumelt, R.P. (2012) Good strategy/bad strategy: the difference and why it matters.
London: Profile.
Thuring, F. (2012) 'A credibility method for profitable cross-selling of insurance products',
Annals of Actuarial Science, March 2012, volume 6 (issue 1), pp. 65–75.
*MyCII login required to access this article.
 Underwriting policy
4
and practice
Contents Syllabus learning
outcomes

Chapter 4
Introduction
A Managing change 5.1
B Evaluating risk 2.9
C Establishing cover and terms 1.1, 2.4, 2.8
D Portfolio management 2.1, 2.7
E Scheme underwriting 2.3, 2.8
F Scenario 4.1
Conclusion

Learning objectives
This chapter relates to syllabus sections 1, 2 and 5.
On completion of this chapter and private research, you should be able to:
• evaluate current underwriting policy and practice by assessing their appropriateness and
effectiveness;
• identify options for the amendment of underwriting policy and practice;
• assess the implications of proposed changes to underwriting policy and practice; and
• consider how best to apply the agreed changes to underwriting policy and practice.
 4/2 960/December 2020 Advanced underwriting

Introduction
Whether an insurer’s underwriting strategy is documented in brief, technical terms or in great
detail, it is underwriting policy which defines the full implications of the strategy and
underpins the day-to-day practice of underwriters. While certain aspects of underwriting
policy are derived directly from underwriting strategy (for example, authorised classes of
business and maximum exposures), other aspects of policy have to be tested, selected and
refined to meet both corporate and customer requirements.
In this chapter we examine how this is achieved by considering:
• risk evaluation through classification and categorisation of risks;
• acceptance and renewal criteria;
• risk improvement and control;
• establishing cover and terms;
• portfolio management; and
Chapter 4

• scheme underwriting.
We shall start, however, by discussing your role in monitoring and amending underwriting
policy and practice.

Key terms
This chapter features explanations of the following terms and concepts:

Ballpark price Business mix Categorisation Cherry-picking

Classification Cover comparisons Cross-subsidisation Expense allocation
Historical internal Market claims data Portfolio Product design
claims data management
Product mix Risk acceptance Risk control Risk improvement
Scheme underwriting Survey strategy

A Managing change
Be aware
Anticipating, determining and handling change through the amendment of underwriting
policy is a major responsibility of all underwriting managers and this capability is at the
core of their professional expertise.

As the requirements of insurers and their customers change, so must underwriting policy.
Change in underwriting policy may be necessary because:
• policyholders and/or brokers may have requested other cover options;
• the market may have to react to new reinsurer requirements or newly implemented
legislation;
• an insurer’s claims experience may be consistently worse than expected; and/or
• opportunities may arise to exploit new technology in the sales process or a new source of
business may emerge.
The manager responsible for dealing with the underwriting aspects of such issues and
proposing changes in underwriting policy has to evaluate carefully the issues involved,
potential solutions and impacts. Any new policy must fit within current underwriting strategy
and avoid conflicting with other relevant strategies, such as marketing or distribution.
Claims staff, risk control surveyors and actuaries will often be key collaborators in
evaluating policy options; they have access to important, relevant information and their work
may also be directly affected by any change implemented.
As well as investigation, reflection, liaison with colleagues and a degree of creativity, the
evaluation of different options will generally require a financial assessment in the form of
Chapter 4 Underwriting policy and practice 4/3

projected monetary sums, such as total premium, claims cost and exposure, as well as an
assessment of the business risks attached to each option. Finding data relevant to the issue
under consideration and using it appropriately can represent a considerable challenge.
In many instances, the appropriate data with which to project the impact of a change in
underwriting policy may not be readily available or may be less than ideal (they may be scant
or corrupt). Historical data may be unavailable or of poor quality due to the failure to collect
relevant data, poor data-entry standards, the use of bordereaux in delegated authority
arrangements and/or the limitations imposed by multiple legacy systems. Notwithstanding
the efforts made by insurance companies in recent years to improve the quality of their data
and access to management information (MI) (increasingly necessary in order to satisfy the
requirements of Solvency II), finding the necessary data with which to project the impact of
future changes will still often present a challenge.
Assessing the potential impact of change is necessary, however, even when everyone is
convinced that it is ‘the right thing to do’. Actuarial or statistical colleagues will be able to help
model the potential impact of changes to assist decision-making, determine how the impact

Chapter 4
of the chosen option should be represented in financial plans or budgets and agree a means
of monitoring those impacts after implementation (see chapter 5 and 9).
Need for effective implementation
Each underwriting policy change must be supported by MI and portfolio management data
to allow underwriting and pricing teams to assess the impact of the change against
expectations.
Underwriting strategy may be clear and underwriting policy well-considered but if
underwriting practice fails to follow the required policy, an insurer’s business is fundamentally
undermined as executive management is no longer in control. Underwriting governance has
already been mentioned in chapter 3 and monitoring and operational controls will be
discussed later in chapter 9, but it is worth mentioning here that it is pointless to devise a
change in underwriting policy without considering carefully how it should be implemented
and subsequently monitored.

Underwriting management decision: implementing policy changes

Have all operational impacts been assessed and discussed with those areas affected?

Policyholders (new and existing), brokers, underwriters and customer service staff, as well
as claims staff and risk control surveyors, may all be affected in different ways. What might
be done to explain the change in advance?
An insurer’s underwriting policy should be made as explicit as possible in order to support
good governance and efficient operations and thus a successful, sustainable business.
Every effort should also be made to document changes in underwriting policy, as this
information will greatly enhance the insurer’s ability to make best use of its historical
premium, claims and exposure data.

Example 4.1
The full impact of revising an aspect of policy cover or of changing risk categories may
only be apparent five or more years after the change is implemented, once everyone
involved in the change has moved jobs or forgotten the details. Potentially important
knowledge may be lost about:
• internal processes (Was the impact of the change correctly assessed? How might such
assessments be improved?);
• competitive advantage (If the change was beneficial, should we go further? Or, if the
change proved far less beneficial than anticipated, why was that so?); and
• the use of historical data (What part did the change under consideration play in
changing claims experience or business mix?).

Look before you leap

As a new underwriting manager, you require as much information about underwriting policy
as possible and should be careful not to dispense with information about what was done in
the past. As you learn about the company’s strategies, you will be consciously relating what
 4/4 960/December 2020 Advanced underwriting

you know about underwriting policy to underwriting strategy, as well as developing an

understanding of other relevant strategies. Is there a good fit between underwriting policy
and strategy or are there apparent conflicts? Keep asking questions and, when you identify
gaps in your understanding, do not be surprised if they turn out to be gaps in everyone else’s
understanding (which require filling). The different perspectives of colleagues in other areas
of the business and of intermediaries and end-customers will greatly enhance your own
understanding and ability to devise and implement successful underwriting policy initiatives.
You will inevitably be comparing your current company and its underwriting strategy and
policies with other insurers you have worked for or know of. It is important to understand not
only what is done in your current company but also why. Although many common
approaches and practices underpin the operation of general insurers, no two insurance
companies are the same. Underwriters and their managers must understand and observe
the specific requirements of their own company.

Research exercise
Chapter 4

In your current company, investigate how effectively new customer service staff and
underwriters are advised about the company’s policy and practices. How are existing staff
kept up to date? How is this monitored?

B Evaluating risk
Whether an insurer’s target markets are narrowly – or broadly – defined, it is the
responsibility of underwriting managers to:
• establish and maintain suitable classification systems;
• classify and categorise the risks which fall within the insurer’s target markets;
• establish which classes/categories are acceptable, acceptable with modification or
special terms, or unacceptable;
• explain the principles which underpin the classification and categorisation;
• explain the company’s approach to risk acceptance (including relevant gross
acceptance limits and reinsurance arrangements);
• set branch referral limits and establish the framework for personal underwriting authorities
or licences; and
• ensure effective audit procedures are in place to monitor compliance with the
underwriting policy.

B1 Classification and categorisation

The work of classification and categorisation is intended to identify and group risks based
on the degree of hazard they typically present. Historical internal claims data, as well as
any market claims data available, will form the basis of classification and categorisation
exercises with the addition of any relevant external data that can be obtained. For example,
forward-looking socioeconomic or meteorological information can indicate that the claims
experience of particular groups of risks may improve or deteriorate.

Reinforce
Definitions:
Classification: the systematic identification of common features in insurable risks (such
as vehicles, drivers, trade activities or types of premises) relevant to specific classes of
business (for example, different classifications are required for motor, property and
liability).
Categorisation: the allocation of a category (such as below average, average or above
average) to classified insurable risks according to their assumed degree of hazard.

Refer to
Think back to M80, chapter 3, section D
Chapter 4 Underwriting policy and practice 4/5

Example 4.2
Two small businesses: a plumber’s business and an electrician’s.
The vans each use for their businesses present a similar, average degree of risk; they
have small purpose-built business premises, both used purely for storage (both located in
areas with an average crime rate and no flood risk); however, depending upon the type of
contracts undertaken, the degree of hazard they present for public liability purposes could
be very different. Does the plumber use heat? If so, to what extent? Do they undertake
heating and ventilation contracts? Does the electrician work on purely domestic contracts
or a mixture of domestic and commercial contracts?
In this simple example, the classification criteria are as follows:

Class of business Classification criteria

Motor Nature, size and use of the vehicle.

Property Standard of construction, use and location.

Chapter 4
Public liability Nature of the processes undertaken and potential third-party values at risk.

In this instance, both businesses can be categorised similarly for motor and property but
they may be categorised differently in respect of public liability.

Designing and amending systems of classification and categorisation for insurance risks is a
complex task and you will need to make a number of decisions as illustrated by the following
diagrams:

Figure 4.1: Classification system development

10, 100, 1,000 or

10,000?

At what level of detail How many separate Room for

should the risks be classifications are development needed?
classified? required?

How many digits/spaces

are required on system?

You will need to consider the following questions:

• Have you access to data to support this level of classification (historical/current data)?
• Are the claims costs at individual classification level statistically significant?
• Is this level of classification meaningful and useful to underwriters?
• Are they motivated to use and maintain the classification?
• How many classifications will they search through, to find the correct one, before they use
the default code?
 4/6 960/December 2020 Advanced underwriting

Figure 4.2: Categorisation system development

Acceptable?

Acceptance
Decline?

How many categories

are required? Refer?
Chapter 4

How many separate

Rating rates are there within the
range for acceptable
business?

Recorded against
Terms individual classifications
and/or by category?

B1A Re-categorisation
Although an insurer’s classification and categorisation of risks needs to be reviewed
regularly, underwriters will be wary of amending categorisations too quickly in case an
apparent trend proves to be short-lived. Insurers are also concerned not to damage their
competitive position by being markedly out-of-step with the rest of the market. Of course, an
individual insurer may make the right call and identify the need to re-categorise a particular
group of risks before the rest of the market and thereby secure the success of their business.
The potential impact of re-categorisation must be considered carefully.

Underwriting management decision: re-categorisation

Risks in a specified range of postcodes are moved from Risk Category 2 to Risk Category
1 – their risk category has improved and the associated property rating has been reduced.
This is good news for new business but should all existing business within these
postcodes also benefit from the reduction?

In reaching your decision, a number of issues will need to be considered:

• What impact will this have on revenues?
• To what extent will the retention rate on existing business improve?
• If the reduction in base rating is very substantial, should existing business cases benefit
fully at next renewal or should their rates be reduced gradually over two or three years (in
those cases where no claims are incurred)?
B1B New risks
As well as monitoring the appropriateness of existing classifications and categorisations,
underwriters must assess new risks as they appear. The emergence of radically new risks,
such as nanotechnology, presents real challenges to specialist underwriters in the first
instance but all underwriters must keep up to date with the many influences that impact the
risks for which they are responsible. The ongoing impact of globalisation, 24/7 working and
new arrangements with suppliers (such as just-in-time delivery) are most clearly influential in
commercial lines business. How should insurers respond?

On the Web
Zurich. (2014) 'The unknown risks of nanotechnology', March 2014. http://bit.ly/2hohQf5.
Chapter 4 Underwriting policy and practice 4/7

The renewable energy sector presents many opportunities and challenges for insurers. The
London Market is taking a lead in investigating the risks associated with this new sector.

On the Web
Lloyd's Register. (2014) 'Wind Turbine certification sets the standard to harness wind
power', 28 November 2014. https://bit.ly/2RNKYwM.
Murray, E. (2014) 'Renewable energy: an ill wind?', Post Online, 14 October 2014.
www.postonline.co.uk/insurer/2374852/renewable-energy-an-ill-wind.

Other developments have an impact across the market, such as the current concern
surrounding modern methods of construction, particularly timber-frame buildings.

On the Web
The following article makes clear the difficulty in isolating the impact of the different factors

Chapter 4
behind the upsurge in claims and the insurers' dilemmas in deciding how to react to the
situation:
'Fire risks – timber frame: the burning issue', Post Online, 10 March 2010. http://bit.ly/
2ywPiqW.

Input from other areas of the business

Some categorisation work may be reviewed in conjunction with colleagues from marketing
and distribution. They may have ideas about targeting particular customers or risks and
underwriting staff may have identified areas which appear to perform better than expected
(see Customer segmentation on page 3/16). Sales staff may also be keen to alert
underwriters to apparent discrepancies in an insurer’s categorisation of household and SME
risks, in particular.
B1C Classification and categorisation across the market
Not surprisingly, the classification and broad categorisation of risks can be very similar
between insurers operating in mature markets. While recognising similarities, underwriters
must focus on what makes their company’s approach distinctive.
For those insurers operating in high volume markets, typically personal lines, complex
multi-dimensional rating tables are built and maintained using these classifications and
categorisations. This type of very significant investment enables insurers to respond quickly
to changes in the market or in product performance by amending their categorisations and/or
associated rates or terms. By this means, significant competitive advantage may be derived
by maintaining an appropriate balance of risk (and revenue) within their respective accounts.
Due to the high volumes involved, errors in classification, categorisation or the associated
premium rates could have a significantly adverse impact on volumes, the mix of business
written and/or profitability.
For those underwriting large commercial risks, a failure to understand the insurer’s
approach to risk acceptance could undermine the company’s success, or indeed survival,
through the inappropriate acceptance of a relatively small number of risks. At this end of the
market, the main focus is on the in-depth assessment and evaluation of individual risks
rather than fitting the risk into a particular classification and categorisation system for the
purposes of acceptance and rating. However, if accepted, the risk must be fully classified to
ensure that its exposure, in particular, is correctly represented in the insurer’s MI systems.
An individual insurer’s approach to risk acceptance, whether supported by complex tables or
the exercise of individual judgment, must match the company’s particular formulation of
strategic and financial objectives, and recognition of this intentional differentiation between
insurers is critical. Taking time to discuss and explain your company’s principles of risk
acceptance and reviewing individual risks or risk categories which appear to fall on the
borderline of acceptability/unacceptability is therefore time well spent by underwriting
managers. As well as supporting staff through discussions and referrals, underwriting
managers are also responsible for ensuring that underwriting guides and computer programs
accurately reflect the company’s acceptance criteria.
Explaining the company’s approach to risk acceptance is particularly important where
individual underwriters are expected to evaluate risks which cannot be easily categorised.
 4/8 960/December 2020 Advanced underwriting

This can be as relevant to the supervisor of customer service staff in a call centre dealing
with motor or household insurance as to underwriters evaluating large industrial risks.

B2 Acceptance and renewal criteria

Although insurers’ risk classification systems utilise numerous risk features and
characteristics, acceptance procedures that are not wholly automated provide underwriters
with the opportunity to review other information, either supplied by the customer or broker or
easily accessible via the internet, in their assessment and evaluation of individual risks.
While underwriting management must endeavour to provide as many relevant guidelines as
possible to cover issues that may arise in new business presentations, proposals or at
renewal, underwriters must take care to assess all information available to them (whether
specifically requested or not). They should also document what they consider to be the key
features of the risk, how these have been assessed and on what basis they have arrived at
their final decision regarding the risk’s overall acceptability.
It is often the case that a risk presents a mixture of positive and adverse features that need
Chapter 4

to be evaluated individually as well as collectively. Recording the features and their

assessment is an essential part of the process that will enable the efficient handling of the
risk, if accepted, at subsequent renewals or when changes are notified. This record may also
be used, along with others, when changes to risk acceptance criteria are being considered.
The documented rationale for the acceptance (or declinature) of individual risks also
supports typical audit procedures (see chapter 9).

Underwriting management decision: establishing acceptance criteria

Although committed to a particular target group of customers, some risks within the group
may present identifiable adverse features that you would rather limit or exclude. In these
circumstances, how would you evaluate each of the following options?
• Decline all risks with that feature.
• Decline all such risks once a quota level has been reached.
• Decline those with a high degree of the feature.
• Exclude or limit cover for claims arising from that feature.
• Continue to accept all risks from the target group.

In the above circumstances, if you decided to decline all risks with a particular feature while
looking to target the group more generally, this could provoke an adverse reaction from
brokers who are looking for an insurance partnership with a balanced portfolio. However,
improved data analytics and portfolio management, coupled with pricing sophistication, is
allowing insurers to segment and sub-segment their portfolios with brokers. While this focus
on superior risk solution may leave a broker with reduced options for higher risk customers, it
is in this niche that specialist insurers with specialist products can find an opportunity, for
example, targeting younger drivers.

Be aware
‘Cherry picking’ may be used as a pejorative term but it is a rational approach to the
business of general insurance: underwriters must be selective because they know that
even the most carefully selected business can produce very substantial claims costs. At
the same time, insurers must underwrite appropriate volumes of business in order to cover
their expenses and each insurer therefore has to balance their view of insurance risk
against their need for volume and revenue. An insurer’s underwriting policy should explain
to staff how to determine where that balance lies.

B3 Risk improvement and control

Some types of risk improvement form part of standard acceptance criteria, particularly
those relating to physical security: for example, types of lock, the installation and operation of
alarms, acceptable safes and money-handling arrangements. In establishing and reviewing
these and similar acceptance criteria, underwriting managers need to balance the interests
of the insurer with the perception of their customers (and their brokers) and market practice.
Although certain risk standards will be fairly common throughout a given market, some
Chapter 4 Underwriting policy and practice 4/9

insurers may differentiate their offerings by requiring markedly higher standards, often in
return for another benefit (premium reduction or enhanced cover) or possibly as an absolute
criterion for acceptance.
B3A Risk control surveys
Risk control surveys (whether in-house or outsourced) are a significant investment and cost
to an insurer, and the underwriting manager needs to target this resource at the right parts of
the portfolio, for example by:
• targeting – either by risk hazard or by size of exposure – those risks that would benefit
from additional risk management in order to achieve the desired loss ratio; and
• supporting the customer proposition, particularly in larger commercial risks where the
broker and client would value the risk management expertise that an insurer could
provide.
Survey strategies must be designed to fit the risk profiles of target business, as well as to
satisfy the requirements of the reinsurers and the insurer’s own internal risk management

Chapter 4
procedures.

Underwriting management decision: survey strategy

Which risks should be surveyed (type of risk, location, values at risk, number of
employees etc.)? When (pre- or post-inception) and how frequently should risks be re-
surveyed? Should only risks generating premiums over a certain threshold be surveyed?

Value of surveys
Risk control surveys are commonly regarded as a means of validating information
provided by the proposer or broker (possibly of growing importance with the increased use of
statements of fact rather than proposals). They can also be used to validate the approach
adopted by underwriters: is the risk within strategy, has the estimated maximum loss been
assessed correctly and/or is the level of discount for sprinklers appropriate?
Surveys also provide insurers with an opportunity to require or suggest risk
improvements appropriate to the particular circumstances of individual risks, thus avoiding
potential claims, as well as distress and disruption to insureds. As risk improvements
generally cost money to implement, it can be difficult to sell the benefit of a survey to some
insureds, although many small businesses and high net worth customers appreciate the
support provided.
Larger corporate businesses are more likely to regard risk control surveys as a worthwhile
part of the insurance package, as they provide a professional external opinion to
complement the company’s own risk management procedures.

Be aware
From the insurer’s viewpoint, the value of conducting surveys is entirely undermined if
underwriters, on receipt of the surveyor’s report, file it without reading it or fail to follow-up
the risk improvements required or suggested.

Whether in respect of an individual risk or over the course of many surveys, the surveyor
may well notice:
• risk features about which questions are not normally asked;
• proposal questions which have failed to elicit relevant information;
• changes in what might be understood as the ‘normal’ activities of particular types of
business; and/or
• changes in typical employees, for example, more casual workers.
Although surveyors typically visit only a sample of risks, have any changes been noticed in
the type of risks accepted by the insurer? This may be one way for underwriting
management to check that a desired change is taking place or that nothing unintended is
happening. In-house surveyors should be assisted to develop a good understanding of the
underwriting strategy and policy. This is more difficult to achieve with an outsourced risk
control service.
 4/10 960/December 2020 Advanced underwriting

Having established a survey strategy (at an acceptable, proportionate cost), it should not be
left to the discretion of local underwriters or managers whether they follow the strategy or
not. The strategy defines a minimum level of activity which the reinsurers and internal risk
management have been advised will be undertaken. A small additional budget for ad-hoc
survey requests may be provided to local managers, as well as allowing for post-loss
surveys in the overall budget.
Making use of additional information
The internet has provided underwriters and underwriting systems with the ability to access
third-party databases (for example, vehicle licensing) and a vast amount of additional
information, particularly related to location (for example, mapping sites, area crime statistics
and the Environment Agency), which can be used to good effect. However, surveyors’ visits
provide an unrivalled source of cohesive information and digital photographs, as well as
surveyors’ views of the management of individual risks, which can support individual
underwriting decisions as well as validating and helping to refine underwriting policy.

C Establishing cover and terms

Chapter 4

C1 Policies, contracts and products

Be aware
It is not the purpose of this unit to consider the construction of policy wordings (contracts).

Refer to
Think back to M80, chapter 2, section B

An insurer’s underwriting policy should indicate the range of policies/products available and
the extent to which it is acceptable to consider amending policy wordings. At one extreme
no changes may be permitted other than the application of standard endorsements; at the
other, large commercial contracts may be subject to lengthy, detailed negotiation making
each one unique. However, the requirements of contract certainty make the use of
standardised clauses and wordings increasingly useful even for the largest risks.

Research exercise
In your current company, who is authorised, on a day-to-day basis, to apply non-standard
endorsements and who may sign-off wording changes? Find out how claims staff are
alerted to the use of a non-standard wording in an individual policy.

Refer to
Refer back to chapter 1

Underwriting management is required to ensure that current and proposed wordings (and
endorsements) do not conflict with corporate risk appetite, including the scope of the
insurer’s reinsurance protection. Proposed changes to wordings must be evaluated from
financial, legal and regulatory perspectives and formal change-control should be applied to
all wordings. It is the role of the underwriting manager to explain and communicate the
changes to the claims team as well as the underwriting community.

C2 Product design/policy terms

What is described as ‘product design’ in personal lines and SME insurances might be
considered the equivalent of determining policy terms on large commercial risks. A similar
process of evaluation has to be undertaken, balancing what is regarded as necessary and/or
attractive to policyholders with what is acceptable and cost-effective to insurers. The main
criteria used in determining terms are therefore suitability and cost.
While the core covers appropriate to most types of general insurance are fairly standardised,
many insurers use the extension of these covers (on a mandatory or optional basis) and the
inclusion of added-value services as a means of differentiation in the marketplace. Brokers,
Chapter 4 Underwriting policy and practice 4/11

particularly scheme brokers, will often inspire/encourage the enhancement of cover as a

means of differentiating one insurer’s offering from another’s. Other insurers, whose focus is
predominantly on price as a differentiator, will focus more closely on what is regarded as
core cover in order to achieve as high a position as possible on price comparison
(aggregator) website lists. Thereafter, once the customer has been attracted to a competitive
base premium, the insurer can offer a range of additional covers and benefits to meet
precise customer requirements. Certain insureds, notably large companies, may choose to
avoid purchasing anything other than core cover and may choose to limit even that through a
measure of self-insurance.

C3 Limits
Apart from those policy limits defined by legislation (for example, employers’ liability in the
UK), underwriting management must decide what limits they wish to provide for different
types of risk or product.

Be aware

Chapter 4
The limits underwritten will affect the cost of an insurer’s reinsurance cover, as well as
reinsurers’ willingness to support that insurer.

Limits tend to increase throughout the market either as a competitive move amongst insurers
or when claims settlements/inflation can be seen to have eroded the value of the current
limit. As with the extent of cover more generally, some insurers will deliberately moderate
limits in order to offer more (apparently) competitive premiums, as well as to fit their overall
risk appetite. The standard limits offered in certain products need to be considered carefully
in the light of fair treatment of customers' requirements, particularly in respect of non-advised
sales to SME businesses.

Underwriting management decision: establishing policy limits

Given the prevalence of private homes worth in excess of £1m in the south-east of
England, what public liability limit of indemnity should be offered as standard to small
tradesmen (for example, plumbers and electricians) operating in this area?

Having stated that limits tend to increase over time, insurers have always used inner limits to
reduce the impact of a large number of insureds being hit by the same event and these limits
have been under increasing scrutiny of late. Reinsurers have become particularly interested
in the limits applied to contingent business interruption extensions in primary property
damage policies, due to increasing claims costs and the unpredictable aggregation of claims
from many insurers (re-insureds), impacted by the disruption of a single supplier to their
many insureds, for example.

On the Web
Sousounis, P. (2012) 'The 2011 Thai Floods: Changing the Perception of Risk in Thailand',
AIR Worldwide, April 2012. http://bit.ly/2zE99rB.

Different classes of insurance have cover/limit arrangements peculiar to those classes, such
as first loss insurance for property risks.

C4 Cover comparisons
The potential complexity of a product comparison requires some consideration: How deep
should the comparison be? Should full policy wordings be compared or simply
prospectuses?
 4/12 960/December 2020 Advanced underwriting

Three ways in which product comparisons generate challenging questions:

• Although most core covers are fairly standardised, this still leaves lots of scope for
variations. Extensions and add-ons can be very varied. How significant are they for the
purpose of the comparison?
• The request for a product comparison may arise in response to a particular situation
which highlights differences in cover which may not have been considered as significant
by most end-customers, intermediaries or, indeed, insurers. Consider, for example, the
public controversy which arose regarding the disruption caused by the volcano eruption in
Iceland in April 2010.

Travel insurance policies will differ in this situation; there is no standard set of conditions
which applies to a situation of this kind.
Nick Starling, Director ABI: ‘Ash shows travel cover limits’, Insurance Times, 16 April
2010.
Chapter 4

On the Web
Dunkley, D. (2010) 'Business interruption policies need 21st century update: Aon', Post
Online, 21 April 2010. https://bit.ly/2T6ZTDt.

Critical reflection
Is the situation a one-off incident or one that will influence customers’ purchasing
decisions in the future?

• Marketing and underwriting areas are likely to have quite different perspectives on certain
aspects of cover that can only be rationalised acceptably through a collaborative
approach in which each relevant aspect is costed and evaluated. Before considerable
expense is incurred, how can the potential demand for a new or amended cover be
assessed?

C5 Inclusions/exclusions
Underwriters have every reason to be wary about extending cover. If cover is to be
extended to include subject matter or contingencies not currently insured, the underwriters
are not likely to have claims data on which to assess suitable base rates and they will have
great difficulty in predicting how customers and claimants will react to the extension. Some
customers may ignore or forget about the new cover and simply not claim; others may use
the cover as intended; some may recognise an opportunity to claim that the underwriters had
not anticipated: how many claims might be expected and at what cost?
It is worth noting that even though there may be exclusions in policy wordings, when an
unexpected or rare situation arises some insurers may choose to pay claims which are
excluded, for example, after the 2011 UK riots or the Iceland volcano mentioned in Cover
comparisons on page 4/11.
Both in respect of standard, long-established covers and novel cover extensions, many
years or decades may pass without a particular aspect of cover attracting attention until a
circumstance arises, either affecting a great many individuals or companies in a short period
of time or involving a prominent, exceptionally costly case that attracts everyone’s attention.
While insureds question if they are covered (whether directly affected or not), insurers’
executive management query whether anyone realised this particular source of claims was
covered and had such significant potential. Has an equitable premium been charged for this
exposure in the past? Should that premium be increased? In the light of recent experience,
should the cover be restricted or withdrawn? What are the potential financial and reputational
impacts of continuing to offer the cover versus withdrawing the cover?
Limiting or withdrawing cover is usually motivated either by the recognition that the potential
exposure is higher than acceptable or that the exposure is higher than acceptable and
insurers have already incurred heavy losses from this source. Insurers would rather be in the
former position than in the latter but if in the latter, is the most clean-cut solution to withdraw
cover? Particularly where heavy losses have already been incurred (and thus insureds and
Chapter 4 Underwriting policy and practice 4/13

their governments are well aware of the issue), this can be the hardest solution to adopt if
the move to withdraw is widespread throughout the market.
Government intervention
Although requiring direct governmental intervention in issues such as terrorism, there are a
number of very significant issues where parts of the insurance industry (primary insurers and
reinsurers) have worked together to continue to offer cover, even if in a restricted form.
Offshore employers’ liability exposures (in the aftermath of the Piper Alpha disaster), sudden
and accidental pollution and contamination cover, and cover for claims arising from the
production and use of asbestos are examples of such instances. There have been
recent developments relating to the compensation available to those who develop asbestos-
induced cancer, mesothelioma. Following the Mesothelioma Act 2014, victims and their
families are able to apply to the government for compensation worth on average £123,000.
Although some insurers have withdrawn from offering cover in these areas (as is their
prerogative), others have continued to offer limited cover, generally in association with
enhanced risk management measures, closer scrutiny, reporting and, crucially, the support of
their reinsurers.

Chapter 4
Irrespective of any government influence, insurers have to be alive to the fact that if they
withdraw cover for some of the most significant risks run by insureds, they will find it
increasingly difficult to sell their products and will encourage large insureds, in particular, to
self-insure.

On the Web
DWP Press release: 'Asbestos victims to get £123,000 in compensation', 6 March 2014.
www.gov.uk/government/news/asbestos-victims-to-get-123000-in-compensation.

Research exercise
Investigate what restrictions regarding asbestos apply in your company’s public liability
covers. Does the level of cover offered vary between different products or different
groups? How does this cover compare with that of competing insurers? If you have
access to this information, what protection is provided by your company’s reinsurance
programme in respect of asbestos?

According to research Actuarial Profession’s UK Asbestos Working Party, the total

undiscounted cost of UK asbestos-related claims to the insurance market is expected to be
around £11bn for the period 2009 to 2050. See appendix 1 for more information.

On the Web
‘UK asbestos-related claims to be around £11bn for 2009 to 2050’, New Statesman, 29
January 2010. Published in appendix 1.
'Asbestos claims to cost insurers £11bn by 2050', Post Online, 27 January 2010.
www.postonline.co.uk/claims/1588818/asbestos-claims-to-cost-insurers-ps11bn-by-2010.

Another example of a cover dilemma for insurers relates to the ways in which policy
wordings are interpreted in different jurisdictions, notably in the USA.
Not only is it impossible to avoid this particular issue if your company deals with multinational
customers, but every small business with a typical products liability cover (even if they do not
‘knowingly export’ goods outside the UK) can become involved in defending actions abroad,
with unpredictable results. Insurers and reinsurers do what they can to identify and manage
exposures and limit the scope of cover (for example, by excluding punitive and exemplary
damages) but it is an issue that cannot be avoided.
Assessing the potential impact of limiting or withdrawing cover (in respect of claims costs
and business retention) can be very difficult, particularly if the motivation to limit cover
springs from a sudden upsurge in claims (implying that the historical, developed claims
experience does not reflect the more recent experience). For some classes of business,
particularly liability covers, even the total withdrawal of cover may not halt new claims
intimations for years or even decades. The cost of these claims will have to be absorbed
despite the cessation of premium income.
 4/14 960/December 2020 Advanced underwriting

Additional reading
The cost of asbestos losses continues to increase for US carriers – it is now estimated
that these may reach $100bn as litigation across the US evolves.
Read 'Asbestos loss outlook rises to $100bn for US Carriers', Insurance Insider, 29
November 2016. Published in full in appendix 2.

C6 Excesses, deductibles and incentives

C6A Excesses
A common method of modifying cover is through the application of excesses. When the
excess is mandatory, such as those applying to windscreen damage (motor) or subsidence
(household), as well as reducing the total cost of common claims, the excess is also
designed to modify the insured’s behaviour. In both these instances, the excess is intended
to discourage claims for minor, cosmetic damage.
Chapter 4

C6B Deductibles
Insureds willing to accept a voluntary excess (often in addition to the standard excess) in
return for a premium discount will often prove to be more risk-aware, careful customers. Is
their behaviour inherent or solely motivated by the voluntary excess? This question needs to
be considered when calculating the appropriate premium discount. Accepting a voluntary
excess could be regarded as a form of selection against the insurer!

Refer to
Refer to Rating factors and features on page 7/10

Many large commercial enterprises choose to self-insure much of the attritional risks
associated with the business. For example, a business with a large fleet of vehicles may
wish to self-insure minor own damage day-to-day ‘knocks’ by way of a significant deductible.
By doing this they can avoid the insurer’s ‘turn’ on these minor claims.
For large commercial risks, a careful examination of the risk’s historical claims costs (and
that of other similar risks) will be undertaken to determine what level of deductible is
appropriate, whether an aggregate deductible should be used to limit the total cost to the
insured and how the remainder of the insured risk should be rated. The insurer may
essentially be providing a claims handling service to the insured for 95% of all claims
occurring in a year but the insurer has to ensure that an equitable premium is charged for the
5% of claims that may exceed the deductible (in addition to the cost of providing the claims
handling service). For underwriters unfamiliar with this type of business, there is a danger
that the 95% of claims (that tend to occur year-in and year-out and that should be highly
visible in the historical claims experience) disguise the potential cost of the 5% of claims
(which although few, will be highly variable and costly).
Although primarily focused on matters relating to underwriting (such as risk, policy limits and
claims experience), some product features are more heavily influenced by marketing
concerns than others: one such example is no claims discount (NCD). With the introduction
of protected NCD and levels up to 90% NCD in motor insurance, it should be apparent to
those studying this unit that base pricing has been adjusted upwards to enable such large
discounts to be offered. The success and prevalence of NCD arrangements in motor
insurance is largely due to the very high volume of policyholders in this class of business,
which provides an excellent rating base for the calculation of premiums and the opportunity
to adjust base rates gradually over time in order to accommodate increasing NCD scales.
C6C Incentives and discounts
With all forms of renewal incentive and premium discount, it is important to distinguish
between characteristics or aspects of risks that truly merit distinctive treatment due to the
reduced level of risk they bring to the ‘pool’ and those aspects that are or have become
predominantly marketing features. All parties (underwriting, marketing and actuarial) are
responsible for evaluating and monitoring what a feature is actually worth in monetary terms
(reduced acquisition or claims costs or improved rates of retention, for example), utilising
that information in the planning process and providing underwriters with clear criteria
regarding the value and application of such incentives and discounts.
Chapter 4 Underwriting policy and practice 4/15

Whereas in automated systems base rates can be adjusted by a series of loadings and
discounts based on characteristics of the risk and the cover requested, for business where
the evaluation of the risk and its pricing is either partly or entirely manual, the choice of base
rate and all subsequent loadings and discounts may be in the hands of an individual
underwriter. It is particularly important therefore that underwriters exercising such discretion
fully understand how base rates have been calculated, what has already been accounted for
in their calculation and what has not (see chapter 7 on pricing).

Underwriting management decision: establishing discount policy

If discounts are available for ‘superior’ features, what constitutes ‘superior’? For an
average selection of new business, what proportion of risks would you expect to exhibit
‘superior’ characteristics – 5% or 50%?

In an industry not usually noted by outsiders for its optimism, a frequent answer to this
question seems to be 90% to 95%, judging by the typical application of discretionary

Chapter 4
discounts (independent of any supplementary commercial discounts designed to assist
matching a target price).

D Portfolio management
Be aware
In its broadest sense, the term ‘portfolio management’ refers to the balancing of distinct
elements within an area of responsibility in order to achieve overall objectives. To provide
more detail in an insurance underwriting context, it refers to the management of a portfolio
of risks rather than individual risks, through the development of consistent and predictive
MI to provide insight to current and future performance.

The process necessarily involves monitoring how the distinct elements within the portfolio
perform and change over time as well as determining how best to manage the portfolio,
primarily via acceptance/renewal criteria and pricing.
The distinct elements could be:
• different products within a personal lines account (home, motor and travel);
• customer segments within a construction account (tradesmen, demolition contractors and
general builders);
• classes within a commercial combined account (property and liability);
• a range of exposures or degrees of hazard present within an account; or
• many other ways of segmenting a general insurance portfolio: large general insurers may
have many portfolios initially broken down by class of business and then by distribution
channel.

D1 Importance of business mix

In addition to monitoring the performance of these distinct elements (their growth or decline
and relative profitability), it is necessary to monitor the overall mix of business closely.
An insurer’s underwriting strategy should set out, in broad terms at least, the type of
business the company wishes to accept. The underwriting policy needs to provide the detail
of the desired mix of business to ensure that the risk profile and performance of the business
match the expectations of the shareholders and optimise the use of the capital allocated and
reinsurance purchased.
The expression of strategic intent may focus on rate of growth, market position or the nature
of the returns expected (their scale and volatility). Underwriting management’s role is to
select and maintain the mix of business which can be best relied upon to deliver the strategic
requirement. For example, an insurer required to produce steady returns with low volatility
might consider limiting the proportion of liability business in the account and exposures in
regions prone to extreme weather events (e.g. hurricanes).
Alternatively, if the strategic decision has been taken to raise the necessary capital,
purchase appropriate reinsurance, recruit highly experienced underwriters and claims
 4/16 960/December 2020 Advanced underwriting

officials in order to write a high hazard (high returns) book of business, there is little point in
writing lots of standard motor or SME business as that will not generate the necessary
returns. An appropriate balance is still required, even within a high hazard portfolio, to help
the business survive the inevitable volatility in results. The methods by which underwriting
managers previously determined their optimal mix of business are being supplemented by
the more intensive use of capital modelling required under Solvency II.

Refer to
Refer back to Capital modelling on page 1/14 for capital modelling under Solvency II

Having established what mix of business is required, underwriting management’s next

challenge is to achieve that mix and maintain it. Although individual underwriters can be
advised about the desired mix of business and referral processes established to review large
or unusual individual risks, only underwriting management can monitor the overall balance of
the portfolio and make appropriate adjustments.
Chapter 4

Be aware
Monitoring the mix of business is a very important area of work because a relatively small
change can have a disproportionately large effect on the profitability of an account or
portfolio.

Monitoring the mix of business can be a more difficult task than it first appears because
important changes of mix are often well-disguised in aggregated figures. Establishing a
monitoring approach that identifies changes of mix before the profitability of an account is
affected requires knowledge, imagination and persistence.
D1A A good mix of business?
As well as satisfying strategic requirements, what other characteristics do portfolios
described as containing a ‘good’ mix of business share?
• Enough of it: whatever segments, categories or classes of business comprise the
portfolio, there should be sufficient business of each type to enable underwriters to gain
an understanding of the business and to produce sufficient data on which rates may be
reliably based.
• But not too much: the portfolio should not be over-exposed with more than its ‘share’ of
a particular type of business unless that represents a specific strategy (for example, most
insurers would not wish to have a disproportionately large share of business in known
flood zones).
• Countervailing tendencies: in other words, when some parts of the portfolio are
experiencing poor returns, other parts are performing well; the portfolio is not
concentrated on areas in which all customers/products suffer low growth/poor experience
simultaneously. But any ‘support’ offered from one part of the portfolio to the other should
not always move in the same direction.
• Fit: does the portfolio make proper use of the company’s resources, not just capital and
reinsurance but also its human resources and ICT capability? Or does it include ‘odd’
pieces of business for which the company is not appropriately resourced or equipped?
D1B Change of mix (cover) and interpreting claims experience
Just as it is impossible to evaluate an individual motor claims experience without first
establishing whether the cover is comprehensive, third party fire and theft, or third party only,
the same is true of the claims experience of a motor account as a whole.
Chapter 4 Underwriting policy and practice 4/17

Example 4.3
How has this small fleet performed?

Vehicle/years (v/y) Total claims cost Claims cost per v/y

Year 1 10 £9,600 £960

Year 2 10 £9,000 £900

Year 3 10 £8,400 £840

Without specific information about the cover mix of an account, there is a tendency to
assume that the cover has been constant and therefore the above summary seems to
indicate an improving claims experience against a constant exposure of ten vehicle/years
per annum.
In fact, the fleet has vehicles insured on comprehensive and third party only bases.

Chapter 4
Vehicle/years (v/y) Comp exposure and TPO exposure and
claims cost claims cost

Year 1 10 8 v/y £8,000 2 v/y £1,600

Year 2 10 5 v/y £5,000 5 v/y £4,000

Year 3 10 2 v/y £2,000 8 v/y £6,400

While the cover mix has changed from predominantly comprehensive cover to
predominantly third party only cover, the claims cost per vehicle year has been static over
the three years, at £1,000 for comprehensive vehicles and £800 for third party only
vehicles. What appeared as an improvement in claims experience was solely attributable
to a change of mix.
This highly simplified example demonstrates that the use of aggregated figures, without
checking for change of cover mix, may result in significant misinterpretation of results.
In the above example, on what basis should the premium for year 4 be calculated? We
have been advised that the fleet’s exposure will increase, at renewal, to 15 vehicles.
One approach may be to take the year 3 claims cost of £840 per vehicle/year, gross it up
for expenses, commission and profit and multiply by 15. (Let us assume, for the sake of
the example, that no adjustment is required for inflation, change in claims frequency or
late-reported claims.) Or, maybe, take an average over the three years of £900 per
vehicle/year?
The correct answer is, of course, to project forward into year 4 the likely claims costs for
comprehensive and TPO vehicles separately (£1,000 and £800), based on the actual split
of vehicles in year 4. How many of the 15 vehicles will be comprehensive; how many
TPO?
The insured is not sure: the split may be 9 Comp/6 TPO or 2 Comp/13 TPO, but they
would like to agree one overall rate per vehicle, for simplicity’s sake.
Projected claims costs for year 4:

Comp TPO Total claims cost

exp & claims cost exp & claims cost

Option 1 9 v/y £9,000 6 v/y £4,800 £13,800

Option 2 2 v/y £2,000 13 v/y £10,400 £12,400

Depending upon the mix of business (options 1 or 2), the projected claims cost per vehicle
for the whole risk could be £920 or £826.67 per vehicle (a difference of almost £100 per
vehicle). If the underwriter had used either £840 or £900 per vehicle as the basis of their
year 4 premium projection, the fleet with 9 Comp and 6 TPO vehicles would have been
significantly underpriced, while the insured would have found a cheaper quote elsewhere
for the fleet with 2 Comp and 13 TPO vehicles.
 4/18 960/December 2020 Advanced underwriting

Should the insured be offered one overall rate per vehicle for the renewal of their
small fleet?
No! The insured needs to advise the split for renewal: the premiums for the Comp and
TPO vehicles should be calculated separately, then the renewal premium and any mid-
term adjustments will be correct.

Cross-subsidisation
The consequences of ignoring cover mix can be significant and that principle holds true for
other forms of mix encountered in insurance portfolios. As in the cover mix example, a
feature or characteristic of some risks within a portfolio, which generates a significant
difference in the claims experience of those risks, should be recognised in the rating of those
risks. If the additional claims cost is not attributed to the risks that generate it but is
accommodated within the overall pricing of the portfolio, those risks are being cross-
subsidised. The premiums for some risks are cheaper than they should be, while other risks
are paying a higher premium than necessary.cross-subsidised
Chapter 4

Underwriting management decision: cross-subsidisation policy

Should a young driver or a tradesperson using heat pay the same premiums as other
drivers or tradespeople, respectively?

For a static portfolio in a market with little competition, cross-subsidisation might not
destabilise the portfolio. More commonly, customers and brokers will notice which of the
insurer’s premiums are relatively high or relatively low compared with the rest of the market
and the insurer will experience an inflow of the cheaper (cross-subsidised) risks and an
outflow of the more expensive risks. Having lost a proportion of the business that provided
the subsidy and gained more business requiring a subsidy, a portfolio could quickly move to
a loss-making position.
Although cross-subsidies are undesirable, they cannot be wholly eliminated from insurance:
they are part of the ‘pooling’ process. Although each risk should make an equitable
contribution to the pool, the individual contribution at any point in time will rarely, if ever, be
absolutely correct. The aim should be to avoid prevalent cross-subsidies and to monitor
closely those that are known to exist.

Critical reflection
A form of cross-subsidy?
An internal debate may surround how best to charge for those risks which rely particularly
heavily on the highest levels of reinsurance cover purchased (treaty and/or facultative).
Should the reinsurance cost be absorbed by the whole account or should a charge be
allocated on a pro-rata basis based on exposure? Internal administrative costs have to be
considered and probably only a straightforward charging mechanism will be acceptable.
Alternatively, it may be argued that the purchase of reinsurance is to be regarded as
means of protecting the account as a whole and it is therefore appropriate for the cost to
be treated as a central charge.

D1C Product mix and operational expenses

The product mix of a portfolio may be influenced by the insurer’s desire to satisfy the
insurance requirements of particular end-customers, a strategic focus on particular areas of
insurance business or a desire to diversify. The relative diversity of an insurance portfolio
can influence the amount of capital required to support it (in general, greater diversity may
reduce the capital requirement). As noted in A good mix of business? on page 4/16, many
factors contribute to the achievement of a well-balanced portfolio or account, which satisfies
the company’s strategic requirements.
A portfolio’s mix of business will significantly influence the servicing of the business: how and
at what cost? Operational considerations and the need to maintain efficient, cost-effective
solutions will, in themselves, influence the mix of portfolios.
Adding Product Z to a portfolio already containing Products W, X and Y may seem attractive
from the end-customer and intermediaries’ points of view but if Product Z requires specialist
Chapter 4 Underwriting policy and practice 4/19

handling, how much needs to be sold in order to justify the cost of establishing the new
handling arrangements? By contrast, if Product Z can be serviced in exactly the same way
as the existing products, there is a good chance that sales of Product Z (even at a relatively
modest level) will improve the overall productivity of the existing operation (in other words,
the handling of Product Z may be absorbed at little or no additional cost).
Understanding the cost of handling different products is very important when determining
underwriting policy, as well as in budgeting and pricing. As establishing accurate costs for
individual products is a notoriously difficult exercise, most insurers establish their own
conventions about how costs are to be assessed and allocated to products as part of the
budgeting process. Whatever convention is chosen, the nature of the allocation of expenses
between products, how the allocation impacts pricing and sales and how change of mix may
undermine the usefulness of the allocation need to be concerns of underwriting
management.
The expense allocation may be based on:
• a percentage of premium, derived from the experience of a number of years; or

Chapter 4
• a flat sum plus a percentage of premium.
Both methods are designed to recover the total cost of expenses. Although these methods
appear equitable, they do not reflect the actual cost of handling different products and can
lead to difficulties when the mix of business changes.

Example 4.4
Company X
Total premium £5m; Total costs £1m = 20% of premium
Year 1 Premium Allocated Expenses
expenses per recovered
policy

Product A £1m 1,000 policies @ £1,000 £200 £200,000

Product B £2m 1,000 policies @ £2,000 £400 £400,000

Product C £2m 5,000 policies @ £400 £80 £400,000

Totals £5m 7,000 policies £1m

The underwriting manager of Company X is aware that the £80 recovered from each
Product C sold is less than it actually costs to handle each policy. However to remain
competitive in the market for Product C, price is all-important and it has been
demonstrated that Products A and B can provide the balance of expenses.
Year 2 Premium Allocated Expenses
expenses per recovered
policy

Product A £1m 1,000 policies @ £1,000 £200 £200,000

Product B £1.6m 800 policies @ £2,000 £400 £320,000

Product C £2.4m 6,000 policies @ £400 £80 £480,000

Totals £5m 7,800 policies £1m

In Year Two, the insurer’s total premium income has remained static at £5m and the
existing expense allocation of 20% has recovered £1m from the three products, as before.
However the total number of policies has increased to 7,800 (from 7,000). An additional
800 policies (11%) apparently had to be handled within the existing £1m budget. How did
operations manage the productivity challenge?
Although we have been told that it costs more than £80 to handle Product C, we do not
know the actual cost and we have not evaluated the savings generated by the loss of 200
Product B cases (which we understand generated particularly high claims handling costs).
Without further information we cannot evaluate the impact of this change in mix on
expense budgets and the balance between numbers of new business handlers and claims
staff required.
 4/20 960/December 2020 Advanced underwriting

This example demonstrates the impossibility of making sound decisions without monitoring
product mix, as assumptions about overall claims costs, operational requirements and
expense allocations can be undermined by a change in mix. Although most portfolios do not
experience radical change year-on-year, more gradual change over a few years could result
in similarly adverse results, if the implications of change in mix have not been considered
and managed.

Minimum policy premiums

The application of minimum policy premiums can be another means of dealing with
expense allocation and/or it can reflect the desire to exclude smaller risks from a portfolio.
A small business might accept a minimum premium of £300 but look elsewhere if the
minimum premium was £500. What starts as an attempt to manage expenses, can result
in an unexpected change of mix with implications for claims experience. For this reason,
the ongoing impact of the application of a minimum policy premium should be monitored.
Chapter 4

Having discussed how influential mix of business is and how potentially damaging an
unrecognised change of mix can be, some of the implications for planning (see chapter 5)
are apparent. Key assumptions regarding claims costs and expenses (as well as capital,
reinsurance and solvency) are necessarily based on a specific, assumed mix of business.

Be aware
Specifying how much of what business is to be written in the forthcoming period (and
monitoring achievement) is essential: a simple premium income target is not sufficient.

D1D Mix of business and pricing

Although underwriters talk about ‘the price for a risk’, seeming to imply that there is a single
correct price for every individual risk, this is a theoretical concept based on assumed perfect
knowledge in an unchanging world. In reality, where a range of prices for a single risk are
calculated by individual underwriters, there is tendency, through competition, for the typical
market price to move to a narrower range or 'ballpark' pricing. Underwriters know that if
their price is above the ‘ballpark’ range they are unlikely to compete effectively for the risk,
unless there are other strong reasons for the insured to choose a more expensive insurer.
Even where very similar processes are adopted, the historical claims experience of a
particular portfolio, its mix, expense allocation and the assumptions used in its projection will
ensure that no two insurers’ base rates are identical. The technically correct premium for an
individual risk is determined by the context of the portfolio to which the risk belongs.
This ‘context’ includes the relevant reinsurance arrangements: the level of protection
purchased and its cost (see chapter 7 and chapter 8).
Underwriting managers are therefore responsible for not only approving the correct
premiums or rates – technical rates – to be used but also the degree to which these may be
amended (loaded or discounted) to meet market expectations of ‘ballpark’ pricing. The
overall level of amendment needs to be tracked, as do any particularly extreme
amendments.
In some instances, technical rates that are significantly different from the market norm may
reflect the historical experience of a small or unbalanced portfolio but they should not be
dismissed as simply ‘wrong’ unless further investigation confirms an unwarranted bias. A
technical rate which appears out of step with market expectations may reflect an important
underlying feature of the relevant portfolio which should not be ignored. A significant
discrepancy may also reflect the movement of market rates away from the level of pricing
necessary to generate profit and, as such, indicate that continued participation in this market
should be on a highly selective basis.
When examining the historical and current experience of any portfolio of business, the
underwriting manager must:
• understand the mix of business and how it has changed in the past and is changing now;
• understand how technical rates have been arrived at and whether there are any
significant cross-subsidies;
• monitor how technical rates are amended by underwriters on a day-to-day basis;
Chapter 4 Underwriting policy and practice 4/21

• watch for distorting trends either in the mix of business written or the amendment of
technical rates;
• create specific targets regarding business mix; and
• be prepared to take steps to rebalance the portfolio.
D1E Broker portfolios
Throughout this section the discussion on portfolio management has focused on insurers’
portfolios of business and how they might be managed to achieve agreed objectives.
However, the term ‘portfolio management’ can also refer to the approach taken by insurers to
brokers’ portfolios of business.
Rather than approaching an insurer with a succession of individual risks prior to their
renewal dates, an intermediary may approach one or more insurers, requesting terms based
on their overall evaluation of a portfolio of risks. The broker is, of course, looking for
advantageous terms based on the potential profitability of the portfolio and any
administrative savings that might accrue through the arrangement as enhanced commission.

Chapter 4
The broker is not (cannot be) obliged to place eligible business with any particular insurer, as
each customer must be offered the best options to meet their specific requirements.
However, if the arrangement has been considered with care and the insurer’s underwriters
have completed a portfolio review in advance of the agreement, there is every chance that
the majority of eligible insureds will find that it is to their advantage to renew under the
portfolio arrangement. As a result of the portfolio review, the insurer should be able to specify
the type of business they are unable to accept and which business they regard as eligible.
An intermediary can agree to more than one such arrangement and insurers will often
continue to find themselves in competition for the best business. Brokers may also look for
this kind of arrangement at short notice when another insurer withdraws suddenly from the
market and many of their customers require cover immediately or from first renewal.
The assessment and management of this type of portfolio arrangement follows the same
principles outlined above, with some of the additional considerations discussed in the next
section on scheme underwriting.
• Does the portfolio, as currently constituted, fit with the insurer’s underwriting strategy and
policy?
• How do you assess the mix of business the portfolio contains – very diverse or relatively
homogeneous? The more diverse, the more difficult it will be to agree general terms.
• What is the history of the portfolio (previous insurers; how has it been handled; volume,
recent growth, claims experience; quality of data)?
• What approach to administration, commission levels and pricing are you willing to offer
and what is the broker looking to achieve? If the broker requests a profit share
agreement, this requires the input and support of actuarial and finance colleagues in
order to model the impact on pricing and ensure that internal budgets correctly reflect the
potential cost of such an agreement in future years.

E Scheme underwriting
Schemes are a common means of intermediaries exploiting their knowledge of and access
to particular end-customer groups. In return for this improved access, insurers provide
tailored covers, differentiated service and/or keener pricing. At least, this is what is generally
understood as a valid basis for scheme underwriting.
The intermediary’s superior access to specific end-customers is a necessary element of any
scheme arrangement. The end-customers could be:
• members of an affinity group (National Trust members or classic car owners, for
example);
• customers of banks or building societies; or
• end-customers whose risk profile makes them, to some extent, less attractive to the
general market (e.g. scaffolders, solicitors, oil distribution firms).
The underlying proposition may be that the affinity group is in a sense self-selecting and has
a lower-than-average exposure to risk or, for some commercial schemes, membership of the
affinity group is directly linked to qualifications/registration, again ensuring a lower-than-
 4/22 960/December 2020 Advanced underwriting

average exposure to risk and superior claims experience. Regular access to large numbers
of customers through banks or supermarket loyalty card arrangements may imply little about
typical exposure to risk or claims experience but simply provide the benefit of regular access
(opportunities to market/sell) and scale.
Some schemes are created to enable individual risks with common risk-related issues to be
presented to insurers as a group. This approach may, if successful, provide the insurer with
a better appreciation of the group’s true claims experience, which justifies a more moderate
application of terms than would be appropriate if single risks of the type were presented.
Such customer groups may also wish a modification of standard product cover to fit their
particular needs (see chapter 3).
Given the wide range of motivations and opportunities which may underpin scheme
proposals, what is required of insurers is similarly varied. This can include:
• the provision of re-branded documentation for an entirely standard product;
• minor amendment of products and wordings;
Chapter 4

• bespoke claims handling and processes; or

• the creation of a radically different product.
Having first established that the proposed scheme arrangement is within underwriting
strategy and its volumes/values and mix of business fit within corporate risk appetite, the
scheme proposal must be fully assessed. The main differentiator may be the marketing
approach rather than the product cover or it may be the administration of the scheme which
is believed to generate a competitive advantage. Price will usually be a very important
differentiator.
Underwriting managers should determine, in advance, the type, quantity and quality of
information required in order that propositions may be considered on an equitable,
appropriate basis within a reasonable time frame.

Underwriting management decision: evaluation of scheme

propositions
What evidence exists and what assumptions can be made regarding:
• future claims costs;
• expenses; and/or
• level of sales?

Some intermediaries are not well-acquainted with the ways in which insurers evaluate
scheme proposals and an early response from the insurer, detailing the information required,
may save time for both parties. While intermediaries will always understand the insurer’s
focus on a target maximum claims ratio, the issues around expenses and sales may be less
apparent. The insurer needs to assess the expense involved in evaluating the proposal and
setting up the scheme, as well as additional recurring expenses.

Example 4.5
For a scheme requiring an amended policy wording, underwriters will have to consider the
broker’s requirements to confirm whether the proposed changes would be acceptable in
principle. If so, underwriters then have to make the changes and have them validated, and
the new policy wording has to be formatted professionally and printed. The new wording is
allocated a new system code and every computer program using policy wording codes
has to be updated to recognise the new one and associate it uniquely with the scheme
intermediary. All relevant internal staff, including claims staff, must be advised about the
use of the new wording and the changes it introduces.
From then on, the new policy wording code generates additional work each time a
program referencing such codes is maintained or updated and a new line has to be
included in each relevant MI report. When general changes are made to policy wordings,
for example reflecting new legislation or regulatory details, the new wording has to be
updated. Whether the new scheme sells 1, 100 or 1 million policies, the type of expense
described here is incurred regardless.
Chapter 4 Underwriting policy and practice 4/23

Hence the focus on the scheme’s realistic sales potential. What is the ‘whole market’
potential: how many solicitors operate in the UK, how many National Trust members are
there? What special degree of access does the intermediary have to these potential
customers? What evidence demonstrates that this access can be translated into
actual sales?
Additional considerations
Delegated authority – the scheme proposition may involve aspects of delegated authority.
Is this appropriate? Does this delegation of authority improve customer service, improve the
quality of underwriting, de-duplicate administrative procedures and/or reduce expenses? Are
there any downsides to this arrangement? How will the exercise of delegated authority be
monitored? What will this cost? Is the insurer satisfied that the intermediary company is a
suitable potential partner in this venture? Remember that although work can be delegated,
responsibility cannot: the insurer remains accountable.

Refer to

Chapter 4
Refer back to Delegated authority arrangements on page 3/20

Administration – whether the administration of the scheme (the means of administration

and the allocation of work between the intermediary and insurer) is an innovative or
conventional feature of the proposed arrangement, all of the details and costs must be
established before the scheme arrangement can be agreed. This includes agreement
regarding the collection and exchange of data and MI, the payment of premiums and
commission, scheme performance review dates, referral and audit arrangements and,
possibly, the sharing of ICT facilities.
Competition – does the scheme proposition have any direct competitors? If so, what are
this scheme’s unique selling points? Does the insurer already participate in other similar
schemes? Might the new scheme draw business from existing schemes (underwritten by this
insurer) and thereby antagonise other intermediary partners? Might the scheme draw
business from the insurer’s general account? As well as annoying other intermediaries (and
internal staff from branches without access to the new scheme), the insurer may face
recycling its own business: incurring the cost of new business policy set-up, at a lower
premium and higher commission than previously charged. This possibility does not
necessarily rule out the new scheme proposal: the likelihood, scale and cost have to be
assessed and included in the overall evaluation.
All of the above serves to explain why, for every successful scheme (generating profit for
both intermediary and insurer from a satisfied customer base), there are innumerable other
unsuccessful schemes.

Be aware
Schemes underwriting is a specialist business requiring professional focus.

F Scenario 4.1
F1 Question
Your company's relationship with a substantial broker has broken down badly and the
broker's account will be run-off over the next 15 months. The account is proportionately
significant for your company; it has run profitably until now and comprises a book of fairly
homogeneous business.
The marketing, sales and distribution managers have been tasked with devising ways of
replacing this business. The budget approved by the general manager, to whom the whole
management team reports, requires total income to grow in line with general inflation, at
least, and an underwriting profit to be made. There is a recognition that expense levels
(including commission) will probably increase and allowance has been made for this.
As underwriting manager, you can anticipate that many different types of proposal will be put
to you, particularly in the next few months as the run-off gets under way. This is a serious
situation for the company and the general manager expects each member of the
 4/24 960/December 2020 Advanced underwriting

management team to focus on this issue for the next year or so, until the lost business is
replaced.
Describe the underwriting issues which you can envisage arising from attempts to replace
this business.
In anticipation of these types of issue, outline the ground rules you would propose to your
marketing, sales and distribution colleagues and any other actions you would take.

F2 How to approach your answer

Aim
This scenario is concerned with the adaptation of underwriting policy and practice to a
change in company circumstances: namely, the need to write a substantial volume of
business quickly. It tests your ability to understand the potential implications of a range of
business options and to identify necessary underwriting actions.
Key points of content
Chapter 4

You should aim to include the following key points of content in your answer:
Issues:
• Poor quality and/or under-priced business may be acquired to plug the gap. This could
lead to general price rises in later years, resulting in a loss of further good business.
• It may be difficult to evaluate accurately the quality of business available from potential
new sources or arrangements
• New business pricing levels may come under immediate pressure, undermining ability to
achieve underwriting profit. Remaining, supporting brokers may not appreciate a marked
distinction between new and existing business pricing.
• Reinsurers may react adversely to any uncertainty around risk profile and to general
market comment regarding loss of original broker's support and new business drive.
• Service levels (underwriting/sales) for remaining business could suffer, with focus on
filling the gap. If new business quality is poor, claims service levels may also be put under
pressure in due course.
• Although the immediate business requirement/target is short-term, the potential
implications are long-term.
Ground rules/actions:
• Remind all concerned of underwriting strategy and key aspects of policy; with clarity on
no-go areas, confirm which areas are worth considering.
• Identify which aspects of existing accounts (known relationships) should be targeted and
what support you, as underwriting manager, will provide to encourage those
intermediaries to offer the company more good business. You must consider how any
such options support the underwriting profit target. (Example: an existing broker may
want a slightly modified product offering, possibly broker-branded. If achievable within
short time-frame, this may increase expense levels modestly but need not affect
underwriting profit, if product modification is considered appropriately.)
• For entirely new accounts or propositions from less familiar brokers, you must confirm
what information/data will be required. Guidelines should be provided to help quickly
eliminate any proposals not worth pursuing and highlight those with the best chance of
success.
• Confirm your approach to scheme underwriting and how requests for delegated authority
and/or profit share will be handled. Outline typical arrangements for portfolio reviews.
Confirm underwriting department service standards (how long to review an initial scheme/
portfolio proposition and how long to initiate, if successful).
• Confirm approach to risk acceptance to your own staff: if any amendment is to be made,
explain changes and confirm in writing. Advise risk control staff. Make necessary
arrangements to enhance monitoring of mix of business and exposure control. Consider
management information requirements. Advise reinsurers of issues and plans and keep
them updated.
• Potential pricing issues (pressure to discount; response to increased commission levels)
need to be discussed with underwriters and sales staff, before they approach the market.
• Consider creating teams within underwriting to focus exclusively on new versus existing
business; also, consider overall staffing and skill levels.
Chapter 4 Underwriting policy and practice 4/25

Conclusion
The main ideas covered by this chapter can be summarised as follows:
• As the requirements of insurers and their customers change, so must underwriting policy.
Any new policies must fit within the current underwriting strategy and not conflict with
other relevant strategies.
• Each underwriting policy change must be supported by management information and
portfolio management data to allow underwriting and pricing teams to assess the impact
of the change against expectations.
• As well as monitoring the appropriateness of existing classifications and categorisations,
underwriters must assess new risks as they appear.
• An insurer’s underwriting policy should indicate the range of policies/products available
and the extent to which it is acceptable to consider amending policy wordings.
• Underwriting management is required to ensure that current and proposed wordings do

Chapter 4
not conflict with corporate risk appetite, including the scope of the insurer’s reinsurance
protection. Proposed changes to wordings must be considered from financial, legal and
regulatory perspectives.
• Portfolio management involves monitoring how the distinct elements within the portfolio
perform and change over time. It is also necessary to monitor the overall mix of business
as this will significantly influence the servicing of the business.
• Schemes are a common means of intermediaries exploiting their knowledge and access
to particular customer-end groups.

Additional reading
Swiss Re and Bloomberg New Energy Finance. (2013) Profiling the risks in solar and
wind. Swiss Re Ltd. https://bit.ly/2T7rDIq.
 The planning process
5
in underwriting
Contents Syllabus learning
outcomes
Introduction
A Plans and budgets 5.1
B The underwriting manager’s role 2.8, 5.1
C Assumptions and forecasts 2.8, 5.1

Chapter 5
D Expenses 5.1
E Cash flow and investment income 5.1
F Liaison 5.1
G An ongoing task – monthly monitoring 5.1, 5.2
H Management and financial accounts 5.1
I Your plan and budget 5.1
J Scenario 5.1
Conclusion

Learning objectives
This chapter relates to syllabus sections 2 and 5.
On completion of this chapter and private research, you should be able to:
• explain the central role of planning in underwriting;
• distinguish the contribution of underwriters and others to the planning process; and
• identify the key inputs and outputs of planning and budgeting.
 5/2 960/December 2020 Advanced underwriting

Introduction
The development of underwriting strategy has already been described, as has its translation
into the day-to-day practice of underwriters through the creation and application of
underwriting policy. Use of the planning process turns these strategic intentions and
practical approaches into coordinated and prioritised actions, with measurable outcomes.
Planning poses questions about:
• which actions should be undertaken, when, how and with whom;
• how much actions will cost;
• how much business can be accepted;
• what level of profitability needs to be achieved; and
• how we will know we have achieved our plan.
Thus planning and budgeting processes underpin many aspects of underwriting policy
involving the assessment of profitability, the determination of pricing requirements, the
management of exposures and other forms of monitoring, all of which will be discussed in
later chapters.
In this chapter we shall be discussing:
• typical planning and budgeting approaches;
• your involvement, as an underwriting manager;
Chapter 5

• important components of plans and budgets;

• the need for monitoring; and
• distinctions between management and financial accounts.

Key terms
This chapter features explanations of the following terms and concepts:

Assumptions Budgets Cash flow Combined operating

ratio (COR)
Critical success Deliverables Expenses Financial accounts
factor
Forecasts Investment income Management Measurable targets
accounts
Monitoring Planning process Plans Return on capital
employed (ROCE)
Timing

A Plans and budgets

Refer to
Refer to 990, chapter 5, sections A and B, and chapter 6, sections A and B

Plans articulate and guide the implementation of strategies, projects and policies. Budgets
translate plans into financial measures which specify inputs and outputs and are used to
manage performance. Planning, budgeting, monitoring results and explaining exceptions or
variances are significant, time-consuming tasks for most managers.

Be aware
Each company approaches planning and budgeting in its own way.

From an underwriting perspective, ‘plan’ and ‘budget’ may appear to mean the same thing. If
next year your unit is required to increase its premium income by 10% and achieve an
Chapter 5 The planning process in underwriting 5/3

earned loss ratio of 55% or less, that might be referred to by staff as ‘the plan’ and those are
the measures which would appear in the related budget.
In fact, the plan should explain by what means:
• income is to be increased (for example, by selling more of the same products via different
intermediaries; by launching new products; by focusing on larger cases); and
• the loss ratio contained at 55% (for example, by focusing on better performing products
or customer groups; increased excesses).

A1 Return on capital employed (ROCE)

The plan will be a mixture of top line and bottom line targets, and should include clear
actions and owners against each item. Ultimately, the targets are typically linked to capital
allocation and return on capital measures, as well as metrics such as loss ratio and
combined ratio.

Refer to
Refer back to Competition for capital on page 3/3 for more detail onROCE

Your budget should tie in the underwriting initiatives and actions to the overall plan so that
all stakeholders (including actuarial) can help to predict and project the potential impact of
actions on profitability.

Chapter 5
A2 Which of the possible options are to be used: what’s
the plan?
The actions proposed in your draft plan must reflect corporate plans and strategies. If the
company’s strategy is to limit the number of intermediaries it deals with, your plan needs to
reflect this approach. The plan also needs to detail the implications of your proposed actions
which may include the need to recruit staff or retrain others, open new branches or improve
current ICT systems. Typically, the agreed plan will be the result of discussions between you,
your staff, your immediate superiors and more senior management: a mixture of top-down
and bottom-up planning.

A3 Measurable targets
The plan should include measurable targets/deliverables (such as launch dates for new
products or timescales for the recruitment of staff/recruited staff). It is important to identify
those deliverables which represent critical success factors (namely, things which need to
be in place in order to achieve an objective; things which are vital for success). The specific
highlighting of these deliverables is intended to provide a shared focus which assists
prioritisation across the organisation. For example, if without the timely launch of a new suite
of products this year’s plan and budget are not achievable, the product launch is critical to
the success of this year’s plan. All relevant parts of the company need to be aware of this
and act accordingly.

A4 Financial measures

Refer to
Refer to 990, chapter 6, section A

Financial measures (representing income, claims and expenses) are compiled into the
budget which relates to your plan. Your budget should be much more than a passive
prediction of how your area of responsibility will perform in the next twelve months, all things
being equal. It should reflect the impact of the actions you plan to take to ensure that the
result meets corporate requirements in all respects.
The budget approval process should present all budget holders with real challenges: are
their proposed budgets sufficiently ambitious (in terms of profit and growth) and, at the same
time, achievable? No individual budget can be approved in isolation as each must be viewed
in the context of the company’s major divisions, as well as at an aggregate level, in order to
ensure that the overall capital allocation (based on business volumes and underwriting
 5/4 960/December 2020 Advanced underwriting

results) is acceptable. Once approved, the plan and budget become the source of your unit’s
financial and non-financial targets for the year.

B The underwriting manager’s role

Your involvement, as an underwriting manager, in planning and budgeting will depend upon
your role, the size and nature of the insurance company you work for and the company’s
approach to these processes. As we will see later in this unit, approaches to monitoring are
closely related to how companies approach planning and budgeting.

B1 High-level planning
As an underwriting manager, you are likely to be involved in agreeing high-level planning
guidelines in conjunction with your company’s central planning function (or finance and
actuarial teams).

Underwriting management decisions: high-level planning

• How much capital is likely to be available?
• What ROCE is required and how does that relate to next year’s anticipated mix of
business?
• Which rates of inflation should be used for the next twelve months for projecting claims
costs or for rebuilding costs?
Chapter 5

• What allowances should be made for reinsurance costs in the course of next year?
• What increase in headcount is permissible?
• What overall increase in salary costs should be anticipated?
• What is the regulatory context?
• What are the current and expected future market conditions?
• What amounts will be used for fees and levies?

B2 Product planning
If you are the manager responsible for a group of products, you will use the centrally-set
guidelines to develop your unit’s plan and budget in detail for the forthcoming year.

Underwriting management decisions: product planning

• For a given set of products, what scope for growth exists (given likely competition and
the position of the underwriting cycle)?
• Which products will grow faster than others?
• Which will produce most/least profit?
• If you plan to exit a product next year, what impact will that have on the budget? Will it
impact on other products? If commission costs are rising, what implications are there
for your products’ projected rating increases?
• Will there be cross-subsidy between products or will each product be expected to
achieve a positive return?

With the increased use of risk-based capital modelling, you will be required to relate
planned changes in exposure to your products’ allocation of capital and their relative
performance (ROCE).

B3 Regional planning
As an underwriting manager at a regional operational unit, you will have significant input to
the development of the unit’s plan and budget, particularly in explaining the use of any
assumptions which vary from those set centrally.
Chapter 5 The planning process in underwriting 5/5

Underwriting management decisions: regional planning

• If the company has recently amended local postcode ratings for household business,
what impact will this have on your region’s household business next year? Will
increased new business from lower-rated postcodes compensate for lapses from
higher-rated postcodes?
• Two new schemes should go live next year in your region: how much income will they
generate and how do you anticipate the volume of claims to build up in the course of
the year? What are staffing/expenses considerations?

C Assumptions and forecasts

None of the questions posed in The underwriting manager’s role on page 5/4 are necessarily
easy to answer: in fact, most cannot be answered with certainty. Just because some
postcodes will attract lower rates next year, will this automatically generate increased sales
in those areas? Clearly not.
It is necessary to examine each issue in turn and create forecasts, based on assumptions,
of what may happen. Assumptions and forecasts must be based on the best-available
research and data and this information should be documented, so that the assumptions and
agreed forecasts can be reviewed, validated and subsequently monitored. In this way valid
assumptions and forecasts can be distinguished from mere assertions, in which senior

Chapter 5
management can place little confidence.

Example 5.1
Regarding the questions raised in Regional planning on page 5/4 about the lower-rated
postcodes, if at the end of the year sales have increased by only 2% compared with a
forecast of 10%, what went wrong? If the rationale behind the 10% forecast was recorded,
it should be possible to determine whether something truly unexpected happened or
whether the approach to determining the forecast or any underlying assumptions was
poor.
• Will higher sales be generated in those postcodes where rating has been lowered and,
if so, what increase in sales might be anticipated?
• What is the extent of the reduction in rating?
• Have you evidence of the impact of other similar reductions in the recent past?
• How many broadly acceptable households are in these postcodes and what is your
company’s current share?
• How do your rates compare with those of competitors?
• Does your company have any particular (non-price) advantages in these postcodes: a
supportive local broker or a willingness to accept risks which other insurers tend
to avoid?
What other questions would you consider?
Depending upon the answers to these questions, it might have been agreed that sales
could increase between 5 and 10% in the plan period.
With the benefit of hindsight, the choice of the figure at the top end of the range (10%)
may not have been wise but the main factor undermining this aspect of the plan was the
entry of a new competitor to the market offering an economy product.
If the failure to achieve the anticipated growth was of significance to the account as a
whole, the conclusion may be that far more effort should have gone into the research
behind the forecast and the actions of new and existing competitors monitored more
closely.

It is important to understand the status of planning assumptions and forecasts. For example,
insurers with property exposures will include assumptions about the cost of severe weather
events in their budgets: they may allocate a specific claims cost or a percentage load on
claims cost, say 5%. This is an assumption based on the projected cost of severe weather
events over a period of years, not a forecast of what will actually happen in the specific
planning period in question. If, in the year in question, severe weather claims costs amount
 5/6 960/December 2020 Advanced underwriting

to 1% or 10%, this does not necessarily invalidate the planning assumption, which was
intended to reflect a likely average cost for a highly variable element of the budget. Other
aspects of the plan will, however, demand a forecast that must relate specifically to the
period in question. Sales volumes, as above, are one such example.

C1 Importance of timing
As well as considering how you and your colleagues wish to develop the account, the timing
of changes and new initiatives must be considered. Unless implemented in the early part of
the year, most of the impact of a rating change will only be evident in the subsequent year.
Similarly, a recruitment exercise to obtain more underwriters (and thus support increased
sales) could easily absorb six months, or more, before the new underwriters are in place.
When creating a plan and budget for your area of responsibility, you have to identify the
issues and risks (internal and external) which are likely to affect the achievement of your
plan and consider how best to manage or mitigate these issues and risks while meeting the
requirements of executive management. These requirements will usually be expressed in
terms of:
• income growth;
• profit; and, increasingly,
• ROCE.

D Expenses
Chapter 5

As well as those components of the budget that relate directly to underwriting (premiums and
claims, primarily), there are many other items for which you may be deemed to have
responsibility, known as expenses. If this is the case, you are likely to be involved in
determining the budget for those items.
For example, although your role may involve responsibility for the effective performance of
staff employed in your unit – and you may be involved in decisions regarding headcount – it
is likely that projected staff costs (pay, benefits and other related costs) will be provided to
you, possibly using a simplified formula calculation. Similarly, within most large companies
there is likely to be a specific budget-holder for ICT costs with whom your plans for the
forthcoming period (for systems-support for a new product or upgraded data capture) must
be discussed and agreed.

D1 Fixed expenses
The calculation of these ICT costs (projected and actual) and their allocation to your unit’s
budget may be on a specific basis or they may be included in an overall management
services charge borne by all units, which covers an allocation of fixed expenses (those
expenses that do not alter with the level of business written, such as the costs of a building).
Even in respect of some items which are very closely related to underwriting, such as
reinsurance costs, you may be required to include specifically projected costs within your
budget or you may be provided with a figure representing a general cost allocation.

D2 Variable expenses
Allocation of variable expenses is typically at product or business level, with adjustments
being made to reflect delegated underwriting or claims handling.
Those responsible for the planning and budgeting processes within your company will
determine the approach to expenses (such as staff costs, ICT and reinsurance) by balancing
the need for proper focus on costs and responsibility for expenditure with the need to focus
on what individual underwriting managers can most effectively influence and the need to
avoid unproductive complexity in allocating detailed costs to individual units or products.
Chapter 5 The planning process in underwriting 5/7

E Cash flow and investment income

But what about cash flow and investment income, both of which are important elements of
the ROCE calculation? You will be expected to consult your finance and actuarial colleagues
who will provide you with either figures developed specifically for your account or a COR
target, adjusted to allow for cash flow and investment income assumptions, as well as return
on capital and profit requirements.

Example 5.2
As advised, your account’s income is required to grow by 10% next year, while achieving
an earned loss ratio of 55% or less. The earned loss ratio target (incurred claims as a
percentage of earned premium) has been derived using assumptions regarding
commission costs and other expenses based on a COR (incurred claims plus expenses
divided by earned premium) of 98%. Actuarial and finance have confirmed that a COR of
98% will support the required return on capital and profit on your account, on the
assumption that the account’s mix of business and cash flow remain stable and the
account does not grow by more than 20%. Although fictitious, these figures are intended
to be broadly realistic; however, different classes of business will have differing earned
loss ratio targets to produce profit depending on how much capital is required to support
the business.

By these means, underwriting managers are encouraged to focus on what they can

Chapter 5
effectively influence (risk exposures, premium, claims and certain expenses) and leave
others to manage ICT costs and investment income returns. This is not to suggest that you
should not take every opportunity to review all relevant aspects of the budget (ideally before
the period of peak budgeting effort within the company), in order to appreciate the validity
and impact of the assumptions used and how you might improve the performance of the
business. Cash flow may not be one of your prime responsibilities but if your underwriters
answer accounts queries more promptly, will overall performance be improved?

Refer to
Refer to Management and financial accounts on page 5/10 for financial accounts

Actuarial, finance and/or the central planning function supply important base data and
targets for your plan and budget but you also need to consult with other colleagues.

Underwriting management decisions: planning and the need for

liaison
• How do your product plans fit with marketing and sales plans?
• At a regional level, are those responsible for distribution recommending any changes
which may impact the balance of the account?
• Will a proposed new product require the recruitment of specialist claims handlers?
• Have your plans for new or amended products or growth initiatives been shared with
the company’s reinsurers?

F Liaison
As an underwriting manager you will be constantly liaising with other staff with an interest in
how your account performs, either on a regular, formal basis (e.g. monthly meetings) or as
and when their advice is required.

F1 Actuaries
Actuaries and their staff deal with the financial impact of risk. They provide assessments of
financial security systems with a focus on their complexity, their mathematics and their
mechanisms. Actuaries evaluate the probability of events and quantify the contingent
outcomes in order to minimise the impacts of financial losses associated with uncertain,
undesirable events. They use various capital modelling tools to assist them in their
deliberations.
 5/8 960/December 2020 Advanced underwriting

Actuarial input to all classes of insurance and reinsurance business is vital. It can be
particularly important in classes of business where there are a large number of claims
expected as a normal consequence of underwriting that particular class.

Example 5.3
Motor insurance (private hire or commercial vehicle/fleet) will generate a large number of
attritional, day-to-day high-volume, low-value claims as well as the occasional high-value,
low-frequency third-party bodily injury claims. Using historical claims data and anticipated
changes in the claims environment, actuarial input into expected loss ratios can be
extremely useful for the underwriting manager in suggesting future strategy.

F2 Compliance
The compliance officer and their staff are charged with ensuring the legislation and
regulations for the class of business in the territory written are adhered to.

Refer to
Refer back to chapter 1

If your unit holds monthly meetings to monitor progress towards targets (see An ongoing
task – monthly monitoring on page 5/9), it is very likely that the compliance department
Chapter 5

would have a representative at the meeting to deal with any compliance issues that may
arise.

Example 5.4
For a UK motor unit there is a requirement to populate the Motor Insurance Database in
an accurate and timely matter. The compliance department will want to be assured that
this requirement is met on a regular basis and that any potential problems are spotted as
early as possible so that measures can be introduced to ensure adherence.

F3 Sales/marketing
Although this function is concerned with premium generation and good relationships with
third-party insureds/brokers etc., they should be aware of your need to generate target
ROCE and that sometimes there are conflicting pressures of turnover and profit. Where
there are conflicting pressures, the need to make sufficient returns predominates.

F4 Other underwriting staff

As the underwriting manager of the unit, you are responsible for ensuring that each member
of your underwriting and administration team is aware of their role and responsibilities within
the unit. They should each have mutually-agreed targets to measure performance and these
targets should be regularly monitored. Communication channels to you should be as open as
realistically possible.

F5 Senior management
Senior management obviously have a keen interest in how your unit’s business is run. It is
usual for a monthly meeting to be held with all underwriting managers to record how each
unit is meeting its pre-agreed targets. Results are discussed, actuarial projections are made
based on historical claims data, and other issues are aired. If necessary, individual meetings
are arranged outside of this forum. As with your own staff, it is important to maintain clear
and open lines of communication with the senior management team.

F6 Claims
For catastrophe classes of business, liaison with claims staff may be limited to occasions
when a catastrophe claim does occur. For classes such as UK motor, where there is a high
frequency of low value claims (as well as the odd catastrophe one), it is likely that liaison
between claims and underwriting staff is very frequent. Underwriters will want to know about
changes affecting the frequency and severity of claims; the claims department will want to
know how any changes in underwriting policy will affect their workload. It is not uncommon
for a claims representative to be involved in the monthly unit meeting for these classes.
Chapter 5 The planning process in underwriting 5/9

G An ongoing task – monthly monitoring

This may sound like a formidable task: to pull relevant data and information together, discuss
plans with colleagues in other functions and units (and with intermediary partners and
reinsurers), agree priorities, all within a relatively tight period of time.
It would be a very difficult exercise to accomplish if the issues were only reviewed once a
year: in reality, work goes on throughout the year in support of planning and budgeting,
although finalising next year’s plans and budgets can still be a testing experience.

Example 5.5
A typical planning process
Throughout the year:
• Executive and senior management participate in conferences and reviews intended to
check the overall direction of the business, assess progress on strategic objectives,
scan the environment for opportunities and threats and, generally, review and update
high-level objectives. Other levels of management may also participate in similar,
formal planning conferences.
• Formal and informal discussions with intermediary partners and reinsurers will
contribute to the assumptions made in your plans and provide a view of general market
trends for current and forthcoming periods. Refer to M92, chapter 3, section B6.

Chapter 5
• At all levels of management, monthly management and financial accounts will be
reviewed against current budgets and the previous year’s actual figures. Within every
unit and project team, monthly performance (financial and non-financial) will be
reviewed against targets. Variances from the plans will be queried (see also chapter 9
on monitoring). Although these monthly reviews examine what has already happened,
they should contain elements which are directly relevant to planning for the future, for
example:
– When variances are examined, why did the current plan fail to anticipate events or
trends which have proved to be significant? If certain assumptions or forecasts were
poor, how can they be better validated in the future? Seasonality impacts need to
be considered; for example, in a motor portfolio one can expect claim frequency to
increase in winter months when the weather is bad. The main way better plans and
budgets are created is by reflection on how the current versions could have been
improved.
– As you advance, month by month, through an annual plan and budget, you will be
obliged to state how you view the outcome of the remainder of the year: what is
your forecast? If sales have been below plan in the first three months of the year,
will this deficit continue through to the end of the year or may some of the deficit be
eliminated by better than planned sales in later months? If a higher than expected
number of large claims has been intimated in the first half of the year, what is the
likelihood of this higher level continuing? Depending upon the nature and scale of
the variance, a decision will be taken whether to stick with the existing budget or to
reforecast the budget for the remainder of the period. In addition, as you reflect on
the plan and budget for the remainder of the current year, you are inevitably
thinking ahead to the next planning period.
• Throughout the year profitability reviews will be conducted for individual products and
classes of business (see also chapter 7). By the time of the annual budgeting exercise,
many of the rating amendments required in the next year will already have been
agreed in principle and, on the basis of regular reviews, reasonable assumptions can
be made about those not yet agreed: these assumptions can be fed directly into the
relevant budgets.
• Monthly meetings allow for regular review of various aspects of the business. Are the
planned premium income targets being met? If not, why not? Are the required ROCE
figures being met? Are staffing levels adequate? Are service standards being met?
What is the state of the market – are rates rising or falling? All these issues and more
can be addressed on a regular basis rather than let issues of concern drag on and
potentially become more serious.
 5/10 960/December 2020 Advanced underwriting

Of course, for those companies who use twelve-month rolling plans, the above work
supports an updated plan every month as opposed to a new plan once a year.

H Management and financial accounts

The budget you prepare or contribute to for your own area of responsibility should directly
reflect those measures you can influence and/or are tasked to monitor. The budget form
should mirror the management account you receive every month. Typically, this will involve
a relatively small number of measures, which may be available at many sub-levels (for
example, at product, scheme, class, intermediary and/or branch level).
A basic monthly management account (and thus budget) would include:
• written premium;
• earned premium;
• incurred claims cost (payments plus change in outstanding estimates); and
• earned loss ratio.
This is usually presented on a gross basis (gross of reinsurance premiums and recoveries).
As management accounts are purely for internal use, they will reflect the needs of individual
units. Expenses may or may not appear, depending upon whether they are calculated/
allocated to the relevant level of analysis. As discussed, a target earned loss ratio may have
been agreed with actuarial incorporating various assumptions which permits underwriting
Chapter 5

managers and staff to focus on a smaller number of variables on a monthly basis.

The rationale and basis for all assumptions used in the creation of the annual budget should
be thoroughly reviewed prior to their use and an ongoing process of review should monitor
their continued validity. See Plans, budgets and forecasts on page 9/2 for a list of the key
measures and assumptions which need to be monitored.
Insurance companies also produce financial accounts on a monthly basis and public
companies publish summaries of these accounts for external scrutiny on a regular basis.
Financial accounts are designed to permit comparison between all companies (not only
insurers); they include measures relating to issues which are not within the remit of
underwriting managers and they are typically compiled at a high level without many sub-level
splits. There are a number of reasons why management and financial accounts do not
produce matching figures, including:
• differences in how certain items are measured;
• timing differences;
• different methods of expense allocation; and
• reserve movements.
Although you and your unit’s performance will be primarily measured by the relevant
management account, it is important to understand something of your company’s financial
accounts for a number of reasons:
• It is what the public and the rest of the market (including intermediaries and reinsurers)
see and you may well be asked to comment on your unit’s performance in that context
(by staff as well as external parties). Refer to M92, chapter 7.
• If you are responsible for a group of products or businesses separately reported within
your company’s financial accounts, it is important that you understand how the two types
of account may be reconciled and continue to monitor the significant elements within that
reconciliation monthly.
• It will help you understand some of the underlying assumptions used by finance and
actuarial in the creation of target ratios.
Chapter 5 The planning process in underwriting 5/11

I Your plan and budget

At the end of the planning and budgeting process, you should have satisfactory (and
affirmative) answers to the following questions:
• Does your budget reflect the resources necessary to accomplish your plan?
• Is it realistic and phased (month-by-month) appropriately, taking into account seasonal
variations?
• Can you and your staff identify the priority elements within both the plan and the budget?
• Do you understand how the assumptions and forecasts have been reached?
• Do you know which assumptions and forecasts have to be monitored closely?
• Have appropriate contingencies been allowed for (e.g. weather worse than expected,
new business lower than expected, claims intimations higher than expected)?
• Do you understand how the accomplishment of the plan and adherence to the budget will
be measured and monitored?
• Have key performance indicators (KPIs) have been agreed?

Refer to
Refer to Key performance indicators on page 9/6

I1 A meaningful process?

Chapter 5
Sometimes planning and budgeting can seem extremely process-driven and removed from
the ‘real’ world. Maybe next year’s plan and budget closely resemble those of last year and
the year before that – are they still appropriate?
Underwriting managers are particularly aware that the underwriting cycle is a fact of life and
that, to be useful, plans and budgets must therefore reflect its influence. Not everyone in the
company will be aware of the influence of the cycle. Given that ‘managing the cycle’
(managing the transition from hard to soft markets and back again) is a key determinant of
success in general insurance, the planning process must pay particular attention to the stage
of the cycle and timing issues. A highly collaborative approach to planning, which draws
information and data from a wide range of sources and shares it appropriately, is best suited
to achieving this awareness and capability.

I2 A good quality process?

Plans and budgets can only be as good as the data, information and assumptions they are
based on. In the next chapter we will look at claims, which represent the single largest cost
in any general insurance budget and the most significant source of uncertainty.
In chapter 9 we will follow the planning and budgeting processes through to monitoring,
which enables underwriters not only to identify what is performing or not performing
according to plan but also helps identify the reasons for variances.

J Scenario 5.1
J1 Question
The sales manager says that staff members are frustrated by the mass of targeting
information provided by the underwriting department. A far more straightforward approach is
required for next year: simple premium income targets.
As underwriting manager, what is your response and why?

J2 How to approach your answer

Aim
This scenario focuses on the uses to which outputs of planning and budgeting are put. You
are asked to consider how underwriting works with other areas to achieve corporate
objectives.
 5/12 960/December 2020 Advanced underwriting

Key points of content

You should aim to include the following key points of content in your answer:
Company requirements:
Quality standards and the agreed mix of business (exposure and class) need to be achieved
as per the budget, as capital levels and allocation, reinsurer expectations and the suitability
of reinsurance programmes depend on business mix as well as overall performance. In
addition, if the rest of the organisation has little idea what business will be written, how can
they plan to service and support it appropriately?
It is necessary to manage top line growth against bottom line profit in order to achieve the
targeted return on capital employed (ROCE).
Sales staff requirements:
What can we (underwriting) do to help? Can we rationalise the targeting information or
present it more effectively? Would it help if senior members of the underwriting team spent
time with sales staff to explain the targets set?

Conclusion
The main ideas covered by this chapter can be summarised as follows:
• Plans articulate and guide the implementation of strategies, projects and policies.
Budgets translate plans into financial measures which specify inputs and outputs and are
Chapter 5

used to manage performance.

• Underwriting managers are likely to be involved in agreeing high-level planning guidelines
in conjunction with the company’s central planning function.
• Underwriting managers will constantly be liaising with other staff, such as actuaries,
compliance, sales/marketing, senior management, and claims.
• Insurance companies produce financial accounts on a monthly basis and public
companies publish summaries of these accounts for external scrutiny on a regular basis.

Additional reading
Lloyd’s Minimum Standards: www.lloyds.com/market-resources/requirements-and-
standards/minimum-standards.
 Claims data and reserving
6
Contents Syllabus learning
outcomes
Introduction
A Reserving policy and practice 2.6
B Claims reserving and underwriting 2.6, 3.5, 5.1
C Forecasting to ultimate: approaches and techniques 3.3
D Interpretation and use of claims information 3.3
Conclusion

Learning objectives
This chapter relates to syllabus sections 2, 3 and 5.
On completion of this chapter and private research, you should be able to:
• explain the implications of claims reserving practices for individual policy and portfolio

Chapter 6
underwriting management;
• describe the different approaches and techniques used to forecast ultimate claims costs
and their uses; and
• adopt a considered approach to the selection, interpretation and use of claims data.
 6/2 960/December 2020 Advanced underwriting

Introduction
Total claims costs are the major determinant of profitability in general insurance: claims data
is therefore used in financial accounts, statutory returns and internal budgets and in
decisions regarding pricing, the evaluation of exposures, capital requirements and the
purchase of reinsurance. As well as considering the use of claims data, the main focus of
this chapter is claims reserving.

Be aware
The extent of an insurer’s claims reserves (the funds set aside to pay for current and
future claims liabilities) is a very significant indicator of a company’s financial strength,
closely scrutinised by regulators and external analysts.

Key terms
This chapter features explanations of the following terms and concepts:

Accident year basis Bornhuetter- Case estimates Catastrophe claims

Ferguson
Claims data quality Claims development Claims inflation Claims practice
triangles
Claims reports Claims reserves Claims run-off Latent claims
Reserve releases Reserving pattern Time value of money Ultimate claims cost
Underwriting year
(incurred) basis
Chapter 6

A Reserving policy and practice

Claims reserving takes place in two stages within general insurance companies. Individual
claims, once intimated, are case-estimated in order to establish their likely eventual total
cost. In addition, actuaries monitor the overall level of case reserves by regularly projecting
their likely total (ultimate) claims cost as a whole and may recommend a general adjustment
(positive or negative) to aggregate claims reserves in the company’s financial accounts. This
process allows for the fact that within every group of intimated claims, a number will not be
pursued and will be settled at nil; some will prove more costly than estimated and others will
settle for less than estimated.
This does not imply that individual case-estimating is necessarily inaccurate: it merely
demonstrates the degree of uncertainty inherent in claims handling and the need to ensure
that overall reserve levels are more than adequate to meet claims liabilities. Owing to this
inherent uncertainty, general insurance companies must demonstrate not only that their
reserve levels are more than adequate but that the relevant review processes (for both
individual outstanding claims and groups/classes of claims) are conducted regularly and
systematically.

Refer to
Think back to M80, chapter 5, sections D and F

In addition to the reserves held as specific case estimates, actuaries assess the requirement
for further general claims reserves to account for incurred but not reported (IBNR) and
incurred but not enough reported (IBNER) claims costs. When all the elements which
make up the company’s claims reserves are reviewed (usually quarterly), senior
management decide whether to increase or reduce them based on analysis of the general
level of case reserves (too low, too high or about right?) and views of claims trends and
costs (including the future impact of inflation, claim frequency, legislative changes and
earnings from investment income). They may wish to reserve additional capital to deal with a
potential increase in industrial disease claims in the future or to make provision for a very
significant, recent event until a clearer view of total costs emerges (for example, immediately
after a catastrophic event).
Chapter 6 Claims data and reserving 6/3

In making these decisions, senior management may be supported by both internal and
external actuaries and will consult senior claims and underwriting managers. While their
objective is to ensure that the company is more than adequately funded to meet current and
future claims liabilities, it is not in any company’s interest to be grossly over-funded due to
the cost of capital and the necessary impact on pricing. In addition, reserves regarded by the
authorities as excessive will be liable to taxation.
Therefore, insurance companies’ general claims reserves move frequently in order to
maintain an acceptable balance between prudence and cost, as well as reflecting the
ongoing intimation, estimation and settlement of claims.

Be aware
The net result of movements in claims reserves is shown on the income statement in a
company’s financial results. Sometimes a company will specifically refer in the results
commentary to the fact that reserves have increased in respect of a particular type of
claim (for example, asbestos-related claims). The timing and scale of reserve releases
can be very important in maintaining underwriting profitability/an acceptable combined
operating ratio (COR). The detail of claims reserve movements will be available internally
at class level.

Research exercise
Ask your manager for claims reserving information for a familiar class of business. If
access to current information is confidential, you could see if older, out-of-date information
is available which will still provide an overview of the approach adopted.

Although general claims reserves can be (and are regularly) adjusted at an aggregate level,
insurers remain anxious to demonstrate the accuracy of their case-estimating and general
reserving processes. Claims run-off (the eventual outcome of these processes as claims

Chapter 6
are settled) is monitored closely by a number of external parties and will often be used as an
indicator of a company’s competence and the degree of security offered. A company’s
external credibility is likely to be undermined if its claims run-off is either significantly
negative (that is, claims have been under-reserved and have cost much more than
expected) or significantly positive (claims have been over-reserved and the company has
held capital in reserve unnecessarily).

Critical reflection
How would the following groups view an insurer which produced significantly positive or
negative claims run-off?
• Regulators
• Shareholders
• Intermediaries and their clients
• Other insurance companies
• Internal staff – underwriters and claims handlers

B Claims reserving and underwriting

Consideration of how underwriters use claims experience (number of claims and claims cost)
to evaluate and price individual risks, accounts and products highlights three points in
respect of claims reserving:
• The confidence with which risks, accounts and products can be evaluated and priced is
dependent upon the quality, accuracy and consistency of case-estimating and reserving
processes undertaken by claims and actuarial staff and underwriters’ understanding of
those processes and their outputs.
• In many instances, data consisting solely of paid plus outstanding claims will not provide
sufficient information to indicate the total cost of claims. At any point in time, the actuarial
assessment may indicate the need to adjust these values to produce a true or
ultimate cost.
• The need for close liaison between claims, actuarial and underwriting is apparent.
 6/4 960/December 2020 Advanced underwriting

Be aware
Adjustments should not be contemplated without actuarial advice.

B1 Individual policies
Good practice dictates that renewal underwriters check for recent claims intimations and any
updated estimates before offering renewal terms on individual policies. It is necessary to
review any large or potentially contentious claims with claims colleagues in order to be fully
informed regarding the circumstances of the claims and claims department’s approach to
their handling and estimation. With this background information, underwriters are then well-
placed to discuss the risk’s claims experience with the insured and/or their intermediary and
avoid prolonged debate regarding the accuracy of individual reserves.
While resisting the temptation to accede to intermediaries’ requests to discount claims
estimates (based on the assertion that ‘your company’s estimates are always too high’),
underwriters may over time recognise a bias in the claims estimating process in respect of a
particular type of claim and this should be discussed with the claims department.
Underwriters need to have confidence in the company’s claims handlers and their approach
and, therefore, should be assisted and encouraged by their managers not only to monitor
how individual claims develop but how the overall account’s claims development patterns
and run-off are reflected in the actuaries’ assessment of the overall performance of the
account.

B2 Portfolios
It is evident that a simplistic approach to profitability or pricing, which ignores general claims
reserves (and their movements), could lead to highly inaccurate conclusions. Thus, in a
liability account which has incurred several exceptionally large claims in a single year, all of
which are still outstanding, the actuarial assessment may be that while each individual case
Chapter 6

estimate looks appropriate in the light of current knowledge, the aggregate value of these
estimates is possibly excessive. If agreed, a negative adjustment could be applied to the
general claims reserve for liability and this adjustment (and its value) should be used in any
concurrent profitability review or pricing exercise for relevant liability products.
In the case of a high volume product, such as personal motor, actuaries will monitor closely
the number of claims intimated each month. If the number intimated reduces (due to
backlogs, sickness or holidays in claims department), the actuaries are likely to increase the
allowance for IBNR in the motor claims reserves until productivity resumes its former level.
As above, this adjustment should be utilised in any work involving profitability or pricing for
the motor account.

B3 Liaison

Refer to
Think back to M80, chapter 4, section G and chapter 5, section C

The value, or rather necessity, of good liaison between underwriting, claims and actuarial is
highlighted most clearly when considering the uses and interpretation of claims data. Each of
the three parties has their own clear responsibilities and requirements but each needs to
consult with the other two in order to achieve a full understanding. Changes in underwriting
policy and/or practice can have knock-on effects on claims numbers and costs and their
subsequent development patterns. As noted above, even temporary backlogs in claims
department can affect claims experience and its interpretation. If actuarial decides to
increase an account’s IBNR/IBNER reserves but fails to advise the relevant underwriting
manager, there is the likelihood that risks in the account will be under-priced.

Be aware
Liaison between underwriting and claims staff is also essential in respect of policy
wordings and cover changes, emerging risks and trends, anti-fraud initiatives and, of
course, individual claims.
Chapter 6 Claims data and reserving 6/5

It should be noted that such liaison is made more difficult where any of the functions are
outsourced or delegated. In such circumstances, greater efforts are required to ensure that
very regular formal liaison takes place.

C Forecasting to ultimate: approaches and

techniques
As we have discussed, in determining overall claims reserve levels, members of senior
management are advised by actuaries who use a range of statistical techniques to forecast
the ultimate cost of claims. Although underwriters are not required to conduct such statistical
analyses, you will be expected to discuss and help validate the results (to identify any
underlying changes which may be affecting the incidence of claims or claims costs, for
example) and to utilise the information in your own work (particularly in pricing and planning).
It is therefore important that underwriters have an appreciation of how actuaries approach
this work and why the use of different techniques can produce different results.
The first main approach is the projection and monitoring of specific groups of claims
from intimation to their eventual settlement. Claims are normally analysed at class level (for
example, liability or property) to ensure that the dataset is as large and representative as
possible.

Be aware
Prior to their inclusion in datasets used for reserving, the quality of claims data is
assessed by testing for unexpected values and internal consistency.

Short- and long-tail claims, very large claims and groups of claims arising from specific
exposures (e.g. industrial deafness claims) may be projected separately. For this type of

Chapter 6
analysis, claims are selected on an accident year basis (relating to the period of exposure
rather than when a claims cost is incurred). This ensures that important underlying factors
such as the rate of claims inflation or judicial guidelines are common for the claims
selected. It also enables the projected claims costs to be measured against the appropriate
earned premium and exposure figures to create ultimate earned loss and burning cost ratios.

C1 Claims development triangles

Claims development triangles are the most effective way of presenting this data and
separate triangles may be created for the:
• number of claims intimated;
• value of paid claims only; or
• value of incurred claims (paid plus outstanding estimates).

Be aware
Essentially the methods used seek to identify patterns in the development of claims data:
their progression from year to year.
 6/6 960/December 2020 Advanced underwriting

Table 6.1: Claims development triangle - claims numbers

Number of intimated claims as at 31/12/2019

Development year

Accident year 1 2 3 4 5 6

2014 720 1,010 1,200 1,205 1,205 1,205

2015 514 928 1,178 1,188 1,190

2016 750 1,050 1,250 1,258

2017 729 979 1,115

2018 762 1,065

2019 770

NB: Claims settled at ‘nil’ cost have not been removed from the above.

Table 6.2: Claims development triangle - incurred claims costs

Incurred claims costs (£) = Paid plus outstanding as at 31/12/2019

Development year

Accident year 1 2 3 4 5 6

2014 779,040 1,924,050 2,268,000 2,289,500 2,417,230 2,385,900

2015 514,000 1,866,208 2,404,298 2,387,880 2,859,570

2016 936,750 1,899,450 2,755,000 2,893,400

2017 920,727 1,965,832 2,654,815

2018 1,120,140 2,252,475

Chapter 6

2019 1,178,100

Please turn to appendix 3 to see how data in claims triangles may be used, including the use
of link ratio techniques.
Is there a typical reserving pattern and mix of methods?
For many classes of business a typical reserving pattern will be one in which the account is
under-reserved at first, over-reserved at a certain point and then, as the larger claims finally
settle, the ultimate total cost emerges.
Not only are there many ways in which this data may be projected but actuaries will
deliberately use a number of different methods in order to test the validity and robustness of
the answers they derive. Some methods involve the projection of loss ratios and burning
costs, as well as the number and cost of claims. The selection of methods will be determined
by the nature, size and maturity of the claims dataset in question.
Chapter 6 Claims data and reserving 6/7

Bornhuetter-Ferguson method
The Bornhuetter-Ferguson method/technique is an example of the combination of
reserving methods: it uses a loss ratio projection in the early years of development and
assigns increasing weight to the paid or incurred claims development pattern over time.
Referring to the incurred claims costs triangle shown in table 6.2, if you knew that the
earned premium for accident year 2014 was £3.7m, you could present the pattern of
claims development for that year as a succession of loss ratios: 21%; 52%; 61%; 62%;
65% and, finally, 65% for 2014 as at end 2019. The Bornhuetter-Ferguson technique is
designed to assist the development and monitoring of claims reserves for accounts whose
incurred (or paid) claims amounts are very low in the years immediately after the year of
exposure. Rather than the pattern of loss ratio development illustrated above, the early
years of a long-tail account might start with loss ratios around 5%, building to a final ratio
of, say, 65% after ten or more years.
The Bornhuetter-Ferguson technique utilises an account’s anticipated final loss ratio and
its typical loss ratio development pattern to arrive at the ultimate cost and an appropriate
claims reserve for each year of development. In this example, if the typical loss ratio in the
first year of development is 5%, the ultimate cost will be assumed to equate to the first
year’s ratio plus 60%: thus equalling the anticipated final loss ratio of 65%. However, if at
the end of the first year the actual ratio is 6%, the ultimate cost would be assumed to
equate to 66% (60 plus 6%) of premium income and the claims reserve would be the
equivalent of 66% of premium income less any paid claims. As years pass and the actual
claims experience becomes better developed, the calculation of the ultimate claims cost
becomes increasingly based on the actual experience rather than the anticipated
loss ratio.

C2 Stochastic methods

Chapter 6
Refer to
Think back to M80, chapter 4, section F3

The second main approach involves stochastic methods, which examine the randomness or
variability of the incidence and cost of claims. Rather than restricting the projection of
ultimate claims costs to an analysis of historical costs, this approach considers the likelihood
of different numbers of claims and different claims costs occurring. It is easy to see how
useful and necessary this approach would be if the account in question was newly
established or relatively immature.
Even for large, long-established accounts, actuaries must consider different claims scenarios
to reflect:
• underlying trends in exposures;
• catastrophe claims (for example, the incidence and cost of floods); and
• latent claims (for example, disease claims arising from modern industrial processes,
which are as yet unrecognised).
Even the largest claims dataset does not contain the cost of the largest claim possible
because it has not happened yet. However, in their assessment of overall claims reserves,
actuaries and senior management must consider the potential impact of such extreme
values (by modelling the statistical distribution of claims severity and frequency). This is a
very difficult judgment to make and the decision is critical to the success and survival of the
company: it impacts the amount of capital raised and set aside, the amount of reinsurance
bought, pricing and the company’s profitability. Much depends upon the actuaries’
assessment of the relevant claims dataset: does it already contain an adequately
representative number of very large claims? The company may contract external actuaries,
with a broader view of general insurance claims experience, to assist with issues of this sort.
 6/8 960/December 2020 Advanced underwriting

C3 The value of claims now and at settlement

The ultimate claims cost is intended to represent the total anticipated cost of claims at their
dates of settlement. In arriving at these values, inflation presents particular challenges,
irrespective of the method used: what is the appropriate rate or rates to use when projecting
ultimate claims costs? Different inflation rates apply to different types of claim and to different
elements within individual claims.

Example 6.1
The cost of settling bodily injury claims in the UK continues to outstrip rates of general
inflation. As bodily injury claims represent some of the largest and potentially longest-
outstanding individual claims in a general insurer’s account, the choice of inflation rate to
use in projections is critical as its impact will be compounded over a number of years until
the projected settlement date. Of course, as individual case estimates for bodily injury
claims already include an allowance for inflation to the date of assumed settlement, the
actuaries’ task involves both assessing the likely current and future applicable rates of
inflation and evaluating the effectiveness of claims estimation processes.

With the assistance of finance colleagues, actuaries must also consider what return might
reasonably be achieved on the investment of claims reserves. Between the payment of
premiums and the eventual settlement and payment of the largest liability claims, there could
be a time lag of many years, if not decades. Although the typical time lag is generally much
shorter for most property damage claims, any time lag between the receipt of premium
income and the payment of claims provides an opportunity to invest available funds: the
longer the time lag, the greater the return. Of course, the actual return achieved by insurance
companies also depends upon prevailing rates of return in the market, their control of cash
flow and investment management skills.
The settlement value of outstanding claims can therefore be discounted by ‘the time value
Chapter 6

of money’ in the assessment of current claims reserves. If the settlement value of a group of
claims, anticipated to settle in three years’ time, is estimated at £10m, the claims reserve
which must be put aside today is £10m less three years’ compounded investment return.
The assumed, reasonable level of investment return is referred to as the ‘discount rate’.

Be aware
For most classes of general insurance, discounting is not permitted under Solvency II
when an insurer calculates solvency capital requirement (SCR).
Refer to Capital and solvency requirements on page 1/7.

The interaction of rates of inflation and typical rates of return on investment varies
considerably over time and therefore has a very marked impact on claims reserving and
company profitability. The current high rates of claims inflation in respect of bodily injury
claims are not in any way compensated for in prevailing investment returns, which have
been at particularly low levels in recent years.

C4 Validating approaches and techniques

As well as recommending general reserve adjustments which are reported in the financial
accounts and statutory returns to the regulator, actuaries monitor the accuracy of their
processes and models. Having determined an agreed ultimate cost for a particular class of
business by accident year, actual claims payments are then measured as a percentage
against the assumed ultimate cost.
Chapter 6 Claims data and reserving 6/9

Figure 6.1: Development of employers’ liability claims payments

100%

80%
Payments as % of
ultimate value

60%

40%

20%

0%
1 2 3 4 5 6 7 8 9 10 11 12 13 14
Years since accident occurred

Figure 6.2: Development of property claims payments

120%

100%
Payments as % of

80%
ultimate value

Chapter 6
60%

40%

20%

0%
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49
Quarters since loss occurred

These graphs compare the development of two classes of business, employers’ liability and
commercial property insurance. The graphs are scaled to eliminate differences in the size of
the portfolio from year to year and therefore clearly highlight the claim development patterns.
For example, the employers’ liability claims payments only approach the 100% level (of
ultimate claims cost) around years 8 to 10, whereas commercial property claims payments
reach the 80–90% level after about two years. It can be seen that even with commercial
property claims, a small number will remain open several years after the year of exposure.
Before considering claims data quality and interpretation more generally, there are a few
points regarding reserving processes that underwriters might bear in mind:
• It is well worth taking every opportunity to be involved in reserving reviews: there is a lot
to learn that will be to your and your account’s advantage. You will note that many of the
methods used in pricing (see chapter 7) are directly comparable to those used in the
estimation of ultimate claims costs.
• The actuaries are likely to be keen to encourage your involvement as reserving feeds into
the capital and risk work associated with Solvency II and you will be required to
demonstrate how consideration of risk has influenced your own work on pricing and risk
selection.
• Think about the extent to which ‘uncertainty’ increases the cost of writing certain types of
business. Liability claims are intimated and settled over an extended period of time: the
 6/10 960/December 2020 Advanced underwriting

uncertainty over their ultimate cost increases the amount of capital which must be held in
reserve and thus its cost. Property damage insurance, both domestic and commercial, is
subject to an increasing number of severe storm claims in the UK: how much capital
needs to be held in reserve to cover the unexpired risk of such policies?
• You may feel that the overall approach adopted by the actuaries does not entirely suit
your own account. This may not be material at the level of the company’s reserves but
your concern needs to be acknowledged and borne in mind when general reserve
adjustments are considered for use in lower-level pricing exercises or when the ultimate
profitability of different accounts is being evaluated.
• Of course, no model is perfect: none can replicate reality. Models and techniques need to
be chosen and utilised correctly; they require the appropriate volume and quality of data
and appropriate parameters to be applied (such as rates of inflation or exchange rates).

D Interpretation and use of claims

information
D1 Claims practice

Be aware
The importance of consistency in the interpretation and use of claims data should not be
underestimated.

Examples of changes in practice or performance which may lead to misinterpretation:

• At intimation, claims are given a formula or standard estimate until they can be properly
case-estimated. If the formula estimate is increased without notice, underwriters could
Chapter 6

easily assume that an account’s overall claims experience had deteriorated.

• In some classes of business, notably liability, a significant proportion of claims are
intimated but not subsequently pursued. Such claims will be formula- and then case-
estimated but will eventually be settled at ‘nil’. If the claims department reduces the
standard period they allow to elapse before closing such claims and settling at ‘nil’, the
relevant account performance will appear to have improved. If a higher proportion of
claims have to be subsequently reopened as a result of this change, this too could affect
the interpretation of the account’s performance.
• As already noted above, the general pattern of productivity within claims departments and
any changes to this pattern can affect the interpretation of claims experience figures. For
example, if backlogs increase in intimating claims, reviewing case estimates or settling
claims, the relevant claims experience will be affected but some of the effects will be
more immediately evident than others. If case estimates are not being reviewed as
regularly as they should be, claims development patterns will be affected with possible
effects on reserving and eventual run-off. This latter development could be particularly
damaging if actuarial and underwriting are unaware of the issue.

D2 Claims data
Claims data is collected, categorised, manipulated and used for different purposes by a
range of internal and external groups and this presents significant challenges in its
interpretation and use.

Example 6.2
While underwriters are very interested in analysing the causes of claims in considerable
detail, most claims handlers have limited time to consider the fine distinctions between
such causes and may not have the necessary information to make an appropriate choice
of cause code until some time after the claim has been intimated. An inappropriate or
default value may be entered at intimation and never subsequently reviewed or rectified.
Senior claims staff are likely to review text describing the cause rather than looking at the
allocated code.
Chapter 6 Claims data and reserving 6/11

This is only one example of the data demands placed on claims handlers which, taken
together, can prove counterproductive. This comment is intended as a warning to
underwriters, rather than a criticism of claims handlers.
An underwriter’s claims data checklist:
• When requesting new claims data fields, please distinguish between necessary and nice-
to-have items and look for ways of rationalising your requirements rather than adding to
them.
• Be careful to validate extracted claims data which plays no functional part in the claims
handling process, particularly if you are using the data for the first time or after a long
interval. Often a common-sense check (How well-spread are the values chosen? How
often has the default value been chosen?) and some sampling will provide a fairly quick
indication of whether the data is of value or not.
• Please do not assume that a field is being used in accordance with its label (or how you
interpret the label): check with claims handlers first.
• You should request that claims quality control procedures include checks on the fields
you regard as critical.

D3 Claims reports
These warnings necessarily extend to claims reports: both pre-existing reports you may be
given and reports you specifically request.
Be quite certain you understand the following:
• Where was the base data used in the report extracted from? Sources, fields and their
use?
• How has the data been selected and ordered? Which time periods? Incurred or accident
year basis?
• What has been included/excluded? Recoveries? Settled claims only? Claims over or

Chapter 6
under certain values? Formula as well as case estimates? Nil claims?
• Have any adjustments have been made to the data? Reserve adjustments? Removal of
the cost of catastrophes or particularly large individual claims?
Just because an existing claims report is produced for the actuaries or some other group, it
does not automatically follow that it must be what you require for your own purposes. The
report may have been designed for a very specific purpose and could easily be
misinterpreted. There are many ways of analysing and interpreting claims experience and in
order to arrive at a valid interpretation (one suited to the nature of your inquiry), it is
necessary to identify suitable data and an appropriate method of analysis. Although these
remarks could be applied to all areas of statistical analysis, they are particularly pertinent in
respect of claims data.
You need ‘the right tools for the job’ but often the hardest part of determining what kind of
statistical analysis, report or data is required is formulating the precise enquiry. We will
consider this issue again in later chapters as part of our examination of pricing and
monitoring, but at this point we can review why the same claims data is presented in different
ways for reporting purposes.
What form do your company’s monthly (management account) results take? Are they
presented on an incurred (also referred to as underwriting year basis) or accident
year basis?
 6/12 960/December 2020 Advanced underwriting

Table 6.3: Example of accident year basis of reporting

Accident year (January to December)

Year of GWP As at Earned Claims Claims Outstanding Total Earned

account £ end premium count paid £ £ loss ratio
£ £

2016 100 2016 50 2 5 20 25 50%

2017 100 10 20 80 100 100%

2018 100 11 50 150 200 200%

Jun-19 100 11 75 100 175 175%

2017 120 2017 60 2 10 20 30 50%

2018 120 8 20 60 80 67%

Jun-19 120 9 20 100 120 100%

2018 200 2018 100 4 15 40 55 55%

Jun-19 175 8 50 50 100 57%

2019 100 Jun-19 25 1 10 10 20 80%

(as at
Jun-19)

Table 6.4: Example of incurred (or underwriting year) basis of

reporting
Underwriting year or incurred basis
Chapter 6

As at GWP Earned Claims Change in Total Earned

end £ premium paid in outstanding £ loss ratio
£ period £
£

2016 100 50 5 20 25 50%

2017 120 110 25 80 105 95%

2018 200 160 55 150 205 128%

Jun-19 100 100 70 10 80 80%

The accident year basis shows the cumulative position for each individual year of account,
at specified intervals.
The incurred or underwriting year basis summarises the changes in all years of account
which have taken place since the last report, resulting in a total of earned premium and
claims incurred in the period.

Example 6.3
An illustration of the calculation of incurred claims as at end June 2019:

Year of account Claims payments Outstanding claims

2016 (£75 minus 50) = +25 (£100 minus 150) = −50

2017 (£20 minus 20) = 0 (£100 minus 60) = +40

2018 (£50 minus 15) = +35 (£50 minus 40) = +10

2019 +10 +10

Total incurred claims at +70 +10

June 2019
Chapter 6 Claims data and reserving 6/13

Some insurers, notably those based at Lloyd’s, reinsurance companies and those providing
capacity to managing general agents through binders or to scheme brokers, need to keep
track of the performance of different years (or periods) of account until they are fully run-off
because their participation in specific risks or arrangements may vary considerably from year
to year. Although all insurers regularly analyse their performance on an accident year basis,
many use the incurred or underwriting year basis of reporting as a more convenient method
of monitoring the performance of an account on a month-by-month basis.

Example 6.4
In a long-standing commercial combined account, there are likely to be a small proportion
of claims which remain outstanding ten years after the year of exposure. There will also be
an even smaller proportion of claims which are first intimated many years after the year of
exposure (typically employers’ liability or environmental liability claims). Although these
outstanding/late claims may be amongst the largest claims incurred, is it worth restating
every single accident year of account each month to track the progress of these few
claims? For most years of account, nothing will change in the course of an individual
month and there are easier ways to track the progress of a small number of specific
claims.

It should be noted that accounts which are changing rapidly are more easily understood
using accident year data and should be planned/budgeted and monitored on that basis. As
noted earlier, actuaries use accident year data to project ultimate costs as all the claims
share a common period of exposure. If analysis is based purely on incurred or underwriting
year data, it may miss key trends and result in poor management decisions.

Conclusion
The main ideas covered by this chapter can be summarised as follows:

Chapter 6
• Claims reserving takes place in two stages within general insurance companies.
Individual claims are case-estimated in order to establish their likely eventual total cost. In
addition, actuaries monitor the overall level of case reserves by regularly projecting their
likely total claims cost as a whole and may recommend a general adjustment to
aggregate claims reserves in the company’s financial accounts.
• The value of good liaison between underwriting, claims and actuarial is highlighted when
considering the use and interpretation of claims data. Each of the three parties has their
own clear responsibilities and requirements but each needs to consult with the other two
in order to achieve a full understanding.
• Claims development triangles are the most effective way of presenting claims data and
separate triangles may be created for the number of claims intimated, the value of claims
paid or the value of incurred claims. The claims development triangles can be used to
calculate average claim costs and burning costs.
• Claims data is collected, categorised, manipulated and used for different purposes by a
range of internal and external groups, and this presents significant challenges in their
interpretation and use.

Additional reading
Institute and Faculty of Actuaries. (1997) Claims reserving manual.
 Pricing
7
Contents Syllabus learning
outcomes
Introduction
A Data for pricing 3.1
B Projecting claims experience 3.3, 3.5
C Rating structures and prices 3.2, 3.3
D Other pricing components 3.3, 3.4
E Experience rating 3.3
F Exposure rating 3.3
G Scenario 7.1
Conclusion: collaboration and judgment

Learning objectives
This chapter relates to syllabus section 3.
On completion of this chapter and private research, you should be able to:
• identify the nature and source of data used in pricing, including the input of other
professional groups;

Chapter 7
• explain how the adequacy of available data is assessed;
• describe different statistical methods for risk pricing and evaluate their output;
• explain the principles behind the creation of rating structures; and
• explain how pricing components impact upon profitability.
 7/2 960/December 2020 Advanced underwriting

Introduction
What do you associate with the word ‘pricing’?

Pricing
System-generated Detailed rates The application of The evaluation of a
prices based on applied to exposure a rating formula risk’s individual
multiple factors (for measures (property (for fleet insurance: claims experience,
private motor: sums insured; based on the last the extent of
vehicle model and turnover; wageroll), three years’ claims cover required
age; postcode; age adjusted for cover/ experience)? and the use of a
and occupation of indemnity levels and target loss ratio?
driver and so on)? the underwriter’s
assessment of the
relative quality
of the risk?

Or

Pricing
The creation of The adjustment The monitoring The creation Establishing
rates for new of existing rates of rates achieved and amendment the overall
products, to account for against technical of target loss increase in
covers or changes in rates? ratios based on rates to be
accounts? claims budget achieved in the
experience, requirements? next period?
anticipated
changes in
experience,
changes in
inflation or in
response to
competition?
Chapter 7

Pricing involves all of these activities and many other variations. It is not the intention in this
chapter to cover any of these activities in detail but rather to consider the common inputs,
issues and techniques which these activities share.
It is likely that your company uses its own specific blend of methods to assess the
profitability of different accounts and products and to arrive at appropriate prices and rates.

Research exercise
Ask to see a recent example of a profitability and pricing review and try to identify the use
of methods described in this chapter.
Chapter 7 Pricing 7/3

Key terms
This chapter features explanations of the following terms and concepts:

Attritional and large Base period Burning cost method Cost of capital
claims
Contribution Experience rating Exposure rating Frequency
Generalised linear Investment income Multi-way analysis Non-conventional
modelling pricing plans
Price elasticity of Pricing components Product rating Prospective risk
demand structure analysis
Risk premium Severity

A Data for pricing

A1 Internal data
Insurers ought to derive competitive benefit from having access to their own claims and
exposure data: the data may be analysed in detail and allowance made for known
imperfections. For most large insurers the issue is not an overall lack of data but rather
managing access and ensuring effective, appropriate use. Correctly matching claims to
exposure data over long periods of time is a complex task and professional skills are
required to store, extract, manipulate and analyse data appropriately. In particular,
determining whether sufficient, representative claims data exist for use in profitability and
pricing exercises needs to be assessed statistically. Insurers are focused on ensuring data is
of a sufficient quality to enable analysis and drive action. This is dependent on the quality of
input from external and internal sources, and then requires significant analytical capability to
drive insight.
Insurers are now more conscious of the competitive advantage which access to large
databases confers and have become less willing to share even aggregated, anonymous data
with competitors. They are also aware of the need to avoid any kind of collaboration which
could appear to be anti-competitive.

Chapter 7
A2 External data
The concept of ‘external data’ from a pricing perspective is now an extremely broad area to
consider. External data can range from aggregated industry reports and government data, to
data provided by an intermediary or individual on a portfolio of risks. More recently, external
data has become more synonymous with the vast volume and variety of data that has
become available to insurers in the data rich environment in which they now operate.
A2A Aggregation of industry data
Regulatory or professional bodies
Some external data sources rely on insurers contributing their claims and policy data either
voluntarily or compulsorily (via regulated reporting obligations) to a third party that produces
aggregated reports showing market data or trends. Examples of entities whose reports can
assist in monitoring a portfolio and checking an organisation’s trends/experience relative to
the market include:
• the Association of British Insurers (ABI);
• the Prudential Regulation Authority (PRA);
• professional bodies such as the CII or Institute and Faculty of Actuaries (IFoA);
• reinsurers and trade bodies; and
• the Office for National Statistics (ONS).
Being able to compare large claim/catastrophe experience, bodily injury trends, claims
inflation and other similar metrics is essential in pricing a successful product. If an
organisation’s experience is different from the market’s, it important to understand the reason
for this variance. In addition, it will also provide a benchmark against the industry that will
help determine strategy.
 7/4 960/December 2020 Advanced underwriting

Market premium information

In addition to professional and regulatory bodies mentioned above, there is another category
of external data that looks to provide information about market premiums and competitor
rates. For example, certain price comparison websites will provide an aggregated and
anonymous view of winning premiums based on the quote information they collect. Others
provide information on a ‘basket’ of risks and obtain the premium for these policies to give an
indication.
Regular price comparison exercises are essential to identify risk segments where internal
prices appear to be either too cheap or too expensive or where competitors’ actions are
affecting conversion and renewal rates. Investigation of such pricing differences may indicate
the existence of errors (internal or external), the existence of niches worth exploiting or the
opportunity to adopt other tactical approaches.
A2B Intermediary or individual risk data
An external party may provide data about an individual risk or portfolio of risks. For example,
an intermediary or insurance company may look to transfer a cohort of motor risks to another
insurer due to it deciding to leave the market in which it operates. The data provided to the
acquiring company is used to support the due diligence process associated with a company
acquisition.
A2C Things to consider when using external data
Data of this nature is generally compiled by a third party and/or supplied by the insured,
some of which may have been drawn from the records of other insurance companies. It is
important to examine such data critically: other companies’ definitions, processes and
methods of presentation do not necessarily equate to those of your current company and
you cannot afford to accept data at face value. For example, when was the information last
updated? What do you know about the holding insurer’s claims reserving philosophy? Are
they noted for under or over-reserving?
Underwriters are also familiar with the situation where data may be missing from a
presentation (for example, updated outstanding claim cost estimates or declaration-adjusted
exposure measure).
The increasing use of different forms of electronic data exchange, based on shared formats,
may also mean that particular data items used in an insurer’s standard rating algorithm are
not provided. In the former situation, the appropriate action may be to refuse to price the risk
Chapter 7

until the necessary data is provided or to proceed on the basis of recorded assumptions
until the correct data is supplied or the assumptions validated. In the latter situation, a new
rating algorithm must be devised to ensure that the available data is used appropriately. In
neither situation is it appropriate to ignore the issues affecting data.
Although general information and data from public databases can be extremely useful (when
considering individual risks and examining issues more broadly), it is important to consider
the source of the information and the original purpose for which it was compiled.

On the Web
Insurers are coming under increasing pressure to develop new ways of pricing. While data
and technology hold the key, this article looks at the significant challenge faced by
insurers.
'Spotlight: The future of pricing – The evolution of pricing', Insurance Hound, 27 August
2019. https://www.insurancehound.co.uk/underwriting/pricing/spotlight-future-pricing-
evolution-pricing-32186.

A2D Big data

Big data is a term used to describe the rapid expansion of raw data available to insurers and
other organisations. Harnessing this data effectively can facilitate a profoundly deeper level
of intelligence and understanding of an insurer’s business model, from risk selection,
marketing, claims and the general customer journey, which is vital in gaining competitive
advantage.
Chapter 7 Pricing 7/5

Big data is characterised in common literature by having four characteristics. They are:
1. volume;
2. velocity;
3. variety; and
4. veracity.
Big data deals with high quantities (tera/petabytes) of data, from a variety of sources and
formats. The speed of the data production is colossal and the need to validate and
understand the information you are collecting is crucial. Examples of big data at work could
be the use of external or internal data to pinpoint fraud or the identification of cross-sell or
up-sell opportunities. Looking at an individual’s social media interactions, website click
stream data and other sources can help build a model to assist in these activities. A topical
example of big data is telematics.
A2E Telematics
Telematics relates to the granular collection of data about the insured’s driving
characteristics to assist in understanding risk and predicting claims propensity. This
information is passed to the insurer (in real time) via a ‘black box’ installed within the car that
uses GPS, inertial sensors and mobile phone technology.
The link to the previous definition of big data is clear. Typical telematics boxes will be
recording and transmitting second-by-second data on an individual’s speed, location, driving
behaviour and other relevant metrics; this requires insurers to hold millions of lines of varying
data collected over a policy period. Of course, the data will need to be validated as they can
dictate continuance of a policy or changes in premium or policy conditions. For example,
some insurers will cancel a policy if a driver is habitually speeding or driving in a dangerous
manner. Once armed with a vast amount of validated data the underwriter/pricing analyst
has the task of distilling this granular information into something that can enhance a premium
or support a policy change.
What big data has facilitated in telematics and other areas is a more intrinsic understanding
of a risk and what driving behaviours cause claims, such as rapid acceleration or harsh
braking and cornering. Before telematics, insurers relied on rating factors to try and proxy
this underlying behaviour, using measures such as no-claims discounts, annual mileage or,
more recently, sociodemographic factors.

Chapter 7
The advent of this technology does start to question the relevance of these more orthodox
risk factors and their use in future pricing models. Annual mileage is a widely used rating
factor used to understand the level of exposure for a risk. The more miles an individual
drives, the more likely they are to have to claim, all else being equal. With telematics this
question has less significance as the insurer knows exactly how many miles the driver is
doing as well as when and their driving behaviour.

On the Web
Barrett, S. (2013) 'Improving underwriting: The bigger the better', Post Online, 21 March
2013. https://bit.ly/2z6VXub.
Marriner, K. (2014) 'Roundtable: Telematics: the future of motor', Post Online, 24 June
2014. https://bit.ly/2T52NJ3.

A2F Underwriting considerations with big data

• The process of analysing big data and drawing conclusions that can benefit your
business is complicated. In addition, this analysis has to be done quickly as some of the
decisions will have to be made in real time.
• Housing this data, and implementing the intelligence derived from it, requires
infrastructure and systems that are both complex and expensive. Big data is pushing the
storage capability of current systems. As mentioned above, the need to potentially
respond in real time requires agile systems that deliver responses in sub-second
timescales.
• Data needs to be validated. Data of this variety and magnitude can be prone to error and
will require cleansing. If underwriters are making decisions based on such data, it is
 7/6 960/December 2020 Advanced underwriting

essential that they are assured of the data quality and that it is justified for use in pricing
or underwriting decisions. If data cannot be validated then it should not be used.
• Any information security processes used within a responsible business are going to apply
to big data as it would to any other information collected about an individual.
• Using individual data has significant ethical and regulatory considerations. The rules
regarding data protection, treating customers fairly and the ethical framework that their
company operates under must be at the forefront of an underwriter’s mind when
embarking on using big data. If it is not, a business could be exposed to significant
reputational and regulatory risk.

On the Web
The Lloyd's market is looking at ways in which big data can assist underwriting risk. An
example of its research can be found in the following link: https://bit.ly/2P9xZbE.

A3 Price elasticity of demand

Be aware
Price elasticity of demand can be defined as a measure of the relationship between a
change in the quantity demanded of a particular good or service and a change in its price

Although, as underwriters, there is a tendency to focus on those aspects of pricing which

relate to risk premiums, it has already been noted in earlier chapters that a number of
behaviours and preferences can impact pricing which have little or nothing to do with
insurance risk. Understanding the elasticity of demand (particularly, the price elasticity of
demand) for your company’s products – and those of your competitors – is essential and
this can only be based on careful monitoring and evaluation of internal and external data and
information.
• If a company increases its prices, how high can they be raised before different customer
groups seek alternative quotes from other insurers and decide to move their business? If
prices are rising across the market, at what point might customers reduce the level of
cover they purchase or cease to purchase insurance (and possibly look for substitutes)?
• If a product enhancement leads prices to rise, to what extent will the additional volumes
Chapter 7

sold to customers demanding enhanced cover compensate for those opting for a
cheaper cover?
• What level of price reduction would deliver a 10% increase in volumes?
In attempting to understand and predict customers’ buying behaviours, many factors come
into play as well as price, such as inertia/loyalty, the strength of a company’s brand and its
perceived financial security. However, as has been discussed earlier, price is a dominant
competitive feature in many markets. Based on how customers have reacted to your
company’s price changes in the past, assumptions can be devised for each product under
consideration, such as:
• a price reduction of A% might increase volumes by around B%; or
• a price increase of C% might reduce volumes by around D%.
With sufficient information, full demand curves can be mapped, illustrating the volume
changes associated with a range of price changes, all other things being equal.

On the Web
Economics Online guide to the price elasticity of demand: https://bit.ly/1NVLp3B

As well as understanding how price influences customers’ decisions (and thus volumes), it is
necessary to understand how changes in price and volume affect profitability. This will be
discussed later in Pricing, expenses, volumes and profitability on page 7/14.
Chapter 7 Pricing 7/7

On the Web
Minty, Duncan. (2016) 'Price optimisation for insurance – optimising price; destroying
value?', CII Think Piece 122, March 2016. https://www.cii.co.uk/news-insight/insight/
articles/price-optimisation-for-insurance/40078.

B Projecting claims experience

B1 Selection of a base period
In the previous chapter on claims and reserving, the main input to the pricing process –
claims data – and the forecasting of ultimate claims costs at company and class level have
already been discussed. In this chapter we discuss the use of claims data to project claims
costs at product or account level in order to set prices or rates for the forthcoming period
and the use of experience rating for the pricing of individual large risks. Claims data only
becomes informative once it is related to the corresponding exposure data; depending upon
the type of insurance product, this could be represented as:
• number of policies;
• number of vehicle years;
• property sum insured;
• turnover;
• wage roll; or
• number of bedrooms.

Be aware
The term ‘prospective risk analysis’ may be used to describe the process of projecting
historical claims costs to future occurrence periods.

Claims and exposure data can be transformed into relevant measures of claims frequency,
severity and cost of claims per unit of exposure (burning cost). In order to create a coherent
set of base data (or base period) with which to project future claims costs, claims and
exposure data organised on an accident year basis must be selected.

Chapter 7
Underwriting management decision: selection of base period
Which accident year or years should be selected?

Criteria for selection

Claims costs should be well-developed (that is, as high a proportion of the ultimate cost as
possible should have been paid) and the underlying exposure and claims experience should
be as representative as possible.
• The claims experience for older years will be better-developed than for more recent years
but the corresponding exposure may have less in common with the current/future account
and will need, in any case, significant compounding adjustments to allow for the impact of
inflation, in particular. The claims experience for more recent years will be far less
developed and estimates of the ultimate claims cost will include a significant allowance
for this degree of uncertainty.
• In considering particular accident years as potential base periods, did the account have a
similar mix of business and cover to those anticipated for the projected period? Did any
particular untypical features affect the experience, such as severe storms, an unusually
high level of arson claims or an upsurge in a particular type of fraudulent claim? Untypical
features could be positive as well as negative, of course. Are claims data from a single
accident year sufficiently representative: are there enough claims to make the experience
credible?
 7/8 960/December 2020 Advanced underwriting

Be aware
The careful selection of a base period – the accident year or years whose claims and
exposure data will be used to project claims costs for a future period – is critical to the
successful outcome of the pricing exercise.

All things considered, the number of claims and the extent to which claims costs are
developed/run-off are the main criteria and adjustments can be made to allow for other
issues within the base period and to re-evaluate the costs to levels likely to apply in the
projected period. Based on typical development patterns, a liability account will usually need
to use claims data from an older period than a property damage account.

B2 Adjustments to base data

In order to calculate the future risk premium, the claims costs from the base period selected
are projected (claims frequency and severity, separately) to represent those anticipated in
the forthcoming period. The pricing exercise would start with an actuarial view of ultimate
claims costs for the base period at a gross level (reinsurance recoveries not deducted).
The following typical adjustments would then be made:

High severity/ • Adjust for the impact of individual high severity or high frequency events to align with
frequency events the anticipated longer-term pattern.
• This may involve adding costs as well as removing them, to allow for the smoothing
of these events over a number of years.

External influences/ • Consider any external issues with particular relevance to the product which have
trends impacted frequency or severity since the base period and/or may impact in the
future, such as legislation, socioeconomic, technological or environmental trends.

Mix of business • Has the product’s mix of business (types of risk, levels of exposure) changed
significantly since the base period?
• If, for example, a particular type of risk is or will be excluded from product eligibility in
the forthcoming period, you may wish to strip out the historical claims experience for
those risks.

Cover changes • Adjust the claims experience for cover changes, such as different levels of
indemnity, excesses and deductibles or new benefits.
Chapter 7

Claims inflation • Adjust for the impact of claims inflation, from the base period until the date of the
typical claims settlement in the projected period (see figure 7.1).
• As previously discussed, the rate of inflation varies for different types of claim and
will generally be above the rate of general inflation.
• It should be noted that while inflation also affects exposure values (property sums
insured, wage rolls etc.), claims costs generally inflate at a greater rate: the net
effect cannot therefore be assumed to be neutral.

Reinsurance • The projected claims costs, still at a gross level, should then be adjusted by
recoveries removing assumed reinsurance recoveries (based on planned reinsurance
purchase).
• Although the cost of reinsurance, along with other expenses, will be added to the
risks premium in the insurer’s rates and prices, reinsurance purchase should smooth
the impact of extreme events on the risk premium over a number of years.

Example 7.1
In July 2020 you are asked to determine product rates for business written (incepted or
renewed) during 2021. Note that business written from January 2021 to December 2021
will be exposed for 12 months during the 24-month period from January 2021 to
December 2022.
Which base data will you use for your analysis and projection? Which accident year
or years?
Figure 7.1 illustrates your options.
Chapter 7 Pricing 7/9

Figure 7.1: Percentage of ultimate cost paid by accident year

%
100 Policies incepted
or renewed in
2021 will be
exposed in the
70% paid period 2021–2022
to ultimate

50

0
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027
% of ultimate cost paid In July 2020 you are
by accident year asked to determine the
rates to apply to business
projected % of 2021
written during 2021
ultimate cost paid

The exposure and cover mix of the product account in 2019 is probably closest to that of the
prospective 2021 account but, as at July 2021, the paid to ultimate claims cost for accident
year 2019 is only around 20%. (Ultimate cost having been assessed by the actuaries.) Even
by choosing 2015 as the base period, the paid to ultimate claims cost is still only around
70%. However, the actuarial assessment of ultimate claims costs for 2015 is far more certain
than that for 2019 (new intimations for 2015 exposures represent a trickle now, whereas
there is a steady flow of new claims for 2019) and that relative certainty should convey a
benefit to prices/rates based on 2015 claims costs (as less uncertainty is priced-in).
It may be decided that the 2015 accident year alone provides too few claims to form a
representative sample and, instead, data from 2014, 2015 and 2016 are to be used together,
once adjusted for inflation.
For business written in 2021, when will claims on those policies be paid? If previous patterns
of claim settlement are indicative, around 70 to 80% of the ultimate cost of these claims may

Chapter 7
have been paid by the middle of 2026. This implies that while up to 70 to 80% of claims
payments will reflect rates of claims inflation applying to that point (mid-2026), the remaining
20 to 30% will continue to incur further inflationary increases and this must be allowed for in
the pricing.
An illustration of the impact of inflation on claims costs:
For every £100 of claims cost at 2015 values, at an extremely modest claims cost inflation
rate of 2% per annum, by 2020 the cost is £110.41 and by 2026, £124.34 (1.0211 × £100). As
noted earlier, bodily injury claims currently sustain inflationary increases in excess of this
percentage.
Please see appendix 4 for an example of a risk premium projection.

C Rating structures and prices

So far product risk premium has been considered at an overall level: representative historical
claims data and the associated exposures have been used to project overall claims
frequency and severity values. It is likely, however, that most products will require rates or
prices for individual risk types, characterised by key rating factors, and for different levels of
cover.
 7/10 960/December 2020 Advanced underwriting

Be aware
The product rating structure will be unique for each set of products. For example,
general/public liability rates need to reflect:
• third-party bodily injury claims;
• third-party property damage claims;
• the trade of the risk;
• limit of liability provided; and
• any additional cover.

Very few products, even in the largest insurance companies, will have many segments
(representing discrete cover/customer group and risk combinations) which have sufficiently
numerous historical claims to be projected and priced entirely independently. When actuaries
review the experience of whole class accounts at company level, they rely upon the
experience of as many accident years as possible and are keen to receive market input
(from external actuaries) regarding the representativeness of their own data. Similarly,
individual products need to be reviewed and projected in the broadest possible context to
ensure that the basic pricing is as robust as possible.
How then are different employers’ liability rates created to be applied to wage roll estimates
for agricultural contractors and nursing homes; for package rates for grocers and chip shops;
for 50 year-olds driving Honda Jazz or Mercedes A-class cars in Manchester or Northern
Ireland?

C1 Rating factors and features

In all these cases, the overall projection of future claims costs (frequency and severity) for
the product provides a specific risk premium framework. More detailed statistical analyses
are required to examine:
1. the ways in which rating factors can be used to generate appropriate risk premiums for
specific risks; and
2. how rating features – such as introductory discounts, NCD scales or voluntary excesses –
may be costed and applied.
Chapter 7

Be aware
Irrespective of how the rates are created or adjusted, they must recover the overall risk
premium required to meet the projected claims experience of the group of customers/risks
in question.

Rating structures and features form part of an insurer’s marketing approach – as well as
reflecting how underwriters understand relative risk exposures – and they have a significant
impact on the degree to which an insurer can attract and retain target customers, over a
period of years.
The relationships between variables can be identified and weighted, such as the relationship
between average cost of household claims and number of bedrooms and number of motor
claims and driver’s age, through statistical methods such as correlation and regression.
These straightforward relationships may seem very obvious but for high volume insurance
products multiple rating factors are used, which may themselves be correlated, and the
resulting inter-relationships are not always immediately apparent.
Chapter 7 Pricing 7/11

Example 7.2
A simple example will illustrate the issue, as observed in a particular account:
Factor 1: Age of driver – drivers under 25 make more claims than those over 50.
Factor 2: Type of car – sports cars generate more claims than superminis.
Can you spot a potential correlation between the factors?
One might assume that more drivers aged over 50 may drive superminis than those under
25, and more drivers under 25 may drive fast sports cars than those over 50. On the other
hand, that assumption could be incorrect as it could be argued that older drivers can
afford a sports car but younger drivers have more accidents – and therefore the
correlation is weak.
These factors (and their respective influence on claim frequency) are not independent and
therefore we cannot simply conduct a series of one-way analyses (factor by factor) and
compound the results in order to build rating tables. In the case of the simple example
above, we need to establish four separate claim frequencies for under 25s and over 50s
driving sports cars and under 25s and over 50s driving superminis.

C2 Multi-way analyses
Multi-way analysis need to be conducted, firstly, to establish the true independent influence
of the various rating factors on frequency and severity and, secondly, to allocate to the
chosen factors appropriate values for use in the rating algorithm. This process utilises a
statistical method known as generalised linear modelling (GLM) which helps use the
available data to best effect. Given the number of possible combinations of factors (for
example, a product with five rating factors, each with five levels, produces 3,125 possible
combinations (55), many cells will contain limited data. While statistical techniques may be
used to compensate for this, judgment also needs to be applied regarding the credibility of
the base data and which rating factors should be used.
The distinction between high volume products such as home and motor and other, notably
commercial, products is extreme in this respect. Home and motor claims databases are
interrogated on the basis of multiple rating factors, to identify the influence of rating factors
on severity and frequency by type of claim (for example, the influence of location on vehicle
theft claim frequency or of vehicle make/model on the average cost of accidental damage

Chapter 7
claims). By contrast, SME commercial package business has to rely on a far more limited
range of rating factors (such as area and trade) due to the limited quantity, and thus
credibility, of claims data available.

Be aware
The scale of the commercial customer base can only support limited multi-way analysis:
few cells will contain sufficient representative data.

In fact, the rating of many SME products is heavily influenced by location-related claims data
(which might be regarded as ‘benchmarks’) drawn from household accounts (such as the
incidence of theft, flood and subsidence). As regards larger commercial risks, the rating
categories become increasingly broad and the rates used (based on burning costs)
increasingly indicative rather than prescriptive.
 7/12 960/December 2020 Advanced underwriting

Case study
There are, from time to time, attempts to rationalise and simplify the rating of volume
products – see Swift, J. (2010) 'Start-up claims motor insurance first with
Moneysupermarket', Post Online, 14 June 2010. http://bit.ly/2zDVyR1.
In this case, a direct measure of exposure (record of mileage, when, where and how
driven) is being substituted for the normal proxy measures (age/location/occupation) and
the insurer will have direct access to current data.
Once the use of multiple rating factors for a particular product becomes the norm or the
conventional approach, it is very difficult to introduce a product with fewer rating factors in
the open market. Insurers introducing such a product may be selected against by
consumers (those who would normally pay a higher premium) and under-cut by other
insurers (whose more extensive rating structures highlight groups with superior
performance). In order to avoid these potential pitfalls, more rigorous initial selection
criteria may have to be applied before access to the simplified product is permitted, as is
the case in many scheme arrangements.

Whatever decisions are made regarding the product rating structure to be used, at the
conclusion of the pricing exercise it must be demonstrated that the rates or prices are
equitable (that they bear a direct relationship to the degree of risk brought to the common
pool) and that they will achieve the planned level of income and earned loss ratio (ELR) or
combined operating ratio (COR) for the product.
Part of the pricing exercise (in conjunction with planning and budgeting activities) is to
consider the level of sales and thus exposure in the forthcoming period. The planning
assumption may be that policy numbers will increase by a certain amount but the mix of
business will remain stable. Alternatively, the plan may be to attract specific customer
groups/types of risk and the mix of business is anticipated to change. In both cases (and,
indeed, if the mix of business changes but not in the planned manner), it is essential that
each risk is priced as equitably as possible to ensure that the targeted level of profit is
achieved. If the rates or prices contain errors or significant cross-subsidies, a change of
business mix could significantly undermine the product’s planned result.

D Other pricing components

Chapter 7

Having established the projected risk premium and rating structure for the product, a number
of other future costs (or 'pricing components') must be calculated and added in order to
arrive at the final premium. Just as the assistance of actuarial colleagues is essential in the
assessment of projected claims costs, in addition you will typically rely upon finance
colleagues to determine the other costs which need to be assessed and applied in the
pricing process.

Refer to
Think back to M80, chapter 5, section A2 and section A3

The relevant costs include both fixed and variable expenses, such as:
• sales, underwriting and administration costs;
• claims handling costs;
• reinsurance;
• levies and taxes;
• intermediary remuneration; and
• profit and return on capital employed (ROCE).
Chapter 7 Pricing 7/13

On the Web
'An update to how insurance premiums are calculated', Zurich Insider, 28 March 2017.
http://bit.ly/2iaysb4.
The article provides an insight into the current external factors influencing price across
different classes of business. There are, from time to time, attempts to rationalise and
simplify the rating of volume products.

D1 Assessment and allocation

It is worth emphasising that it is future costs which must be assessed and included in prices/
rates: some may be forecast with a reasonable degree of accuracy; others, such as levies,
can only be based on current assumptions. Of course, all of these costs have already been
assessed at a higher level as part of the company’s planning and budgeting process. The
task now involves the appropriate allocation of costs to individual products and possibly
risk types.
As discussed in chapter 5, the approach adopted by your company may be to provide
general cost guidelines and/or target claims ratios which already make allowance for various
expenses, as well as for the required return on capital employed (ROCE) and profit. In
whatever manner the information is supplied, your task is to consider the individual product
in question and the ways in which its expense allocation (and ROCE/profit contribution)
should differ from the norm and how that difference should be reflected in its pricing.
For example, if the product pays a significantly higher or lower level of intermediary
remuneration than standard or if a profit share scheme applies, the costs should be modelled
and adjustments made. If a product benefits particularly or exclusively from features such as
an instalment scheme, risk management service or facultative reinsurance arrangement, the
costs associated with these features should be considered for inclusion in its pricing. If a
particular product is required to produce a higher than standard ROCE or profit contribution
then this must be included in the pricing calculation. However, if the product’s conversion
ratio (the ratio of new business cases to quotes) is declining – implying that the acquisition
cost of each new business case is increasing – should the increased cost be allocated to
that particular product, or would that simply make the situation worse?
Clearly, a balance must be struck between the administrative burden and cost of allocating
expenses in infinite detail, and the usefulness of understanding a product’s ‘true’ cost and

Chapter 7
thereby charging equitable, appropriate premiums.
The ways in which costs are recovered and targets met through the pricing process is
specific to individual insurers and is closely associated with their planning and budgeting
processes.

D2 Investment income
Although investment income returns continue to be of critical importance to insurers, they
should not normally be treated as a direct component of pricing.
In the past, at times of high investment returns, insurers wrote business at low premiums on
the assumption that investment income would compensate for underwriting losses. It was
observed therefore that movements in the investment cycle affected overall pricing levels in
general insurance. At the current time, and for the foreseeable future, not only are
investment returns low and uncertain but underwriters should not assume that the insurer’s
investment returns, such as they are, are available to subsidise pricing levels. As noted in
chapter 6, the value of current claims reserves is usually ‘discounted’ by the assumed
investment income potential of these reserves: this particular, significant source of
investment income is therefore already being utilised.
Investment returns have been reduced as a result of the economic crisis of 2008–2012 as
equity volatility and an ultra-low interest rate environment has led to reduced returns. An
underwriting loss is now more likely to lead to erosion of the capital base on a reduced
operating profit/operating loss, once investment returns are factored in.
 7/14 960/December 2020 Advanced underwriting

D3 Cost of capital
Under Solvency II, the cost of capital and the degree of risk presented by individual
insurance products or accounts are key inputs to all profitability and pricing exercises.
For some time a number of insurers have been using a capital asset pricing model (CAPM)
to support their business and pricing decisions. The CAPM is a general finance model which
can be used to compare the underwriting margin achievable on different accounts or classes
of business – weighted by the degree of risk associated with each account or class – with
the returns achievable on other forms of investment.
A key issue in the use of the CAPM is how to accurately assess the ‘degree of risk’.

Research exercise
Ask your manager to explain the capital allocated to a class of business or an account
with which you are familiar. Investigate how and why this differs from other classes of
business or accounts.

D4 Pricing, expenses, volumes and profitability

Pricing is necessarily a dynamic discipline as change is constant and those involved must
consider how best to react to external challenges, as well as internal requirements, and how
to evaluate the impact of their proposed actions.

Underwriting management decision: renewal discounts

In the face of competition, the renewal rate for your product is under pressure. What
discount on renewals is justifiable in order to avoid the cost associated with replacing
lapsed renewals with new business cases?

A straightforward response to this question might be to focus on administrative savings:

renewing a policy costs less than acquiring and setting-up a new one, therefore might not a
discount equivalent to this saving be justified? Unfortunately the level of discount necessary
to retain a renewal case often goes far beyond that of administrative savings. Although the
underlying assumption of the question about renewal discounts is that it is in the insurer’s
interest to retain profitable customers and thus maintain volumes, the question remains: are
Chapter 7

all customers worth retaining and at what discount?

The relative value of customers might be assessed based on how long (in the future) their
business is likely to be retained by the insurer, their typical claims experience, future
investment returns and the value of any other business they may consider placing with the
same insurer. This kind of detailed consideration is commonplace amongst underwriters of
large commercial risks. For underwriters devising pricing criteria for customer service staff
handling volume motor or home business, they too must use similar considerations in
relation to identifiable groups of customers. Their understanding of customer behaviour and
assessment of the price elasticity of demand for their particular products (see Price elasticity
of demand on page 7/6), in the context of anticipated levels of market competition, will
enable them to assess how different types of customer may react to varying levels of
renewal discount.
How far may renewal premiums be reduced, in order to protect volumes, before a product’s
profitability is affected? The answer to this question depends upon the contribution each
product makes to the insurer’s fixed expenses and profit (those components of the pricing
equation which must be covered for the company to stay in business). A product’s
contribution is defined as its selling price less its variable expenses (including claims cost).
Therefore, the balance between fixed and variable expenses in the make-up of an individual
insurer’s cost base is a critical influence on the company’s approach to business
development, competition and the insurance cycle. This can also explain differences in
approach to individual products within an insurer’s portfolio.
Please see appendix 5 for an illustration of how this question of pricing, expenses, volumes
and profitability might be evaluated.
Although risk premiums tend to dominate underwriters’ thoughts regarding pricing – as
claims costs are almost always the largest single pricing component – the absolute value of
Chapter 7 Pricing 7/15

the other components and the balance between fixed and variable expenses are of
considerable importance, particularly when evaluating business development options. As
most insurers wish to pursue strategies of ‘profitable growth’, underwriting managers must
incorporate the overall volume and profitability planning targets provided to them into the
plans (and prices) for their individual products in a balanced manner. The example provided
in appendix 5 illustrates how precarious that balance can be.

E Experience rating
The techniques known generally as ‘experience rating’ might be considered to be at the
opposite end of the scale from the creation of rating structures for high volume products such
as home and motor. In fact, although the output may appear to be different, the inputs,
issues and many of the statistical techniques involved are exactly the same.

Refer to
Think back to M80, chapter 5, section B

Experience rating is used to price unusual or very large individual risks or schemes/
portfolios of risks, which are assumed to have sufficiently large (and thus credible) individual
claims experiences. The burning cost method has been described elsewhere, along with
its potential drawbacks. While the experience rating of a risk is generally accomplished by an
individual underwriter, it is of particular importance that underwriters of this type of business
understand the relative credibility of claims data and the need to price for uncertainty. In
many companies there is an increasing trend to involve actuaries in the analysis of
experience rating.

Critical reflection
How credible can the experience of an individual risk really be?

Clearly an individual claims experience based on 1,000 claims has more credibility than one
based on 20 claims but when one considers the efforts made by actuaries at class/company
level to understand the development of ultimate claims costs over many years, based on
claims arising from multiple accident years, the relative credibility of the data used in most

Chapter 7
burning cost calculations is brought into proper perspective.
There are approaches, such as link ratio techniques, which attempt to project more realistic
ultimate claims costs using an individual risk’s claims cost triangles on an accident year
basis. However, due to the limitations of the available claims data (its relative development
and credibility), it is clear that the use of experience rating methods can place
disproportionate emphasis on run-of-the-mill, attritional claims costs and insufficient
emphasis on the cost of exceptional claims (which are infrequent but very costly).
A typical claims distribution would be one in which almost 99% of all claims by volume fell
within the lower claims value bands, amounting to around 55% of total claims cost. The
remaining 1% of large and very large claims would account for around 45% of total claims
cost. The very largest claims, whose numbers barely register as a percentage, would
typically cost around 15% to 20% of total claims costs.
If the cost of the large and very large claims (1% by volume) was removed entirely from
experience rating calculations, (‘just a one-off claim’, ‘it won’t happen again’) the risk
premium based on the attritional net losses would have to be loaded by 82% to recover the
total claims cost.

Underwriting management decision: how large is a large claim?

How would you treat the cost of large claims in experience-rated cases?
 7/16 960/December 2020 Advanced underwriting

E1 Severity or frequency?
Experience rating can only be expected to deliver planned profitability if the true cost of large
claims is understood and their treatment is consistent. Within an account of experience-rated
cases, only risks which can bear the cost of a large claim (of predetermined size) in a three-
or five-year experience should be eligible for experience rating. Accepting that the cost of
very large claims must be spread across the account, excess claims amounts (above a
predetermined limit) can be removed from the experience-rating calculation for individual
risks and every risk within the account should then be loaded by a standard amount
designed to compensate for this ‘top-slicing’. The adjustment for the excess cost of very
large claims should be calculated on as wide a basis as possible, not solely based on the
account’s recent experience.

Example 7.3
It is deemed that a large claim for a sizeable motor fleet case is £100,000. A few years
ago, there was a claim for £250,000. In setting the future price for the risk, only £100,000
of this claim (after adjustment for inflation) would be taken into consideration in the pricing
process, with the other £150,000 to be paid for by a ‘large claim fund’ accumulated by
charging an amount to every vehicle in the whole of the insurers fleet account adjusted by
the vehicles likelihood of drawing from the large claims pot. An articulated lorry is more
likely to inflict a large claim than a small car due to its size and exposure on the road.

As in product risk pricing, the claims experience of individual large risks must be adjusted to
account for their likely ultimate cost (including IBNR and IBNER). Past and future inflation,
relevant claims trends, cover and exposure changes must be factored into the calculation.
It is contrary to accepted insurance wisdom that so much effort goes into the adjustment of
an individual risk’s average claims cost, when its claims frequency is generally regarded as a
far better predictor of future performance. The incidence of claims is a telling measure of an
insured organisation’s approach to risk management: once an incident has occurred, its
eventual severity is extremely random and not particularly indicative of the quality of the risk.
Having established a projected risk premium/burning cost for the forthcoming period, it is
well worth making a few comparisons:
• How does the proposed rate, and the claims experience from which it has been
Chapter 7

calculated, compare with those of similar large risks?

• How can differences be explained?
• How different are the proposed rates from the conventional rates applied to smaller
commercial risks?
• If the difference is substantial, is this credible?
• Which risk features explain these differences?

Be aware
In order to support underwriters as they exercise judgment on these matters, underwriting
managers must ensure that they have as much relevant, contextual information as
possible.

E1A Input of reinsurance expertise

The concern is not that the attritional claims experience has been misinterpreted but rather
that insufficient allowance has been made for the risk’s proper share of large claims costs.
Bearing in mind the limitations of all insurers’ internal claims datasets in respect of very large
claims, the assistance of reinsurers should be sought to build more appropriate loadings or
risk premiums for this level of exceptional claim. An appropriate benchmark might be a class-
based assessment of exceptional claims costs expressed as a burning cost combined with
the individually projected attritional burning cost, plus expenses, ROCE and profit allocation.
Chapter 7 Pricing 7/17

E1B Non-conventional pricing plans

The term 'non-conventional pricing plans' covers a multitude of insurance arrangements,
most of which rarely apply to any but the largest commercial risks. It includes the pricing of
arrangements involving self-insurance and captives, retrospective rating and other variations
on these themes.
As in every other form of pricing, the proper evaluation of claim data and its prospective
adjustment, as well as the use of appropriate benchmarks, is fundamental. Issues such as
the impact of inflation on aggregate deductibles serve to highlight the fact that these
arrangements often place even greater emphasis on the underwriter’s appreciation of claims
settlement patterns, notably, the long-tail. As these arrangements are generally designed to
leave the risk of exceptional losses with the insurer, a clear focus on their true costs is
essential.

Underwriting management decision: assessing bespoke pricing

components
What other costs, beyond the norm, need to be considered?

As well as additional general administration, these arrangements may involve:

• particular claims handling arrangements, the cost of which must be assessed;
• where deferred premium payments are involved or claims funds are to be established, a
careful assessment of the time value of money (investment income foregone) will be
integral to the negotiations; and/or
• the assessment of credit risk (Is it acceptable and at what price?).

F Exposure rating
Consider this…
What if there is very little claims data available because the event rarely happens?

This situation may arise if the insurer or reinsurer’s underwriting strategy is to write high
excess layers for particular classes of business. This is a feature of the Bermudan and

Chapter 7
London Markets. For example the insurer or reinsurer may specialise in writing excess of
loss catastrophe covers providing protection against:
• Natural catastrophes – hurricanes, earthquakes etc.
• Man-made catastrophes – terror attacks, gas, oil or nuclear plant explosions, rail accident
resulting in extensive injury and loss of life, etc.
External data, relating to these types of event, over many years and detailed actuarial
analysis are essential to the calculation of exposure rating. Actuaries will undertake
stochastic modelling, which is a mathematical description of potential future losses in terms
of the number of losses, their severity and their timing (frequency). The output from the
analysis is an aggregate loss model which predicts the size of the loss for a certain event
based on a time period, e.g. 1 in 50 years, 1 in 200 years. These may also be referred to as
probabilities whereby a 1 in 200 loss has a probability of 0.05%. It is the ‘tail’ of the model
that is most difficult to predict as the longer the time period the higher the loss and the
greater the volatility.
The underwriter will make a loss pick from the resulting loss curves. For example, if the
underwriter decides to write excess of loss protection of $50m in excess of $100m for a
Trans-American railroad company they will look at the probability of losses in the $100m to
$150m range and determine the premium required to build up a loss fund over a number of
years. To this the other pricing components discussed earlier in the chapter will be added.
 7/18 960/December 2020 Advanced underwriting

Underwriting management decision: impact of a catastrophe

What is the impact on prices following a catastrophe?
During 2017 Hurricanes Harvey, Irma and Maria caused major devastation to the USA and
Caribbean. They represent three out of the five costliest hurricanes in US history with an
estimated economic cost of $265 billion*. Lloyd’s has issued an insight paper which
considers the impact of these three hurricanes. Please see https://bit.ly/2DAMEX4.
The paper makes the following key conclusions:
• Historically prices would rise after a major catastrophe as insurers and reinsurers seek
to recoup their losses. However this payback seems to be reducing due to:
– better analytics and more complex modelling; and
– current economic conditions resulting in more readily available capital.
• Strong portfolio management encompassing a robust catastrophe underwriting
strategy, sophisticated modelling, efficient reinsurance arrangements and a first-class
post-loss claims service are requirements of operating profitably in the current market.
• Natural catastrophes are expected to occur and the 2017 hurricane season whilst
severe was not a statistical outlier.
• Each hurricane is unique and may impact many classes of business. While some have
complex models, others such as in-transit cargo risks and yacht insurance would
benefit from more sophisticated aggregation management tools. In addition, coverage
extensions such as contingent business interruption were impacted and the cluster of
storms during 2017 has highlighted the need for these risks to be better understood
and priced.
* https:/coast.noaa.gov/states/fast-facts/hurricane-costs.html

G Scenario 7.1
G1 Question
You have just been given responsibility for Product Y. A long-established product, it has had
a reasonably profitable history but has recently slipped into unprofitability. While profitable,
Chapter 7

Product Y was largely ignored and other products received management attention.
You don't know a great deal about Product Y but have been advised that, apart from a few
minor amendments, little has changed regarding its cover and policy limits over the years.
Another feature drawn to your attention is that a degree of discretion (limited by user profile)
is permitted in the application of discounts for both new and renewal business.
You have decided that Product Y must be the subject of a full review before any further plans
for its future can be considered.
Outline the objectives you wish to set for the review. List the information and data which
needs to be assembled and indicate how each item is to be used. Remember that you are
able to ask your colleagues for their assistance.
Chapter 7 Pricing 7/19

G2 How to approach your answer

Aim
This product management scenario encompasses issues considered in chapters 3 to 7
inclusive. It tests your grasp of the range of information, data and input required to manage a
product; the identification of essential elements and understanding of their use.
Key points of content
You should aim to include the following key points of content in your answer:
Objectives:
1. To understand nature of Product Y; demand for the product; short- and medium-term
prospects.
2. To assess Product Y's financial performance and identify source of current unprofitability.
3. To assess the consequences of making no changes to Product Y.
4. To identify and evaluate options and make recommendations regarding the product's
future.
Information, data and input:
To support Objective 1
• Current plan for Product Y (and/or for relevant product group).
• Detailed description of Product Y: scope of cover, optional covers, policy limits, rating
basis (factors and features); relevant underwriting guidance; commentary on changes to
product, with details and dates of changes.
• Current risk profile; exposure split by key cover/rating factors; commentary on significant
changes or trends in exposure.
• From Marketing: report on Product Y's target market; current position in the market; views
on future potential; customer/broker views.
• Feedback from underwriters, intermediaries and customer service staff: attractiveness of
product; issues.
To support Objective 2
• Current Budget for Product Y.
• Management account for Product Y (figures on incurred/underwriting account basis), for
current year and for as many past years as available; figures split by cover-type, branch,

Chapter 7
region or distribution channel, if relevant.
• Product Y performance on accident year basis, for as many years as available.
• Claims data: claims triangles; list of large claims; trends in average attritional claims and
claims frequency. From Actuarial: view of reserving pattern, run-off and ultimate cost.
• Current base rates; effective rates (once discretionary and other discounts applied); rating
history; Product Y expense allocation and commission costs (current and historic).
To support Objective 3
• Use the above data to conduct a prospective risk analysis in which no pricing or cover
changes are projected for the forthcoming period (but forecast trends in inflation, the
incidence of claims and assumptions regarding economic conditions are projected
forward). In addition, marketing, sales and distribution support for Product Y are assumed
to remain unchanged.
• This exercise will demonstrate whether Product Y's recent unprofitability is likely to
continue around current levels or whether there may be a slow or rapid deterioration. Is
action required urgently or can it be delayed? Are the actions required major or minor?
To support Objective 4
• Based on the above, a range of options can be identified and evaluated, not simply in
terms of Product Y's development but in cost-benefit terms for the whole account bearing
in mind current corporate and strategic business unit strategies and plans.
 7/20 960/December 2020 Advanced underwriting

Conclusion: collaboration and judgment

Pricing is self-evidently a highly collaborative activity within general insurance, involving
actuarial, finance and marketing, as well as underwriting. Data and models will never be
perfect but experience and judgment can improve the use of both.
Underwriters and customer service staff can only exercise proper judgment in the pricing of
individual risks if they understand the basis on which risks are intended to be priced, the
extent of their own authority and the relevant plans which define the agreed balance
between pricing, volumes and profitability. Underwriting management is therefore
responsible for both the quality of rating structures and the timeliness and accuracy of pricing
adjustments, as well as for the effective communication of matters relating to pricing to all
relevant staff.
While making full use of the data and statistical techniques available, the uncertainty at the
heart of any pricing process should be acknowledged and emphasis placed on the centrality
of appropriate risk selection in the achievement of underwriting profitability.

Additional reading
Cummings, D. (2014) ‘Big data can make a big difference in modern underwriting’.
Visualize. https://vrsk.co/2T6uroX.
Ferris, A. et al. (2013) ‘Big data’. The Actuary Magazine, December 2013/January 2014.
Volume 10 (issue 6). https://bit.ly/2RK5dvc.
IBM Global Business Services. (2013) Integrating the value of data in the underwriting
process. White paper. Available on RevisionMate.
Murray, E. (2014) ‘Big data’. Lloyd’s Market Magazine, Summer 2014. Available from
www.lloyds.com
Ordnance Survey. (2013) ‘The big data rush: how data analytics can yield underwriting
gold’. https://www.insurancehound.co.uk/underwriting/pricing/big-data-rush-how-data-
analytics-can-yield-underwriting-gold-16964.
StackIQ. (2012) Capitalizing on big data analytics for the insurance industry. White paper.
https://bit.ly/2zNiGuU.
Chapter 7
 Managing exposure
8
Contents Syllabus learning
outcomes
Introduction
A Risk appetite and risk acceptance 2.1, 2.9
B Accumulations and ‘clash’ 4.1
C Internal exposure data 4.1
D External environment 4.2
E Emerging risks 4.2
F Communicating exposure-related issues 4.1
G Aggregate management techniques 4.1, 4.3
H Reinsurance strategy and procurement 2.1, 4.3
I Alternative risk transfer options 4.3
J Scenario 8.1
Conclusion

Learning objectives
This chapter relates to syllabus sections 2 and 4.
On completion of this chapter and private research, you should be able to:
• explain the need for the active management of exposure;
• explain the impact of accumulations of exposure and the techniques used to reduce the
risk to insurers;
• explain how exposure is measured and how underwriters use the data to best effect;

Chapter 8
• evaluate emerging risks;
• explain how reinsurance is used as a method of enabling capacity; and
• explain how alternative risk transfer is used to increase an insurer’s capacity.
 8/2 960/December 2020 Advanced underwriting

Introduction
Refer to
Think back to M80, chapter 6, section B

At this point in the course, you should have a clear understanding of the framework within
which underwriting managers operate in order to translate their organisation’s underwriting
strategy into practice. In Operations on page 3/28, we saw that this involves establishing a
control environment to manage the acceptance of insurance risk, including limits on the
financial exposures under each policy, accumulated exposures in terms of regions or certain
types of industries, and exposures due to multiple losses from a range of policies from the
same event, such as an earthquake that damages private and commercial buildings, cars
and infrastructure, e.g. roads and railways.
The risk of ‘aggregation’ and understanding how it arises was the subject of the M80:
Underwriting practice unit. The focus in this course is on understanding the techniques
available to underwriting managers to evaluate and manage these exposures both at a
strategic and operational level.
As the options available to an insurance company to fund its risks are becoming more
innovative, we shall also consider some of the alternative solutions that are being used to
enable capacity in addition to the use of reinsurance.

Key terms
This chapter features explanations of the following terms and concepts:

Accumulations Aggregation risk Alternative risk Business interruption

transfer (ART)
Capital markets Catastrophe bonds Clash Control of exposure
Emerging risks Industry loss Realistic disaster Reinsurance
warranties scenarios (RDS) strategy
Risk acceptance Risk appetite Risk sharing Systemic losses
policy
Uncertainty

A Risk appetite and risk acceptance

We saw in chapter 3 how the broad corporate risk appetite choices are manifested in the
Chapter 8

types of risks underwritten; for example, an insurer underwriting natural catastrophe

property insurance will have an appetite and strategy for business that may produce very
good profits in most years (in the absence of significant catastrophes) but accepts that in
some years there will be large losses when hurricanes, typhoons, earthquakes etc. result in
widespread property losses.
We also saw how these decisions are translated into practice through risk acceptance
policy, containing definitions of target and excluded business, exposure limitations and
typical or actual distributions of key exposure measures. These could be, for example:
• number of policies by total sum insured (TSI) or by limit of indemnity;
• number of vehicles by vehicle value; and/or
• number of insured persons by age.
Unless clearly stated to the contrary, the reasonable assumption of anyone referring to these
documents is that these definitions and distributions will continue to apply whether the
account in question grows, shrinks or remains stable in income terms. Therefore, an account
with a typical distribution of risks by TSI (lots of small risks, few large risks), which suddenly
acquires a significant number of large risks (without a proportionate increase in small and
medium risks), will be subject to review by both underwriting manager and internal actuaries.
As an underwriting manager, as well as discovering the reasons behind the acquisition of
Chapter 8 Managing exposure 8/3

these risks, you will need to consider how your unit’s plan and budget may have been
affected.
The appropriate control of exposure therefore stems from a clear understanding of the
insurer’s risk appetite.

B Accumulations and ‘clash’

There are many ways in which risks can be anticipated to accumulate but not measured with
any accuracy for an individual insurer (for example, the sum of own vehicle damage plus
third-party damage and injury in a motorway pile-up or personal accident exposures in an
aircraft crash). These unknown accumulations (in other words, the aggregation risk) must
be dealt with by ensuring that an insurer’s net retained liability for single events is tailored to
its level of financial resource.
Similarly certain types of external event can impact several classes or accounts
simultaneously, as in the case of an aircraft crash: a single insurer could have multiple
exposures, including aviation, property and personal accident. Insurers often purchase
EL/PL ‘clash’ cover in anticipation of single events involving injury both to employees and
members of the public. Other types of event can affect multiple classes over a period of time
and give rise to systemic losses.

Example 8.1
Recession, increased unemployment and the crash in UK domestic and commercial
property values in the early 1990s led to a massive increase in the number and cost of
creditor and mortgage indemnity claims.
Unemployed policyholders claimed when they could not repay loans or mortgages; banks
and building societies claimed when the resale value of repossessed properties failed to
cover the outstanding loan amounts. As the recession continued, surveyors and valuers
who had provided original property valuations (which were believed to have been inflated)
were sued by lenders: the surveyors and valuers claimed against their professional
indemnity policies.
This sequence of events played out over a number of years and was particularly difficult to
predict due to the high number of repossessions, uncertain economic conditions, the
extremely high valuations placed on some of the commercial properties involved and the
uncertain outcome of court cases. Insurers with exposure to the creditor, mortgage
indemnity and professional indemnity markets, as well as to property insurance (which
was suffering high levels of fire/arson losses) incurred very high cumulative losses which,
at the time, were largely unanticipated. The number of employers’ liability claims also
increased as individuals became unemployed and looked for ways to enhance their
financial position.

Another example of an unanticipated accumulation of exposure was revealed by the upsurge Chapter 8
in deafness claims, reflecting the ageing of a cohort of industrial workers in the 1980s and
1990s. The lesson learned by those insurers who were particularly affected by the cost of
deafness claims was that they had been over-exposed to particular types of heavy industry.
Insurers and reinsurers are now far more wary regarding the potential cost of industrial
disease claims arising from known sources (such as asbestos and stress) as well as from
those sources which are so far unrecognised.
Internal exposure monitoring must therefore encompass:
• potential product/class accumulations;
• the ways in which exposures under different classes may accumulate or clash; and, most
importantly,
• any evidence that new hazards are emerging.
Underwriting strategy will also be affected by these considerations. Insurers may choose to
avoid market-leading positions in respect of certain types of risk or product and limit their
exposure to classes of business which are closely related.
 8/4 960/December 2020 Advanced underwriting

C Internal exposure data

Underwriting management decision: monitoring exposure
In order to monitor exposure, what internal exposure data is required?

The standard measures of exposure are not difficult to define but it is more difficult to capture
and utilise the data to best effect.

C1 Consistency and interpretation

The calculation of measures such as estimated and possible maximum loss (EML and PML)
requires particular attention and, critically, an internal consistency of approach. Similarly,
internal conventions must be established to ensure that measures such as floating sums
insured are recorded on computer systems in a consistent manner. Everyone who may use
the data must understand how such measures have been calculated and recorded to avoid
double counting or other forms of misinterpretation. Exposures on products with standard or
maximum sums insured (for example, household buildings cover ‘up to £1m’) need to be
estimated by other means, not simply counted at the maximum level.

Be aware
When assumptions are made in the measurement of exposure levels, they should be
clearly recorded wherever the measures are used.

In earlier chapters on risk assessment and rating, we discussed the ways in which risks are
classified and categorised according to degree of hazard. Similarly, in any examination of
exposures, you might consider how best to subdivide the portfolio in order to highlight any
changes in exposure to significant hazards. The following illustrates some examples:

Account type Significant hazard features

Tradesmen’s Application of heat or no heat used in trade activities.

Product liability Exports to North America or (knowing) exports excluded.

Property Values at risk in low/medium/high risk flood areas.

Research exercise
Investigate how different exposures are or could be sub-divided in the underwriting area in
which you work. Consider whether this could be improved and outline how you would do
so.
Chapter 8

C2 Location
In property classes there are obvious difficulties in understanding how individual risks relate
to other insured risks and how to measure the potential impact of that interaction on an
ongoing basis: risks may be located in close proximity or may be adjoining or
communicating. In the UK, postcode level risk data has been superseded by the monitoring
of exposures based on latitude/longitude risk coordinates, which can identify individual
premises. For insurers with property exposures in many countries, risk zoning on a global
basis is required.

On the Web
MacDonald, M. (2010) 'NIG launches mapping tool', Post Online, 11 June 2010. https://
bit.ly/2zDsmth.
Isaac. S. (2017) 'How Insurance Uses Location Data to Prepare for Natural Disasters',
Carto, 5 December 2017. https://carto.com/blog/how-insurance-uses-location-data-
prepare-natural-disasters/.

Using an insurer's logged property exposures, catastrophe modellers can carry out event
simulations (for example, flooding in the Thames basin or Tokyo earthquake) and extrapolate
Chapter 8 Managing exposure 8/5

the potential future cost from the cost of past events and their interpretation of current trends.
Having assessed the estimated loss for different return periods (for example, 1 in 50 or 1 in
100 years), insurers can set aggregate exposure limits for the relevant peril, in line with
company risk appetite.

D External environment
A number of the examples above reflect the influence of external factors. Identifying such
factors, assessing their influence and monitoring them appropriately are essential aspects of
controlling exposure.
Typically, there will be a number of individuals (and/or functions) within an insurance
company with responsibility for scanning the external environment. Internet access provides
everyone with the ability to access external information far more readily than ever before.
Underwriters, along with claims staff and surveyors, have their own window to the external
environment which they access via clients, claimants and intermediaries. While gaining
access to information presents few challenges, sifting through this mass, selecting those
items which are more likely to impact current or future exposures and sharing the filtered
information with the appropriate individuals or functions presents a far greater challenge.
Those responsible for the control of exposure must ensure that, by whatever means, they
have access to relevant information and that the information is used appropriately.
The appropriate response to changes in the external environment is rarely straightforward,
as their impact is often uncertain and existing risks or client groups are likely to be impacted
by any action taken. In some instances the insurers’ initial approach may be to lobby the
party making the change or regulating the activity in an attempt to lessen the potential
impact.

E Emerging risks
Emerging risks may be generally defined as those risks an organisation has not yet
recognised or those which are known to exist but are not well understood. The former US
Secretary of Defense, Donald Rumsfeld, is quoted as saying: 'There are known knowns.
These are things we know that we know. There are known unknowns. That is to say, there
are things that we know we don’t know. But there are also unknown unknowns. There are
things we don’t know we don’t know.'
By contrast the Lloyd’s definition is more specific and defines an emerging risk as:
an issue that is perceived to be potentially significant, but which may not be fully
understood or allowed for in insurance terms and conditions, pricing, reserving or
capital setting.
Emerging risks:

Chapter 8
• should be considered as part of an insurer’s risk management framework;
• may include non-underwriting as well as underwriting issues, for example the impact of
leaving the European Union and the impact of new technology;
• can represent opportunities as well as threats; and
• include things which might, over the longer term, impact the next generation of
underwriters.
The difference between an ‘emerging risk’ and a ‘risk’ can be summarised by the table
below, although there is an area of overlap, especially as emerging risks develop into
quantifiable risks that should be logged on a company’s risk register.

Emerging risk Risk

Understanding of uncertainty Nature of risk is not well Causes of uncertainty are well understood
understood by the market even if outcomes are not predictable

Time horizon 3 years plus Here and now

Availability of research Limited research available Significant research exists

Consequences Ambiguous – relevance may not Well understood – if it happens, we know

be obvious the impact
 8/6 960/December 2020 Advanced underwriting

Emerging risk can come from new processes, inventions, lifestyle choices and technological
advances. A non-exhaustive list is shown below:
• Big data.
• Climate change.
• Cloud computing.
• Driverless cars.
• Electromagnetic fields.
• Environmental risks.
• Genetic engineering.
• Google Glass Enterprise Edition.
• Intellectual property.
• The Internet of Things (IoT).
• Meta augmented reality (AR) glasses.
• Obesity.
• Wearable technology.
• 3D printing.
By their very nature some emerging risks will apply to all insurance related businesses and
others will be more specific depending upon the markets in which the insurer/reinsurer
operates. For example, driverless cars may only be of interest to motor and liability
underwriters.
Lloyd’s has identified over 40 emerging risks and categorises them into one of three
categories:
• Natural environment, e.g. climate change.
• Society and security, e.g. obesity.
• Technology, e.g. Internet of Things.

On the Web
www.lloyds.com/news-and-risk-insight/risk-reports
www.thecroforum.org/emerging-risk-initiative-2

However, there are other ways of classifying emerging risks that have a closer link to
underwriting strategy and this is can be done by completing a PESTEL analysis.
Political
Social
Chapter 8

Economic
Legislative
Technological
Environmental

In respect of emerging risks, such as climate change or the impact of new technology,
insurers and insurance organisations are working together to build as comprehensive an
understanding as possible of these risks but it is the responsibility of individual insurers to
update their own corporate risk assessments and take action to manage their own
exposures.
Through research to enable a better understanding of emerging risks and those that impact
a particular insurer it is possible to plot the emerging risks on an impact/time chart similar to
the one that follows.
Chapter 8 Managing exposure 8/7

Significant
Price regulation Climate change ‘Big data’
(Legislative) liability (Technological)
(Environmental)

Driverless cars ‘Brexit’

(Technological) (Political)

Cyber attacks
LED lighting (Technological)
(Technological)
Impact

Drones
(Technological)

Ageing loss DIY digital homes Predictive Sports Censorship

adjusters (Technological) maintenance concussions (Political)
(Social) (Technological) (Social)

Broker
Wildfires consolidation
(Environmental) (Economic)

Corporate
responsibility
(Social)
Low

Lifestyle drugs
(Social)

Office of the future

(Social)

Distant Time Imminent

Impact is now
so escalated
to risk register

Research exercise
Investigate the emerging risks that could impact your particular area of business and
create an impact/time chart. Consider the mitigating actions that could be taken.

On the Web
Marriner, K. (2014) 'Europe: Climate change modelling', Post Online, 21 August 2014.
www.postonline.co.uk/europe/2361406/europe-climate-change-modelling.
SwissRe (2014) 'sigma 4/2014 – Liability Claims Trends: Emerging Risks and Rebounding
Economic Drivers'. www.swissre.com/institute/research/sigma-research/

Chapter 8
sigma-2014-04.html.

F Communicating exposure-related issues

The exposure norms and limits derived from corporate risk appetite and the relevant
underwriting strategy need to be translated into a series of unambiguous, practical
descriptions and measures which can be utilised by underwriters and surveyors in assessing
individual risks and potential accumulations and fed into unit plans, underwriting authorities
and processing systems. Underwriting managers must actively support two-way
communication with underwriters and surveyors on exposure-related items, so as to ensure
that issues are identified and approaches agreed at the earliest possible opportunity.

G Aggregate management techniques

All exposures require active management; for some this will involve more effort than others.
Most large UK insurers now manage their property flood exposures (household and
commercial) in considerable detail in order to ensure that they are not exposed to a
disproportionate accumulation of flood-prone risks. In certain sectors or segments, specific
high-hazard exposures will be monitored closely to ensure an acceptable balance is
maintained. Underwriting plans may include exposure targets to manage certain aggregate
 8/8 960/December 2020 Advanced underwriting

exposures up or down in the course of the year through acceptance and renewal criteria
and/or pricing.
The techniques employed are dependent on the nature of the insurances being underwritten.
Some examples are as follows:

Table 8.1: Aggregate management techniques

Risk Techniques

UK household insurance Systems are used to aggregate the policy sums insured (buildings, contents and
flood risk personal effects) by postcode, overlaid with mapping software to identify the higher
risk flood zones. The insurer will keep a real-time total of values insured across all
policies in the areas concerned and should the maximum value per area be
approached or reached then no further policies will be written in that area.

UK household insurance Postcode systems are used to monitor theft losses in different areas and insurers will
burglary risk wish to limit their exposures in higher risk areas. As above, if the values concentrated
in one area reach the insurer’s maximum exposure then no additional insurances will
be written at that location.

Terrorism insurance The specialist area of underwriting terrorism cover (outside of the Pool Re, the
Government-backed scheme) involves careful assessment of aggregate exposures
from the proximity perspective (i.e. accumulation of insured properties within a
certain postal code). Insurers also monitor their insured exposures using blast zone
mapping.

Property insurance Much the same as monitoring insured values in areas susceptible to windstorm or
earthquake risk flooding risk, insurers map their insured values within known earthquake regions. As
well as reviewing the proximity to (or distance from) the likely epicentre of an
earthquake in order to estimate the potential loss, insurers also take into account the
nature of the construction of the insured property and are naturally willing to take
higher insured values for properties with damage-resistant construction.

Property insurance In addition to looking at the susceptible areas, insurers will look at the likely path a
windstorm risk windstorm may follow – especially when risks are written in a number of territories
that fall within the path of a typical windstorm. For example, across Northern Europe.

Group personal accident Insurers seek to limit their major event exposure when underwriting policies where
insured persons may be travelling together (such as in a helicopter flying to a North
Sea oil rig) or are working in close proximity to each other (such as in mining or
hazardous manufacturing operations). The methods of controlling aggregate
exposures could be to identify existing clients who operate at the same location and
restrict underwriting of new clients. Also, limiting the number of insured persons
travelling in the same aircraft is a technique used to control aggregate exposure.

Health insurance Health insurers are addressing the threat of multiple claims from an outbreak of
epidemics contagious disease, such as bird flu, by considering the sums insured per person and
limiting the concentration of exposures from group healthcare schemes.

Supply chain risk Business interruption policies generally provide an extension of cover for suppliers
Chapter 8

(and even suppliers’ suppliers), where damage at the supplier’s premises that results
in interruption to the flow of materials to the policyholder, and consequent loss of
sales, is covered. Insurers must take all steps to identify the accumulated exposures
from all insured suppliers to the policyholder and potentially place an inner limit on
the extent of cover provided by this cover within the policy.
The same applies where the policy is providing a customer’s extension.

Much of the risk information that helps insurers monitor the growth in aggregate exposures
can be drawn from the core underwriting system. However, there are software systems
available that help to capture the exposure data for any particular scenario and provide
aggregated values-at-risk information.
In the example of a terrorism insurer, the address of each policyholder is entered into a
mapping system that will provide a 100 metre or 250 metre circle around the insured
premises. This is the ‘blast zone’ that will suffer damage around a location where there has
been an explosion. The underwriter will manage carefully the values insured under any
further policies that are accepted within the blast zone to ensure that the total value of claims
from one event will not result in losses arising beyond the risk appetite of the firm.
Chapter 8 Managing exposure 8/9

Research exercise
Review the websites for suppliers of aggregation software, such as
www.coforgetech.com/.

G1 Assessing extreme circumstances

Other systems are widely used that help model potential losses arising from major natural
catastrophes. Insurers are able to enter the location and insured values of every property
insured and overlay this with various storm tracks that have happened in the past and could
happen again, or a track very similar. Property insured that lies in the central part of the track
will be assessed as a total loss whereas insured property on the outer edges of the track are
assessed as suffering, say, 75% loss (as it is unlikely to be totally destroyed in the
comparatively slower wind speeds away from the centre of the track). The system calculates
an estimate of the total insured losses from storm tracks selected by the underwriter.
Realistic disaster scenarios (RDS)
A tool used in the Lloyd’s market is the realistic disaster scenarios (RDS) exercise where
Lloyd’s require all their member syndicates to undertake financial assessments of the impact
of certain stated scenarios on their underwriting performance. Lloyd’s publishes details of
over 20 scenarios, which includes information on the assumed total insurance industry loss
(across various classes of insurance), the geographical region (in regard to the natural
catastrophe scenarios), the assumed storm track of major hurricanes/typhoons and the
radius from epicentre of earthquake effect.

On the Web
Lloyd's - Realistic disaster scenarios: https://bit.ly/2FxB77U

H Reinsurance strategy and procurement

Refer to
Think back to M80, chapter 6, sections C and D

Reinsurance has already been discussed at in connection with a number of points: the work
required to establish a new general insurer; the relationship between capital and reinsurance
in determining a company’s solvency; establishing and expressing corporate risk appetite;
and the impact of reinsurance on underwriting strategy. Its role as a key means of enabling
capacity will be explored in more depth here, focusing on the strategic and management
issues for an underwriting manager.

Chapter 8
The reinsurance strategy is a central component of the strategy and management of an
insurance company’s risk profile. Insurers use reinsurance for various risk management
purposes. Clearly the main aim is to enable an insurer to spread (or ‘lay-off’) some of the
insured limits carried on policies underwritten, and this might be on a facultative, specific
policy or across a portfolio or book of business. Reinsurance protects the capital base of the
company as it provides a financial resource in the event of extreme losses that would
otherwise erode premium reserves and solvency capital and ultimately lead to the insolvency
of the insurer.
At the highest level, therefore, an insurance company seeks to ensure its security, continuity
and growth prospects in the most cost- and capital-efficient manner possible through the
purchase of reinsurance.

Be aware
In creating a reinsurance programme, insurers are often motivated in their choice of
arrangement and reinsurer by the desire to gain experience and knowledge of an
unfamiliar class of business by working with an experienced reinsurer. Similarly, reinsurers
may choose to work with particular insurers in order to gain knowledge of less
familiar areas.
 8/10 960/December 2020 Advanced underwriting

H1 Reinsurance programmes
An insurer’s reinsurance programme is made up of a number of contracts, reflecting treaty
and facultative arrangements, which are intended to be complementary. These
arrangements are developed over years and their management and interpretation are often
the responsibility of a central functional area within an insurance company. As the successful
and cost-effective operation of these reinsurance arrangements is fundamental to the
survival and success of the business, key decisions are usually made or approved at
board level.
How this is achieved will vary according to the objectives of the company, its relative stage of
development and how reinsurers view the prospects of the insurer. For most underwriters,
however, the aspects of a reinsurance programme which are of most immediate interest are
those that:
• permit or restrict the risks they may underwrite; and
• limit the impact of exceptional (very large or very numerous) claims on the profitability of
their accounts.
Within an insurer’s programme these may be referred to as the working layers or covers:
those which are intended to be available for use, or exposed, on a day-to-day basis. Insurers
may buy additional reinsurance covers or layers designed to protect the company’s assets in
more exceptional circumstances.

Be aware
While the reinsurance market responds by way of many types of contract based on the
nature of the underlying risk, the cedant insurer’s objectives and the ingenuity of the
reinsurers, there are circumstances where individual reinsurers feel unable to respond and
reinsurance pools may be established and/or government support requested.

The process of procuring the reinsurance programme for an insurer carries risks of its own.
Should the insurer not disclose material information to the reinsurer, the potential for a claim
to be declined arises.
Reinsurance procurement practices should, therefore, be closely controlled and the following
features are some of the issues that senior underwriting managers will be concerned with
when developing and implementing their organisation’s reinsurance programme:
• The reinsurances actually purchased are in line with the reinsurance strategy agreed with
the board.
• An instruction to all underwriters that the purchase of reinsurance is only to be carried out
by authorised staff (usually an outwards reinsurance team).
• Expected changes in portfolio mix, e.g. a cleansing of the book to improve risk selection
Chapter 8

or widening the footprint and moving the mix to higher risk areas.
• Information and data that comprise the application and disclosure pack (such as limits
insured per policy and per event, loss history and policy cover) should be checked and
countersigned for release by the director of underwriting.
• When reinsurance terms are received, either the in-house legal team or an external firm
should review the proposed policy wording.
• The proposed reinsurers are within the security policy of the firm (see Reinsurance
security on page 8/11).
When losses occur that result in an insurer notifying a claim under the reinsurance
programme, an assessment should be made on how this may erode the cover remaining
available for the remaining period. For example, an insurer may have an excess of loss
policy providing £25m limit above a £25m retention by the client. The cover is a fixed amount
per annum. Should the insurer suffer losses of £35m this would ‘eat into’ the reinsurance
protection by £10m, leaving only £15m for any future losses. In these circumstances the
insurer must make risk-based decisions on ‘buying back’ another £10m or perhaps relying
on the residual cover. These decisions are of course linked to the firm’s risk appetite and
tolerance strategy.
Chapter 8 Managing exposure 8/11

Research exercise
Consider the reinsurance purchased in your area of underwriting and investigate why the
limits were chosen.

H1A Changing requirements

Over time, the types of reinsurance purchased by a growing insurance company will change.
Arrangements (such as proportional reinsurance treaties – quota share or surplus) that
provided enhanced capacity in the early years of a company’s history may be supplemented
or replaced by more specific non-proportional treaties (such as risk excess of loss) which
permit the now-established company to write larger risks without incurring the full impact of
very large claims. In its early days, an insurance company will have few, if any, significant
accumulations of risk but will need to monitor its exposures in order to identify when
additional protection may be required (such as catastrophe excess of loss). As an insurer
continues to grow, the company’s retentions (in excess of loss contracts) will increase
significantly, reflecting:
• enhanced internal capital resources;
• knowledge of the portfolio and its performance over time;
• confidence in underwriters and internal systems; and
• the desire to retain as high a proportion of the potential profit margin as possible.
In addition to those types of reinsurance contract already mentioned, others such as stop-
loss reinsurance are designed to provide protection against the excessive accumulation of
small losses rather than the cost of extremely large claims.

Be aware
Please note that this discussion reflects the perspective of the insurer or cedant;
reinsurers have their own strategies and objectives to consider, making different types of
reinsurance arrangement more or less attractive in different circumstances. See unit M97
for a full treatment of the subject.

H2 Reinsurance security
Insurers carry the risk that their reinsurers may suffer an accumulation of extreme levels of
claims from one event and multiple cedants and consequently become insolvent and unable
to pay claims. The insurer remains liable to the insured for claims and, therefore, would have
to fund the non-receivable element of the reinsurance themselves.
An insurer will wish to ensure that the reinsurers providing protection for the firm have
security ratings at the highest level.

Chapter 8
H2A Reinsurer failure
Reinsurance brokers and purchasers of reinsurance also monitor the security of all
reinsurance companies on an ongoing basis. If the transfer of risk from insurer to reinsurer is
to be effective and worthwhile, the insurer must have confidence that the reinsurer will still be
capable of paying claims many years in the future. The security committees of insurers set
minimum standards of security which all their reinsurers must meet: this standard may be
higher for long-tail than for short-tail accounts. A reinsurer’s security rating (claims-paying
ability) reflects its capitalisation: well-capitalised reinsurers need to charge higher prices to
achieve adequate returns and they can command higher prices from those insurers who
want to be, and be seen to be, highly secure.
So what if a reinsurer fails and the insurer cannot make a recovery?
The insurer is responsible to the consumer/insured and must pay legitimate claims in full.
The credit risk (the risk that the reinsurer will not be able to fulfil the contract) falls entirely on
the insurer. This is a particular problem with reinsurance on long-tail accounts where
recoveries from the reinsurer may not be sought until 40 or 50 years in the future.
 8/12 960/December 2020 Advanced underwriting

H3 The reinsurer’s perspective

Reinsurers are increasingly concerned to understand all policy-related exposures, including
those stemming from contingent business interruption extensions, such as those relating to
suppliers: their concern relates to their own unidentified accumulations.
H3A Basic factors shaping reinsurer’s response
The basic factors which will determine and shape the response of the reinsurers (the type of
arrangements offered, levels of cover and price) are:
• class of business (short- or long-tail);
• limits of liability (or unlimited liability, as in the case of motor third-party bodily injury);
• risk profile (how current and planned exposures are distributed by limit of indemnity, sums
insured, trade/activity, geographical location; significant inclusions/exclusions in respect
of cover offered and risk selection policy);
• aggregate exposures and breakdown of premium income; and
• perceived quality of underwriting strategy and related business targets (current and
anticipated approaches to growth, profitability and pricing).
The insurer’s perceived competence (generally and with particular reference to underwriting
and claims handling) and the quality of the relationship established between the insurer and
its reinsurers are also highly influential.
H3B What limits might reinsurance contracts provide?
As unlimited liabilities are unquantifiable and cannot, by definition, be fully capitalised,
reinsurers limit their liabilities in a number of ways. In the first instance, reinsurers will only
agree to arrangements where the primary insurer accepts an appropriate level of retention or
share of risk. Reinsurers then control their exposure by applying a range of limits (aggregate,
per risk, per event) on incurred claims and by limiting the number and cost of reinstatements
of cover available. Therefore, depending upon the shares, lines, layers, limits and/or
reinstatements purchased by the insurer, any excess incurred cost beyond the reinsurer’s
share is the responsibility of the primary insurer.
This is not a remote possibility and can arise when inflation has eroded the value of
reinsurance limits arranged many years previously; for example, in the case of late-reported
employers’ liability claims. The possibility of multiple significant weather claims in one twelve-
month period, each event incurring 100% of the insurer’s catastrophe retention, is another
example of how a primary insurer may incur very significant liabilities. This is why insurers,
having carefully considered their potential exposures, require a programme of reinsurance
contracts to mitigate and spread risk appropriately.
H3C Claims focus
Relevant claims data are, of course, of prime concern to all reinsurers. Those reinsurers who
Chapter 8

currently subscribe to an insurer’s treaties want to know what the cost of their exposure has
been, or rather, will be when the claims are fully run-off (which may not be for many years).
For prospective reinsurers who wish to consider and price future reinsurance arrangements,
they will require as much relevant claims-related data and information as possible, including:
• the incidence and cost of claims;
• the speed of settlement and typical run-off patterns; and
• reassurance regarding the competency and efficiency of the insurer’s claims handling
and estimating processes.
The relevance of the claims data will only be apparent once related to exposure data, at
which point the reinsurer’s underwriters can assess the historical experience of an individual
insurer’s account compared with other similar accounts in the market and consider what
level of claims costs next year’s planned risk profile might generate.
Reinsurers will not rely solely on historical claims data for their projections, as experience
has demonstrated that such an approach is often inadequate. Catastrophe modellers, in
particular, will utilise location, vulnerability and valuation data with stochastic statistical
methods (incorporated into modelling software produced by Risk Management Solutions
(RMS) or AIR Worldwide, for example) to generate projections, cover options and prices.
Chapter 8 Managing exposure 8/13

On the Web
RMS: www.rms.com
AIR Worldwide: www.air-worldwide.com

Be aware
Reinsurers use the same statistical and actuarial methods, as described in chapter 6, in
order to evaluate ultimate and projected future claims costs.

The same fundamental issue of uncertainty underpins both insurers’ need for reinsurance
and reinsurers’ difficulty in deciding what cover to grant and what to charge for it. Where
reinsurers only cover extreme losses (as in excess of loss treaties), the degree of
uncertainty and potential volatility is greatly heightened. In order to produce profitable returns
for their investors and shareholders, reinsurers must achieve a good spread of risk in their
own portfolios through balanced risk selection and the appropriate transfer of risk to other
companies through the retrocession market.
The quality of data and information supplied by insurers has a direct bearing on reinsurers’
understanding of their own exposures and ultimately their own performance. It should not
come as a surprise, therefore, that reinsurers will seek the best data and information
possible from ceding insurers and that poor data will attract restricted reinsurance cover at
higher prices, as greater uncertainty has been priced-in.

I Alternative risk transfer options

The whole regime of exposure control is designed to ensure that accumulation of risks is
managed on a per-location and per-event basis and to create greater spreading of risk. This
helps to retain as far as possible the predictability of the losses during the year of account in
question by limiting large losses.

I1 ‘Subscription market’ risk sharing

In many cases, the insurance requirements for major buyers are shared with a number of
insurers, thereby meeting the client’s requirements but containing the exposure to any one
insurer to an acceptable level. The Lloyd’s and London insurance markets operate much of
their business on this basis and create what is known as a ‘subscription’ market.

Chapter 8
 8/14 960/December 2020 Advanced underwriting

Example 8.2
Consider the insurance needs of a cruise ship operator with five vessels and insured
values of $400m, with the largest value being the flagship of $120m. The insurances may
be shared in the following structure:

Insurer Percentage Value insured flagship Value insured fleet

underwritten
(subscribed)

Syndicate A 20% $24m $80m

Syndicate B 15% $18m $60m

Syndicate C 12.5% $15m $50m

Syndicate D 10% $12m $40m

Syndicate E 5% $6m $20m

Insurer A 15% $18m $60m

Insurer B 10% $12m $40m

Insurer C 12.5% $15m $50m

Total 100% $120m $400m

This structuring of the values allows the larger syndicates and insurers who have greater
risk bearing capacity and appetite to take a larger share of the values, with a
commensurate level of premium. In the event of a major incident, the maximum loss per
vessel is known and these values can be reduced through the use of reinsurance.
Reinsurance will also be in place for the extreme scenario of more than one vessel being
lost at the same time.

This type of risk sharing helps to limit the risk of a major loss from one event and also
creates a diversified book of business that has many other risk reduction benefits, such as
improved credit risk where business emanates from a wider range of brokers, price
resilience by having a portfolio of clients and wider geographical spread. These benefits are
slightly offset with potentially higher administrative costs but these are not material compared
to the advantages of risk spreading.

I2 Alternative risk transfer (ART)

ART has no strict definition, although it is often said to be a ‘non-traditional way of dealing
with a risk transfer problem’. It has become increasingly important as another way to transfer
risk apart from the purchase of conventional reinsurance. One opinion is that ART is a risk
transfer to the capital markets, while others prefer a wider definition that includes any cover
Chapter 8

containing an element of financial risk.

Be aware
Any insurance-linked security that allows investors in capital markets to take a more direct
role in providing insurance and reinsurance protection, and brings about a convergence of
insurance and capital markets, can be considered as an ART instrument.

ART is a set of risk-financing techniques. Traditional techniques were once limited in their
application to single class insurance risks, such as property. The alternative techniques
combine with the traditional to offer a powerful ‘tool kit’ for meeting more broad risk-financing
needs, including the financial management of risks that have not usually been insured.
An ART solution is likely to contain several risk-financing techniques. ART solutions are
hugely varied and often developed uniquely to solve a specific problem.
Insurance-linked securities provide a mechanism within the financial system to transfer
insurance risk to capital markets and supply protection to investment portfolios. The financial
system benefits from the presence of insurance-linked securities, as well as other forms of
ART. As a result of securitisations, derivatives and swap structures insurers are better
positioned to spread their risks across the broad spectrum of the capital markets, as
opposed to relying on reinsurance or capital reserves, so allowing for efficient use of capital
Chapter 8 Managing exposure 8/15

and adding liquidity to the financial system. This ultimately benefits individuals and
institutions seeking insurance protection. Capital market participants benefit from a diversity
of risks and returns that are not dependent on the factors that usually affect them.
I2A Development and features of ART
Capital markets and the insurance industry have long held a mutually-beneficial relationship
where insurers provide risk protection to individuals and companies while capital markets
provide the insurance industry with a wealth of options to earn investment profits and
manage reserve funds. In turn, insurers have been among the largest purchasers of fixed-
income securities from capital markets. This has provided capital markets with substantial
liquidity, enhanced trading efficiencies and lowering borrowing costs for both Government
and corporate debt issues.
In recent years, the relationship between capital markets and the insurance industries has
evolved to the transferring of risk through securitisation, otherwise known as ART. Imbalance
in the insurance and reinsurance industries has given rise to new financial products created
within capital markets, providing insurers with better tools to manage risk and investors with
new investment opportunities. Traditionally, primary and secondary insurance markets have
managed risk by holding capital in reserve or by financing risk positions through reinsurance.
However, capital held in reserve is unavailable to fund business expansion and new
ventures, resulting in stagnation. The desire to free capital, combined with concerns over the
reinsurance industry’s ability to provide future coverage, has provided insurers with the
incentive to look for risk management alternatives.
To begin with, insurance-linked securities were simple fixed income structures that allowed
insurers to manage catastrophic risks. Over time, they have become more complex and
have evolved into a discrete asset class with great appeal to a wide range of investors and
provide insurers with a broader choice of risk management tools. Insurance-linked securities
include derivatives, catastrophe bonds, contingent capital contracts, industry loss
warranties, reinsurance sidecars and catastrophe futures, which further converge capital
and insurance markets.
Cost and capacity limitations in the reinsurance market have created incentives for insurers
to turn to the capital markets by creating the opportunity to convert illiquid assets into liquid
ones. Insurance-linked securities serve to manage and hedge various insurance risks while
increasing the availability of capital by drawing on alternative sources of funding.
Like most other markets, insurance-linked securities have been adversely affected by the
global financial crisis but have proved to be more resilient as issuances continue to grow
despite there being some weaknesses in certain individual sectors.
There are two segments which make up the ART market:

Chapter 8
ART market

Risk transfer
through Alternative
alternative products
carriers

The market for alternative carriers consists of self-insurance, captives and other loosely-
defined risk retention groups.
The use of captives increases dramatically when insurance markets harden. Since many
multinational companies already have a captive, the number of captives is not expected to
rise appreciably, although some growth in captive formation will arise from rent-a-captives
and protected-cell captives, which primarily serve medium-sized corporations.
Captive insurance companies represent an alternative form of risk financing that has been
used for over three decades. Since the 1970s, most major banks, commercial and industrial
companies and privatised utilities have set up captive insurance companies as a way of
retaining more of their own risks. It is estimated that the total number of captive insurers
 8/16 960/December 2020 Advanced underwriting

worldwide is just over 5,000, with the majority domiciled in tax-friendly locations, such as
Bermuda, the Cayman Islands, Guernsey and the US state of Vermont.
The key differential between ART and the traditional insurance marketplace is that insurance
and reinsurance markets provide catastrophic risk coverage whereas the capital markets
provide additional financial capacity for insurance coverage through self-insurance. However,
ART is intended to represent an integrated approach to supplement reinsurance needs
rather than to be a replacement.
Catastrophe bonds
These are the capital market alternative to traditional catastrophe reinsurance. Catastrophe
bonds are used by insurers to purchase supplemental protection for high-severity, low
probability events. They are risk-linked securities that transfer a defined set of risks from the
insurer to investors through fully-collateralised special purpose vehicles.
Historically, catastrophe bonds were structured to offer high yields that attracted investors
with higher risk appetites. Original catastrophe bonds only covered a single peril but now
they may include a multitude of perils. Key investors in catastrophe bonds include hedge
funds, insurers, reinsurers, banks and pension funds.
Contingent capital contracts
These are financing agreements arranged before a loss occurs. Should a named event
occur, the financier provides the insurer with capital determined by the amount of
catastrophic loss. The terms of the deal are arranged during a prior time of normal benign
activity when the borrower can negotiate access funds at favourable rates. If no catastrophic
events occur, there is no exchange of funds.
Industry loss warranties
Industry loss warranties are reinsurance contracts where payouts are linked to a
predetermined trigger of estimated insurance industry losses. They are swap contracts that
are based on insurance industry indices rather than insurer actual losses. Payment of the
warranty is made based on whether the covered insurance industry suffers a predetermined
level of loss due to natural circumstances.

Example 8.3
An insurer has exposure to hurricanes in Florida. They could buy an industry loss warranty
exposed to wind in that region of the USA which would be triggered if the total industry
insured loss rose above $10bn. They pay a premium to the reinsurer or a hedge fund and
in return could receive the limit amount if losses exceed the predefined amount, or
warranty.
An industry loss warranty can sometimes have additional clauses which must be met for a
payout to be made, such as additionally to the industry loss the insurer must also have
experienced a specified amount of loss themselves.
Chapter 8

Reinsurance sidecars
These are limited purpose companies created to work in tandem with the reinsurance
coverage provided to an insurer. Sidecars are capitalised with debt and equity financing from
capital markets and are liable for only a portion of risk underwritten. Sidecars allow insurers
to write more policies while limiting their liabilities. Unlike traditional reinsurance, sidecars are
privately financed, they dissolve after a set period of time, and the risks are defined and
limited.
Catastrophe futures
Catastrophe futures are futures contracts used by insurance companies as a form of
reinsurance. The value of a catastrophe futures contract is determined by an insurance index
that tracks the amount of claims paid out during a given year or time period. When
catastrophe losses are higher than a predetermined amount, the future contract increases in
value and vice versa. Despite ebbs and flows in their trading, catastrophe futures helped
usher in the era of insurance derivative contracts and capital market alternatives to
traditional insurance and reinsurance approaches.
Insurance derivatives
These derive value from the valuation of financial instruments, events or conditions. A few
examples of derivatives include put and call options, forwards and futures contracts, swap
contracts and credit default swaps.
Chapter 8 Managing exposure 8/17

Derivatives offer investors the advantage of instant liquidity, plus they enable investors to
gain exposure to underlying risk classes that may not otherwise be tradeable. They also
allow hedging or transferring of risk positions. Speculators use derivatives with the goal of
profiting from directional price movements. Derivatives are designed to have large pay-offs
and tend to be highly leveraged. Small changes in the underlying asset can lead to large
price swings. Derivatives not traded on an exchange have an increased risk of counterparty
default.
The attractiveness of insurance derivatives is that they shift risk more efficiently than
institutional methods, avoid contractual costs of traditional insurance and reinsurance
methods and create liquid markets for trading. Derivatives allow insurers to purchase
protection for new pools of investors. However, the use of derivatives has received heavy
scrutiny following their role in the collapse of the financial markets.
I2B Finite risk solutions
The term finite risk is used to differentiate risk-based products from the investment-only type
products. These finite risk reinsurance contracts have certain characteristics in common, as
follows:
• They provide a risk financing mechanism for near certain events.
• Pricing took the time value of money into account.
• Reinsurer’s maximum liability was limited, being closely related to the premium paid.
• Reinsured usually participated in losses and benefited from better than expected loss
experience.
• Contracts were usually multiple year.
• Transaction costs were lower than for traditional contracts.
• Regulators will look carefully at the amount of protection purchased through certain types
of ART.
The move towards risk-bearing transactions was assisted by new accounting rules. For
example, the US FASB SFAS 113 rules outlawed such investment reinsurances and
premiums paid under such arrangements were counted as deposits and taxed accordingly. A
new test was adopted under the rules whereby for there to be risk transfer, there had to be ‘a
reasonable probability of the reinsurer losing a significant amount of money or making a
significant loss’. Similar rules now exist under the UK regulatory regime.
Advantages of capital market solutions
• Investors are attracted to the diversification of benefits and above average yields of
insurance-linked securities.
• Returns of insurance-linked securities are independent of factors affecting traditional
financial markets and their returns typically exceed similarly rated investment assets.
• The weak correlation of these financial instruments with traditional financial markets

Chapter 8
enables investors to achieve greater portfolio diversification and higher yields.
• Capital markets have the potential to be price competitive relative to reinsurers in the
longer term.
Disadvantages of capital market solutions
• Investments in insurance-linked securities expose investors to risks that are not typically
associated with traditional investment classes.
• Prior to the credit crisis, some insurance-linked securities were used to augment the
credit rating of the security provider, removing much of the insurance risk and leaving
investors exposed only to the risk that the investment bank issuing the credit would
default. While this risk was previously thought to be negligible, the collapse of Lehman
Brothers in 2008 proved that the extent of this risk was much greater than imagined.
• Traditional reinsurers tend to take a long-term view. In contrast, capital markets often
require a more immediate return and could withdraw their support at critical times.
• Transactional costs can be very high, particularly for smaller deals.
Insurance-linked securities carry a variety of risks
As we have seen, insurance derivatives and other financial instruments are designed to
transfer or hedge primary and secondary insurance risks amongst capital market
participants. The appropriateness of these ART strategies depends on the situation and the
size of the purchaser.
 8/18 960/December 2020 Advanced underwriting

These risks include:

Liquidity risk The uncertainty that results from the inability to buy or sell an instrument.

Basis risk Occurs when the cash flow from the hedging instrument does not perfectly offset the
cash flow from the instrument being hedged.

Moral hazard Takes place when one party transfers risk to another, and the party ceding the risk
has less incentive to ensure that the risk is managed as efficiently as possible.

Adverse selection Occurs when both sides of the transaction do not have access to the same
information.

Credit or Arises when the counterparty to a transaction may not be able to honour their side of
counterparty risk the obligation due to financial hardship or some other cause.

J Scenario 8.1
J1 Question
On introduction, a newly-appointed underwriter tells you that her previous company's
maximum acceptance limit for commercial property exposures was also £15m TSI, '…so I
know precisely the kind of business you want to write.'
What areas of potential difference would you draw to the new underwriter's attention?

J2 How to approach your answer

Aim
This scenario requires you to explain how a company's risk appetite (and the underwriting
strategies which flow from it) is reflected in more than a single measure of exposure.
Key points of content
You should aim to include the following key points of content in your answer:
How this company's risk appetite and underwriting strategy affects:
• the type of risks written (sector-focus or specific bias or restrictions);
• the required risk profile (for example, the balance of small, medium and large risks and
mix of risk types);
• reinsurance purchase and retention levels (and thus the company's total and net
capacities);
• willingness to purchase facultative reinsurance or to become involved in co-insurance;
• approach to potential accumulations including attitude towards risks exposed to specific
natural hazards;
• other specific marketing and distribution initiatives and the company's operational
Chapter 8

approach which may influence the profile of targeted/acceptable risks;

• the respective stages of both the economic cycle and underwriting cycle may also
influence this company's approach to risk acceptance.
Chapter 8 Managing exposure 8/19

Conclusion
The main ideas covered by this chapter can be summarised as follows:
• Broad corporate risk appetite choices are manifested in the types of risks underwritten.
• Unknown accumulations must be dealt with by ensuring that an insurer’s net retained
liability for single events is tailored to its level of financial resource.
• The standard measures of exposure are not difficult to define but it is more difficult to
capture and utilise the data to best effect.
• In order to control exposure, external factors need to be identified, assessed and
monitored.
• Emerging risks should be considered as part of an insurer’s risk management framework.
• All exposures require active management; for some this will require more effort than
others.
• The reinsurance strategy is a central component of the strategy and management of an
insurance company’s risk profile. Insurers use reinsurance for various risk management
purposes.
• Alternative risk transfer has become an increasingly important method of transferring risk.
• The convergence of the insurance and capital markets has created an alternative channel
for insurers to transfer risk, raise capital and optimise their regulatory reserves.

Additional reading
ABI. (2011) Industry good practice for catastrophe modelling. December 2011. https://
bit.ly/2zGgc0S.
ABI. (2014) Non-modelled risks – a guide to more complete catastrophe assessment for
(re)insurers. April 2014. https://bit.ly/2AG5FTg.
AIG. (2013) Think differently about risk. https://bit.ly/2zDKbZu.
Banks, E. (2004) Alternative risk transfer: integrated risk management through insurance,
reinsurance and the capital markets. Wiley.
Clark, P. (2013) ‘Catastrophe models give insurers insights into disasters’, Financial
Times, 30 September 2013.
Lloyd’s. (2014) Catastrophe modelling and climate change. Research report. https://bit.ly/
2z0i6ME.
Lloyd’s Market Association. (2013) Catastrophe modelling. Guidance for non-catastrophe
modellers. https://bit.ly/2Dyi4xB [Accessed: 12 November 2018]
Mathias, A. (2014) Selecting risk. IIL lecture. 8 October 2014 (updated 25 June 2018).

Chapter 8
https://bit.ly/2Pt32Q8.*
Punter, A. (2014) Third-party capital. IIL lecture. 26 June 2014 (updated 22 September
2017). https://bit.ly/2z4wsJM.*
World Economic Forum. (2019) Insight report: Global risks 2019. 14th edition.
*MyCII login required to access IIL lecture content.
 Monitoring and
9
operational controls
Contents Syllabus learning
outcomes
Introduction
A Plans, budgets and forecasts 5.2, 5.3
B Key performance indicators 5.3, 5.5
C Claims, reinsurance and exposure 5.3
D Audit 5.3, 5.6
E Presentation of data 5.3
F Looking ahead as well as back 5.2, 5.4
G Data mining 5.2, 5.4
H People management 5.1, 5.5
I Authority limits 5.6
J Other auditors 5.6
K Delegated authority 2.3, 5.6
L Underwriting policy 5.6
M Scenario 9.1
N Scenario 9.2
O Scenario 9.3
Conclusion

Learning objectives
This chapter relates to syllabus sections 2 and 5.
On completion of this chapter and private research, you should be able to:
• identify what needs to be monitored in an underwriting account;
Chapter 9

• select and use appropriate approaches to variance analysis and action planning; and
• identify and apply appropriate processes and controls to achieve an acceptable level of
underwriting governance.
 9/2 960/December 2020 Advanced underwriting

Introduction
The purpose of monitoring is to evaluate progress against plans and to guide appropriate
actions (immediate, short- and long-term). Monitoring activities are conducted throughout
general insurance companies: all levels and all functions are involved.

Be aware
Individual job descriptions and personal targets should specify key monitoring
responsibilities and the company’s planning and budgeting processes will indicate how
different levels of accountability link with one another. While straightforward duplication is
to be avoided, benefit will be derived from some data and information being reviewed from
different perspectives: this will form part of standard agendas in joint meetings between
underwriting and claims areas and underwriting and sales areas, for example.

Refer to
Think back to M80, chapter 1, section C3A

As well as monitoring internal performance, external information and data of many types
must be monitored: these include external factors and influences which help to explain
company and product performance and external benchmarks (such as the performance of
other insurers) which necessarily influence the company’s plans and internal targets. The
time frames involved may vary from a day (counts of claims intimated) to several years
(prospects for different types of investment) or decades (potential impact of climate change).

Be aware
When establishing a baseline against which to monitor – be that internal measures such
as plans, budgets and targets or external measures such as the financial performance of
other companies, customers’ perceptions of insurance companies and the current level of
economic growth – you should note that monitoring is itself a key element in determining
what should be monitored and what the appropriate baselines might be. The internal and
external awareness that a consistent and comprehensive approach to monitoring can
deliver is the best basis for sound internal plans.

The operational controls typically used in underwriting also involve forms of monitoring.
While the productivity, effectiveness and development of all staff must be monitored, the
discretionary activities of underwriters (namely, their ability to accept and price risks on
behalf of insurers) require particular attention as the effective governance of these activities
is fundamental to the success of the company.

Key terms
This chapter features explanations of the following terms and concepts:

Contingency Data mining Exception report Key performance

allowance indicators (KPIs)
Chapter 9

Lag indicator Lead indicator Moving annual total Pipeline premium

Underwriting Underwriting licence Variance
governance

A Plans, budgets and forecasts

As discussed in chapter 5, an insurance company needs to know whether it is meeting its
planned objectives, both strategic and operational, throughout the course of the year. This
form of monitoring allows issues of underperformance to be tackled as soon as they are
identified, unexpected opportunities to be exploited and expectations (internal and external)
to be managed appropriately.
Chapter 9 Monitoring and operational controls 9/3

As we have established, the monitoring of plans and budgets and ongoing creation of
forecasts (or reforecasts) to the end of the budget period and beyond will follow the
approach adopted in the planning and budgeting processes of individual companies.

A1 Monthly (management account) results

On a monthly basis (a few days after the end of the month), you should receive the basic
figures which outline your account’s performance:
• Written premium.
• Earned premium.
• Incurred claims cost (payments plus change in outstanding estimates).
• Earned loss ratio.
• For the month – actual/budget/last year’s actual.
• For the year-to-date – actual/budget/last year’s actual.
• Split by product, scheme, class, intermediary and/or branch, as appropriate.

Be aware
These figures will usually be presented on a ‘gross’ basis, ignoring the impact of
reinsurance premiums and recoveries. This is not always the case however: please check
that you understand the basis of any figures presented to you.
The board will monitor monthly performance on gross and net bases, as well as additional
items drawn from the company’s financial accounts, such as ROCE, solvency and profit.

A2 Variance analysis
This basic management account (which may or may not also include commission and an
allocation of expenses) is merely the starting point. In order to explain any variances
(differences between the actual and budgeted figures), you require access to data at a lower
level of detail, for the same time period and calculated on a consistent basis. You may
choose to have some of this data presented to you in a formatted report simultaneously with
the management account or you may have immediate access to a systems-based enquiry
facility.
Not all of the following measures will be appropriate for every account and, depending upon
the nature of the account, some measures will only be meaningful at a lower product or
policy-section level.
Drivers of premium:
• Number of quotations and conversion rate.
• Number of new business policies and average premium.
• Number of renewed policies and average premium.
• Renewal lapses and mid-term cancellations (numbers and premiums).
• Value of mid-term adjustments.
• Average rating increase/decrease achieved on renewals.
• Average change in exposure on renewals.
Chapter 9

• Individual large premium cases written/lapsed.

Be aware
The drivers of premium figures will be subject to amendment for a number of subsequent
months, while business relating to the reported month is confirmed as accepted, renewed
or lapsed. This generates what is referred to as ‘pipline premium’: the difference
between what is currently debited in the system and what is ultimately expected to be
received for the period. It would be advisable to refer to the data for at least the last six
months in order to observe the relevant trends in these measures.
 9/4 960/December 2020 Advanced underwriting

Drivers of claims costs:

• Number of claims first intimated.
• Number of claims settled.
• Number of open claims.
• Total claims payments.
• Changes in claims estimates (total and individual large movements). For long-tail
accounts such as liability it is important to distinguish between current year and prior year
claim movements.
• Individual claims first exceeding a selected amount, e.g. £100,000.
• Individual large claim movements exceeding a set amount, e.g. £50,000 or £100,000,
depending upon the size of the account.

Be aware
Information is often as valuable as data in understanding variances. If the underwriting,
accounts or claims areas are experiencing productivity issues for any reason, the effects
are likely to be evident in your results but you may not understand their source, unless you
ask. The company actuaries will monitor claims data closely in order to produce IBNR and
IBNER figures for the financial accounts: they may well notice changes or trends in claims
numbers and costs before they are fully evident in your own results. It is therefore
important to have regular dialogue with colleagues in other departments.

Use of exception reports

For certain types of business you may also require some monthly data relating to exposure
or change of mix. This type of query could be dealt with by exception. An exception report
is only produced if the selected measure (e.g. total sum insured, vehicle value or number of
insured persons) exceeds a pre-selected level (an amount or % of total). This approach can
also be applied to monitor the discretionary activities of underwriters or intermediaries with
delegated authority, for example, if very high premium discounts have been used frequently
(see Authority limits on page 9/11 and Delegated authority on page 9/14).
All of the above relates to what you might typically monitor on a monthly basis: in order to
satisfy yourself and those to whom you report that your account is performing in line with its
plan and budget or you know why it is not.

It’s in black and white: must it be correct?

Do not dismiss the possibility that some figures may be incorrect, for example, an updated
claims estimate may have been re-entered as £300,000 instead of £30,000: a simple slip
on the computer keyboard! ‘End-of-month’ figures may have been run before the last day
of the month, leaving premium and claims figures short. If the figures do not look right,
they may or may not be correct but your job is to know how to validate figures and who
might help you do so.

Blip or trend?
Certain measures can be highly variable from month to month (for example, average claims
cost) and it would be wrong to conclude on the basis of one or two months’ data that an
Chapter 9

account was either performing wonderfully well or doomed. Calculating moving annual total
(MAT) – rolling twelve-months – figures (and plotting them on a graph) may help distinguish
which measures are simply highly variable around an expected level from those which are
trending either upwards or downwards.

A3 Initiating action
Internal issues: you may know that the issue that caused a variance (for example, a
processing backlog) has already been rectified. If not, what actions do you intend to take?
Chapter 9 Monitoring and operational controls 9/5

Example 9.1
If the variance was caused by a failure to debit the premium for a particularly large case in
good time, you may instigate actions to ensure that this does not happen again, such as
introducing warning lists in the last week of the month or amending the targets of
individual underwriters to highlight this activity.

Planning issues: variances can reflect the difficulties inherent in planning and budgeting
and may indicate that more attention need be paid to such issues.

Example 9.2
Might the problem be how a measure such as written premium has been phased, month-
by-month, in the annual budget? Or, if the trend in written premium is expected to change
(from growth to decline or vice versa), have the monthly earned premium figures (which
will lag any such change in direction) been accurately predicted?

Underwriting issues: having checked that the figures are correct, that the variance has not
been caused by a planning distortion and that it is significant, what are you going to do?

Example 9.3
A significant number of large claims are intimated; total intimations are above plan for the
third successive month; many branches report that new business sales are well below
plan; loss ratios are deteriorating – some typical underwriting issues.

Underwriting management decision: variance analysis and action

planning
Do you fully understand the cause of the variance and any contributory factors, or is
further investigation required?
What can be done to manage the variance (reduce/remove) in the current planning
period? What are the options and what other impacts might different courses of action
have? Who needs to be consulted?
How will this affect your forecast for the remainder of the planning period and beyond?

Be aware
As you dig deeper to uncover the reasons behind variances, be aware that the data you
uncover is not necessarily consistent with the original budget data. Check that you
understand how measures have been calculated and where the data has been derived
from; think about who might be able to help you understand unfamiliar data.

A4 Key variables and assumptions

The measures listed above, which might be examined monthly, have not exhausted the list
of variables and assumptions used in the original planning and budgeting exercise. Included
Chapter 9

in this group of key variables and assumptions are:

• impact of economic growth/recession (on claim frequency, sales and exposure);
• rates of inflation (claims and other);
• seasonality;
• allowances made for weather-related claims;
• internal consistency in claims reserving practice;
• mix of exposures (type and size);
• implementation of planned rating and product changes and their assumed impact on
income and retention;
• market share; and
• competitor activity, including pricing.
 9/6 960/December 2020 Advanced underwriting

Be aware
It should be noted that this process of monitoring key variables serves two parallel
activities:
• monitoring, explaining and managing current performance; and
• planning for the future through profitability and pricing exercises, as well as supporting
the development of underwriting strategy.

As you seek to understand variances between actual and budgeted results, other issues
may emerge for which allowances (contingency allowance) were not explicitly included in
your budget. Examples might include:
• the implementation of a new computer system – initial adverse impacts on productivity
and accuracy/consistency of data;
• changes to the distribution network and re-allocation of commission levels – sales
patterns disrupted; and
• competitor activity (reduced prices, new products and services).
While it may have been difficult to predict how any or all of these issues would affect your
account, would it have been appropriate to make a specific contingency allowance for some
of these eventualities? As well as attending to explanations of current performance, planning
and budgeting processes should be appraised to ensure that they are continuously improved
by considering such questions.

B Key performance indicators

The ways in which insurance company staff are engaged and incentivised varies from
company to company but it is common practice to highlight particular measures of
performance in order to provide common direction and focus across large groups of people.
These measures can apply at company, as well as function/unit level, and will appear in
individual performance management contracts. The measures chosen as key performance
indicators (KPIs)reflect the nature of the function and the role of the individual. The
measures selected will vary from time to time, in line with corporate or local objectives (or
critical success factors).

Be aware
KPIs need to be chosen and managed with care in order to avoid unintended
consequences. For example, underwriting staff are likely to have KPIs that involve both
income growth and profitability measures, as emphasis on one measure without the other
would generally be inappropriate.

For the majority of staff, the use of KPIs provides clearer, more focused messages about the
ongoing performance of the company, their functions or units and their own personal
performance, than could be achieved by the circulation of the monthly management account.
Your work in identifying and explaining variances and determining and initiating actions will
also support the presentation and explanation of monthly KPIs to staff.
Chapter 9

Refer to
See People management on page 9/10

C Claims, reinsurance and exposure

As previously discussed, your claims and actuarial colleagues will devote considerable effort
to monitoring the company’s claims experience and you should ensure that underwriting
plays its part and has appropriate access to the results of this work (notably, ultimate claims
costs, reserving patterns, IBNR and IBNER). It is highly likely that you will require access to
lower level claims data in order to understand the detailed experience of your own accounts,
schemes or products (claims frequency and severity by cause, location, trade etc.). In
particular, if you use underwriting year/incurred reporting on a monthly basis, you may wish
to disaggregate these results to examine accident year development, possibly every quarter.
Chapter 9 Monitoring and operational controls 9/7

Refer to
See Claims reports on page 6/11

An examination of accident year development is particularly important in order to distinguish

current from past performance. For example, although underwriting policy may have
changed in respect of a particular type of risk or cover, the experience of former periods is
still developing and will continue to affect incurred reporting until those periods are entirely
run-off. The account must continue to bear the cost of this run-off but accident year reporting
will clarify the impact and indicate whether current experience shows signs of improvement
(in response to the change in underwriting policy).
While claims and finance colleagues will handle the ongoing work of reporting large claims to
reinsurers and calculating recoveries due and premium payments, the underwriting area
needs to monitor the use of reinsurance arrangements.
It is sometimes appropriate to encourage all underwriters to evaluate risks on a gross basis,
as if no reinsurance protection is available to the insurer. In this way underwriters are
encouraged to apply the same standards when considering risk exposures that may impact
the reinsurers’ accounts as they would when considering retained exposures. Moreover, any
business written must conform to the risk profile provided to the reinsurers at last renewal.

Be aware
Individual underwriters should be made aware of the fact that inappropriate use of
reinsurance will rebound on the insurer, either through inability to make a recovery or, at
next renewal, to obtain as much cover as required at an acceptable cost.

As well as high per risk exposures and accumulations, requests for special acceptances, the
use of facultative reinsurance and other specific arrangements such as Pool Re should be
monitored. Before next year’s reinsurance programme is negotiated, the underwriting area
needs to consider what cover is required: are opportunities to write acceptable business
being missed due to inadequate upper limits in treaties or are reinsurance premiums
unnecessarily high due to the cost of arrangements which are rarely used? Attention to
planned exposure to risk, at individual and aggregated levels, has already been discussed.

Refer to
See Risk control surveys on page 4/9 and chapter 8

Although claims tend to attract the blame for bringing uncertainty and variability to the
conduct of general insurance business, how often do the exposures that give rise to claims
appear to come as a surprise to the insurers involved? This could involve:
• inappropriate per risk retained exposures;
• accumulations of exposures that have not been recognised or managed appropriately;
• the nature or severity of the incident leading to the claims not being recognised or being
underestimated; and/or
• an unexpected clash of covers.
Chapter 9

Be aware
As inadequate identification of exposure to insurance risk could result in company failure
(reflected in the ever-closer association of risk profile/exposure-mix, as well as exposure
values, with capital allocation, adequacy and solvency), the monitoring of exposure, its
management and control rank highly on corporate and regulators’ risk management
checklists.

Having agreed the risk control strategy for your account, you should monitor productivity
monthly (are the appropriate risks being surveyed in a timely manner?) and check that the
strategy continues to fit the risk profile of the account.
 9/8 960/December 2020 Advanced underwriting

D Audit
Another form of monitoring that tends to be referred to as ‘audit’ involves the review of a
unit’s or individual’s work to ensure compliance with company standards and to identify and
spread best practice. We shall discuss this in more depth in Authority limits on page 9/
11,Other auditors on page 9/14 and Delegated authority on page 9/14.

E Presentation of data
Our understanding of trends and relationships can be greatly enhanced by the appropriate
presentation of data. The use of moving annual total or rolling twelve-month figures has
already been mentioned. Ratios, which reflect key relationships between independent
variables (such as loss ratio, claim frequency and burning cost), can be very useful in
highlighting significant changes across an account or portfolio over time.

Example 9.4
If a private motor account was undergoing an intended change of exposure mix (say,
moving from younger to older drivers) over a period of years, it would be useful to monitor
the claims frequency of each age group separately as the change in exposure mix took
place. It would confirm whether the expectations of underwriting management, when the
change was proposed, were correct and the targeted results (underpinned by an age-
related claim frequency assumption) achievable.

All three ratios mentioned above include the number or cost of claims: only claims at
comparable development periods should be used in comparative ratios. If the current
year’s earned claims ratio, at the 6-month stage, is 50% and last year’s, at the 18-month
stage, is 70%, this is not a valid comparison and reveals nothing of value. If last year’s ratio
at the 6-month stage was shown (at 40%), the comparison is valid and a worthwhile question
may be asked: why is this year’s ratio higher? Also, might we expect this year’s ratio, at the
18-month stage, to be higher than 70%?
Individual managers may specify a ‘dashboard’ of a few key figures and ratios which they
rely upon to highlight monthly performance issues. This is entirely acceptable as a starting
point but should not be seen as fulfilling monitoring responsibilities. Whether managing a
group of products, class of business or region, monitoring results at too high a level risks
overlooking potentially important underlying trends or issues. Even when planned results are
being achieved, are you sure that the change in underwriting policy (initiated in order to
improve results) is the cause?

Refer to
See Importance of business mix on page 4/15

F Looking ahead as well as back

Senior underwriting roles are heavily involved in planning, budgeting, monitoring and
reforecasting; investigating variances and devising and implementing action plans to address
variances; preparing risk profiles for reinsurers and addressing exposure issues. In order to
Chapter 9

accomplish these tasks you need appropriate access to data, well-established routines and
the support of your colleagues.
Your role will also typically require attention to underwriting strategy and/or product or
scheme development, involving looking beyond the month-by-month performance of the
account or regular pricing reviews. With a longer-term perspective in mind:
• What is the data telling you about the account?
• Can you distinguish lead indicators (highlighting future trends) from lag indicators
(measuring what has already happened)?
• What expectations do you have for the external environment (including market) in which
the account will operate in a few years’ time?
• Are there investigations or actions which need to be initiated now to ensure the account
is well-placed in the future?
Chapter 9 Monitoring and operational controls 9/9

Underwriting management decision: product lifecycle

A radically new product may take a couple of years to prepare, from initial idea to launch.
When do you need to start to ensure you beat the competition and reap the benefit of the
company’s investment? If a significant part of your account is currently profitable but
declining, what will take its place and when?
Managing a portfolio of products requires attention to the development, exploitation and
replacement of current products, as well as the search for and preparation of new
products. What data and information do you need to monitor?

You need to formulate future-focused questions appropriate to your account and then look
for answers and options before you can start to plan actions. Current data may or may not
help answer those questions but it is likely that you will have to find or compile some new
data. As noted earlier, you need ‘the right tools for the job’ which are not necessarily those
most readily available.

Example 9.5
Consider the following scenario:
It is apparent that the number and cost of household claims in respect of escape of water
is moving inexorably upwards: what should you do? Do you know why this is happening?
Is there more than one reason? Is it happening across the account (product, location,
sums insured)?
Possible reasons:
• Increase in average number of bathrooms, utility rooms and appliances per household.
• High specification of décor in houses with highest number of bathrooms.
• Rise in number of second homes (frequently unoccupied/remote).
• Long-hours culture: main homes less occupied.
• Carelessness.
• Poor quality plumbing skills.
• High-spec new homes untested by low temperatures, until a freeze happens.
• Use of plastic push-fit connectors rather than copper piping with soldered joints.
• More heavily insulated lofts (water tank in loft deprived of benefit of heat rising through
ceiling).
Some possible responses:
• Stop writing household business.
• Exclude the cover.
• Try to identify features that indicate greater or lesser propensity to claim, then control
exposure accordingly.
• Buy additional reinsurance protection.
• Apply additional terms and conditions: increase wet perils excesses to reduce
attritional losses; impose requirement to turn off water if house unoccupied for more
than 24 hours.
Chapter 9

• Increase premium: across-the-board or on a bathroom-rated basis.

Although you may regard some of the options listed above as overreactions, in order to
develop a robust plan of action you should state why any credible option is not worth
pursuing. If the household account represents 50% of your company’s business, a
decision to stop writing household business would not be taken lightly but, at the same
time, it serves to indicate the relative importance of the issue and the urgency with which a
solution must be found.
Each credible option must be examined in turn, using the necessary data to assess the
financial impacts and indicating other impacts on customer satisfaction, reputation and
market share, for example. Once the action plan has been agreed, the assessed impacts
(financial and otherwise) need to be incorporated into the relevant plans and budgets.
 9/10 960/December 2020 Advanced underwriting

G Data mining
Do not underestimate the value of dipping into datasets that you do not regularly refer to or
looking at a set of randomly selected underwriting files. Chance discoveries are legitimate
sources of good ideas and/or a deeper understanding of your account.
The term data mining has been coined to refer to larger scale, systematic versions of the
above whereby large, existing datasets are analysed or ‘mined’ in order to discover
previously unidentified correlations between factors or particularly profitable segments. This
approach is only likely to be worthwhile when dealing with very large datasets with decent
data standards (consistent, accurate recording of data over a period of time).
For those lacking the necessary scale of dataset or the financial resources to pay for a data
mining exercise, valuable insights can be gained from conducting small scale, manual or
semi-manual sampling exercises. For example:
• Do policyholders who renew for more than five successive years share any marked
attributes?
• If risks belonging to a current single risk classification were subdivided into two or three
new groups, would clear differences in claims experience emerge?
The information gained from, and further questions suggested by, a limited exercise may
justify a more extensive review, including the gathering of data not currently available to the
company. For example, independent market research might be conducted to identify
customer attributes not currently recorded on file. Initial small scale investigations can shape
and refine questions and objectives, as well as testing data quality, before committing to
significant research programmes or statistical analysis.

H People management
The plan for your underwriting area includes certain assumptions about people. You should
consider the headcount, structure and skill levels necessary to deliver the required levels of
productivity and effectiveness (quality of customer service, ability to achieve job role targets
and collaboration with internal colleagues) to meet your area’s objectives. These are
important assumptions that must be monitored consistently and adjusted as required.
Unlike some of the other measures and assumptions which must be monitored, certain
‘people’ assumptions and outcomes can only be properly assessed by adding personal
engagement to the collection and review of data. Managers can underestimate the influence
of their own behaviour on staff performance. The most sophisticated planning, budgeting and
monitoring systems will be of little use if individual managers are not seen to support the plan
wholeheartedly and to devote their own time to the issues that have been highlighted for staff
attention.
The strategic choices made by the board and company executives, as well as the local
conditions prevailing wherever your unit is based, necessarily shape your approach and
response to ‘people’ issues. While effective people management is a substantial topic (not
for discussion here), in the context of the operational control of underwriting, one facet might
be emphasised: the need for clarity. Do existing staff (and recruitment candidates) have a
clear understanding of what the company and its specific units have to achieve and how? As
Chapter 9

individuals and teams, do they understand how they are expected to contribute to that
achievement? These questions are not referring to a broad or general understanding but
rather to the level of confident understanding that can support appropriate, independent
decision-making and action.
Strategies, policies and plans will not be implemented effectively if they are not
communicated, discussed and understood by all underwriting (and related) staff. Their sense
of responsibility for the achievement of the company’s and unit’s objectives and their ability
to work in a collaborative manner will be strengthened and made more tangible if the
performance management system includes a matrix of KPIs derived from the plan, which are
seen to be in use at unit and personal level.
The monthly review of budget versus actual figures, the explanation of significant variances
and the ongoing performance management of staff should be seen as a single strand of
activity focused on the achievement of objectives.
Chapter 9 Monitoring and operational controls 9/11

Achievement
of objectives

Ongoing performance
management of staff
Explanation of
significant variances

Monthly review
of budgets versus
actual figures

Actions devised to improve performance will naturally include the provision of training
relevant to the business being handled, as well as opportunities to participate in action-
based learning and mentoring schemes.
With individual targets (focused on ‘what?’ and ‘how?’), the key skillsets for job roles should
be more easily defined, along with the experience and motivation required. Most job roles
utilise generic elements or expressions: clarity can only be achieved if these generic
elements are accompanied by a statement that explains the particular context of the
company/unit/role and enables individuals to understand what is required of them.

Be aware
If the role description states that ’analytical skills’ are required, what does that mean?
Does it mean that someone with a questioning approach and interest in understanding
how things work, in a general sense, will do well or will the employee be required to
conduct formal analyses of data?

Development can be a contentious area. Few companies nowadays will choose to spend
money and time providing staff with development opportunities unless directly in support of
current business targets or planned job moves. Underwriters need to maintain and develop
their knowledge but, if a particular type of business plays little or no part in their current
company’s portfolio, they cannot expect company support in that respect. Like all
professional staff, underwriters must take prime responsibility for their own development and
request their company’s support as appropriate. Many companies provide access to a wide
range of learning materials (including internet-based resources) and support the CII’s
requirement for continuing professional development.

I Authority limits
An important way in which individual underwriters understand their own role is through their
allocated personal underwriting licence or authority. This licence is usually expressed in
Chapter 9

terms of various measures (maximum premium size, discount, total sum insured (TSI)/
estimated maximum loss (EML), limit of liability) by class of business or product, with specific
inclusions and exclusions. Underwriting licences are issued for a set period of time and must
be updated/reconfirmed as appropriate. These authorities/limits will often be held in the
underwriting system and apply automatically when business is processed. Cases exceeding
any of the relevant limits may still be handled by an underwriter who then refers the case
(along with their own assessment, evaluation and recommendation) to a colleague with the
necessary authority to underwrite and sign the case off.
 9/12 960/December 2020 Advanced underwriting

Be aware
Technical underwriting assessments are now commonly used to establish an initial
licence level for individual underwriters and to test their continued capability to operate at
that level or readiness to gain an enhanced level. This approach can be seen as
supporting the FCA’s training and competence requirements.

Refer to
Think back to M80, chapter 1, section C1

The person who allocates work within an underwriting team will seek to balance the
immediate requirements of customer service and productivity with longer-term training and
development needs. Those with lower licence levels should be allocated a few stretching
cases, along with the work they are capable of completing by themselves. Those with higher
licence levels in the team, or based remotely, can establish a time each day when such
cases can be reviewed and discussed. In some companies the processes of work allocation,
referral and review are handled through the system.
Whether handled manually or automatically, it is essential that referrals and the use of
personal underwriting authority are documented:
• Personal development targets for those with lower levels of underwriting authority may
include the requirement to have a certain number of cases, with higher limits, signed-off
satisfactorily before their licence level can be raised at the next review.
• When other types of monitoring highlight particular cases due to their adverse features or
poor performance, it is important to know who was involved in their underwriting in order
to determine whether additional training is required, or referral procedures and
underwriting policy need to be adjusted.
• Internal and external auditors also need to see the physical evidence that cases are
being handled in accordance with the stated procedure: a key requirement of corporate
risk management.
In devising a framework of authority limits for your area of responsibility, the framework must
fit the profile of the business in question and support internal efficiency. Ideally, most
underwriters in the team should be capable of (or working towards) writing the level of cases
most frequently handled. As the distribution of large cases peters out towards the maximum
limits acceptable, you will already have given careful consideration to the skill levels and
experience necessary to handle these cases and the number of underwriters with such skills
you need to employ. Clearly an incentive exists for capable underwriters to continue to raise
their authority levels towards the account’s maximum limits.
However, care must be taken to ensure that the underwriters handling the largest, most
unusual cases in the portfolio see a sufficient number of such cases to enable them to put
individual cases of this type into an appropriate, current context. The danger with sharing out
the larger cases among too many individual underwriters is that none will build sufficient
experience to underwrite them to best effect.

Be aware
Chapter 9

‘But in my last company I could write cases of up to £1m, £20m EML etc.’
In the minds of some underwriters, underwriting licence levels have become status
symbols detached from the account they are engaged to underwrite. This can stem from
poor positioning of a new job role and its context at interview stage. A capable underwriter
should be given every encouragement to exercise and develop skill and judgment, but if
the typical risk in the account has a premium of below £5,000, then these are the risks
the underwriter will generally be engaged in handling.
Chapter 9 Monitoring and operational controls 9/13

Underwriting management decision: operational controls

How can you ensure that the small number of very large/unusual cases in your account
are being underwritten effectively?
You may employ underwriters who wrote much more of this business in the past but what
do you and they do to ensure their knowledge of this type of risk and market terms is up to
date? ‘Very large/unusual’ often equates to ‘more’ or even ‘very’ risky: is this a worthwhile
use of your area’s capital allocation? In these circumstances you might review your
underwriting strategy and either reduce the maximum limits acceptable or, if you believe
you have the necessary knowledge, skillsets and capital, consider writing more of this type
of business. As well as improving underwriters’ appreciation of the risks and market terms,
increased income could support the development of a number of underwriters, acting in
lead and support roles. Having a small number of any type of risk is disproportionately
risky: this situation should be avoided, at all costs, with the largest risks in your account.

I1 Approaches to underwriting governance

Good underwriting governance requires that a proportion of every underwriter’s work is
reviewed: this can be achieved in a number of ways, which can be used in combination.

Consider this…
Why should every underwriter’s work be reviewed?

• Sharing real experience and knowledge is the best way to learn and to develop superior
skills.
• Having ‘a second pair of eyes’ review your work from time to time can highlight different
approaches and generate new ideas.
• Working with someone else can generate outcomes that neither would have achieved
independently.
• And, finally, to improve risk management: bitter experience indicates that rogue
underwriters consistently manage to avoid peer review.

Referrals Work can be allocated in such a way that underwriters are required to refer a number
of risks for sign-off. Of course, referrals also arise in circumstances where the
underwriter has sufficient authority but wants a more senior colleague’s advice or
input or has to contact regional or head office underwriters to query a risk’s
acceptability to reinsurers or to request approval for a manual endorsement.
Although the risks in question may not be reviewed in depth in these latter
circumstances, this type of referral provides an important means of sharing
knowledge and best practice.

Peer review/local audit Peer review or local audit involves colleagues or teams swapping a predetermined
number of files on a weekly or monthly basis in order to confirm compliance with
operational and regulatory standards and procedures, observance of appropriate risk
selection, underwriting and pricing standards and accurate data input/document
preparation. A standard pro-forma should be created for this purpose: to promote
consistency in approach and to provide a record for training needs identification,
performance management purposes and for other auditors. Summaries of local audit
results, with key areas for congratulation or improvement, must be reported and fed
Chapter 9

into the corporate risk management process.

Regional audit Local audits will typically be supplemented from time to time by a regional or head
office underwriting audit which should, in the first instance, utilise the same pro-forma
used in local audits. Risks should be selected across all key categories, including a
few risks which have already been locally audited. The auditors may also refer to the
data held on the selected risks: in quotation, survey and risk registers. A visit to the
local unit enables discussions on the audited risks and any issues arising to take
place and provides the regional or head office underwriters with an opportunity to
discuss other important topics such as local relationships with claims and surveyors,
access to and use of management information and local market conditions. These
are excellent opportunities to build relationships and learn from one another. The
auditors’ conclusions and key findings will also be reported and fed into the corporate
risk management process.
 9/14 960/December 2020 Advanced underwriting

Management As underwriting manager, you may wish to retain a level of underwriting authority for
involvement yourself and/or you may specify the types of risk or circumstances in which you wish
to be involved prior to the acceptance of a new business case or before renewal
terms are issued. You would, in any case, be involved in investigating the
circumstances surrounding acknowledged underwriting errors.

Monthly results/variance The review of monthly results and the explanation of variances will highlight
analysis individual risks or categories of risk meriting further examination: regional or head
office underwriters can request sight of sample files. From time to time, risks with
common attributes will be selected for review: those in a particular location, with high
values or poor claims experience, for example. As well as attending to the exposure
and/or performance issues raised by these selected risks, the quality of the
responsible underwriter’s work will also be examined.

J Other auditors
A number of other groups will conduct audits within underwriting areas from time to time:

Internal audit The company will have an internal audit function focused on corporate risk
management. They will be interested in how alert the underwriting management team
are to risk management and what they do about it: how effectively are strategy,
policies and procedures being developed, communicated, implemented and
monitored? The internal audit team will look at individual risks and detailed process
implementation to assess how effectively the management team control their staff
and business.

External audit The company’s external auditors need to confirm that the financial results produced
by the company are a valid representation of the actual state of the business. They
may require access to detailed systems transactions to check the validity of certain
measures and are likely to question underwriting managers about their own month-
by-month review of results, variances and adjustments. How do you know the results
produced are correct? What do you do to check figures or establish their validity?
The external auditors also review and comment on key issues such as underwriting
performance and the run-off of reserves.

The regulator The regulator will also conduct a company audit from time to time. The approach to
date in the UK primarily involves executive and senior management but the
underwriting manager will be asked to explain how exposure to risk and underwriting
authorities are managed, amongst other things.

Reinsurers Last but not least, the company’s reinsurers will conduct occasional file audits,
particularly if your account is changing, growing rapidly or performing badly. The
reinsurers have their own corporate risk management imperatives to satisfy and they
too must demonstrate that they have checked the information provided by insurers is
accurate. This can be a good opportunity to build relationships between reinsurance
and company underwriters.

K Delegated authority
Refer to
Refer back to Delegated authority arrangements on page 3/20 and Scheme underwriting
on page 4/21
Chapter 9

Delegated authority arrangements, ranging from small scheme binders to major MGA
agreements, all require appropriate underwriting authorities and audit arrangements to be
established. Delegated authority arrangements often involve the approval (by the insurer) of
named signatories. Only these named signatories may accept business (‘bind’) on behalf of
the insurer and the submission of CVs and assessment tests may be required before
individual authority levels are agreed and granted.
As authority has only been delegated, the insurer remains wholly responsible in the eyes of
the regulator. A version of the insurer’s internal approach may or may not be suitable for use:
whatever is agreed, the approach must be efficient, cost-effective and it must address
directly the risks presented by the particular arrangement.
Chapter 9 Monitoring and operational controls 9/15

L Underwriting policy
This chapter has discussed people management, underwriting authorities and audit, with a
focus on the performance of individuals and their handling of individual risks. This may
appear to be at the opposite end of the scale from the discussions about corporate risk
appetite and underwriting strategy in the earlier chapters of the study text. What links the
individual risk with corporate risk appetite is, of course, underwriting policy, which describes
the full implications of strategy and underpins day-to-day practice and plans.

Corporate
objectives

Individual
risks Risk
appetite

Plans and
budgets

Strategy

Practice

Underwriting
Policy

Just as the monitoring of monthly results helps to explain current performance and indicates
areas for improvement, regular attention to audit results provides underwriting managers
with the information needed to appraise the suitability and effectiveness of underwriting
policy and to prioritise personal development initiatives and policy updates or changes. Thus
the monitoring and analysis of all types of data and information forms an essential part of the
continuous process through which underwriting management seeks to address the external
environment and achieve corporate objectives.

M Scenario 9.1
M1 Question
You are responsible for a profitable product whose volume has proved resistant to growth.
The product's rating basis is quite simple; geographic location, for example, is not a rating
factor.
Marketing department believes that more demand exists for this product and that a more
differentiated rating basis (with additional options for voluntary excesses, for example) could
generate increased sales in more competitively rated segments. Sales and distribution
departments are also keen to see direct sales introduced (previously only intermediated
Chapter 9

sales).
Actuarial and your underwriters have worked on new rates (more rating factors and options
for voluntary excesses) and these have been agreed (different rates for direct and
intermediated business). The re-launch is imminent.
From an underwriting point of view, what do you need to focus on now? What information
and data do you require? What aspects of underwriting policy and practice need to be
monitored?

M2 How to approach your answer

Aim
This scenario requires you to identify which aspects of underwriting policy and practice need
to be monitored when a product is subject to significant change.
 9/16 960/December 2020 Advanced underwriting

Key points of content

You should aim to include the following key points of content in your answer:
• Separate budget for the product (split direct/intermediated) and a comparable monthly
management account. Is income growth meeting expectations and within bounds of
capital allocation?
• Accident year reporting: to monitor how business on the previous rating basis runs-off
and how business on the new rating basis develops.
• Risk profile: to watch for change of mix and identify any implications (e.g. for income,
claims and/or reinsurance).
• Customer profile: will direct offering attract a markedly different customer profile
(implications for income and claims) or will a substantial proportion of the existing
customer base move from intermediated to direct product? Are risk premiums and other
pricing components sufficiently robust to cope with either kind of shift?
• Sales and distribution departments should be monitoring (and sharing with you) actual
performance against their forecasts. These could be affected by a number of external
issues, such as competitor activity or the economy, so it is important to document, share
and monitor planning assumptions.
• In the longer term: how well has the differentiated rating base predicted the actual
experience which emerges? What impact has the introduction of the voluntary excess
had: how popular is the option; what actual reduction in claims costs against reduced
(discounted) premium income?

N Scenario 9.2
N1 Question
At short notice, you have been asked to take responsibility for an unfamiliar group of
products. The general manager requires a brief results commentary in 24 hours' time. You
have been advised that there are some concerns regarding the current performance of these
products. In 2020 the group of products is targeted with achieving a total gross written
premium (GWP) of £2m and an earned loss ratio (ELR) of 65%.
End of June 2020
Year-to-date (Actual)
Product Group Z

Product GWP Earned premium Incurred claims ELR

cost

A £170,000 £200,000 £100,000 50%

B £310,000 £300,000 £500,000 167%

C £400,000 £500,000 £55,000 11%

Total £880,000 £1,000,000 £655,000 65.5%

Document briefly your initial thoughts based on the above information.

Chapter 9

Bearing in mind the limited time available, what further information and data would you
request before drafting your commentary for the general manager?
Explain why you are requesting each item of information or data.

N2 How to approach your answer

Aim
To meet the demands of monthly variance analysis, underwriting managers require a clear
focus on key variables and their inter-relationship, as well as a degree of insight and
ingenuity: this scenario reflects these requirements.
Chapter 9 Monitoring and operational controls 9/17

Key points of content

You should aim to include the following key points of content in your answer:
Initial thoughts:
• Individual product performance very variable – is that typical of these types of product?
• Large claim or movement in outstanding estimate affecting Product B incurred claims
cost?
• Total GWP lower than earned premium – is income pattern affected by seasonality or
some other issue or are this year's sales generally lower than last year's (for Products A
and C)?
• If this year's sales are generally lower, this will become more evident in total earned
premium in second half of year and the earned loss ratio is likely to deteriorate.
Request:
• Full 2020 budget information for individual products: to understand planned performance.
• Monthly results (January to December 2019 and January to June 2020): to understand
income pattern (GWP and EP).
• Large claims list – new intimations and significant movements in outstanding estimates
(source of high ELR for Product B?).
• Sales data: numbers and value of new business cases over last 18 months; renewal
retention rates; large cases gained/lost.
• Ask local underwriters/customer service staff: what is their perception of how these
products are performing?

O Scenario 9.3
O1 Question
Look at the list of common risks listed in Risk management on page 2/7.
What might be suitable courses of action (from an underwriting perspective) in order to avoid
or reduce the impact of each of these risks?

O2 How to approach your answer

Aim
This scenario focuses on action planning in the context of underwriting risk management.
Key points of content
You should aim to include the following key points of content in your answer:

Claims projections prove inaccurate Seek assistance from actuarial colleagues to ensure claims
projections are as realistic as possible; ensure adequate
reinsurance in place to limit any adverse impact on insurer's net
account; regularly monitor claims intimations and costs.

Adverse economic conditions occur Be alert to changes in economic conditions and ensure plans and
budgets make allowance for potential impacts (such as reduction in
exposures and more fraudulent claims); ensure staff are alert to
potential issues and have access to necessary support (such as
Chapter 9

credit-checking facilities/fraud indicators).

Court judgments impact typical level of Monitor closely trends in settlements and (with actuarial assistance)
claims settlements in respect of bodily make due allowance in pricing; review reinsurance arrangements to
injury ensure adequacy; consider balance of underwriting account – is it
too biased towards business prone to large bodily injury claims?

Poor-quality business is written Ensure underwriting/customer service staff understand the

distinction between acceptable and unacceptable business and
have confidence to act on that understanding; ensure staff have
management support when they turn away poor business or
impose terms and that they understand the system of underwriting
governance; ensure any inappropriate acceptances are discussed
with individual underwriters and discussions logged on their
personal files; seek sales/distribution support to focus on
acceptable business; keep operational and referral processes
under review; monitor acceptances by exception (in addition to
regular audit procedures).
 9/18 960/December 2020 Advanced underwriting

Management information is corrupted Establish strict validation processes to ensure any errors/issues are
identified quickly and before MI used; explain importance of
accurate data-entry to all relevant staff; share relevant unit-level
data to highlight use of data and need for accuracy; identify other
data (for example, finance data) to check totals and differences; be
prepared to use manual sampling exercises to identify trends and
issues rather than do nothing; from the outset, work closely with
those establishing the data warehouse/MI system to ensure the
design is fit-for-purpose.

Business flows from delegated authority Ensure approval process is sufficiently thorough to establish
brokers prove intermittent viability and suitability of any arrangement; agreement (binder)
should contain realistic premium income targets that put
arrangement in jeopardy if not met; ensure each delegated
authority arrangement has an assigned underwriter who maintains
regular contact; audit programme should include regular face-to-
face reviews.

Recruitment targets for underwriters are Plan ahead and be realistic about the time and effort necessary to
not achieved recruit; take great care in specifying job roles, responsibilities and
candidate requirements; be prepared to argue (with senior
management and existing, over-worked underwriters) that it is
better to delay recruitment than to recruit the wrong person; find
ways to support existing underwriters in interim.

In the first year, the business Ensure adequate reinsurance; monitor accumulation of exposures
experiences exceptional weather-related in vulnerable areas and be prepared to limit acceptances until
losses account has grown larger.

Rates rise more steeply than expected: Monitor rating trends; always be selective and write best quality
capital inadequate to write available, business available – this should enable company to secure
targeted exposures necessary additional capital quickly! Consider limiting acceptance
of average quality business.

Rates decrease more steeply than Monitor rating trends; only write better quality business. Consider
expected and volumes or margins cannot withdrawing from the particular market if pressure on margins is
be achieved viewed as extended and unsustainable.

Ancillary income, such as legal expenses Review rates against those of competitors. Deeper understanding
cover, does not sell as well as projected of buying rationale and characteristics of customer. Review factors
in the external environment that may impact the sale of the product.

Conclusion
The main ideas covered by this chapter can be summarised as follows:
• An insurance company needs to know whether it is meeting its planned objectives
throughout the course of the year. This form of monitoring allows issues of
underperformance to be tackled as soon as they are identified, unexpected opportunities
to be exploited and expectations to be managed appropriately.
• The ways in which insurance company staff are engaged and incentivised varies between
companies but it is common practice to highlight particular measures of performance to
provide common direction and focus across large groups of people.
• Our understanding of trends and relationships can be greatly enhanced by the
appropriate presentation of data. Ratios which reflect key relationships between
independent variables can be very useful in highlighting significant changes across an
Chapter 9

account or portfolio over time.

• Strategies, policies and plans will not be implemented effectively if they are not
communicated, discussed and understood by all underwriting (and related) staff.
• The monthly review of budget versus actual figures, the explanation of significant
variances and the ongoing performance management of staff should be seen as a single
strand of activity focused on the achievement of objectives.
• Personal underwriting licenses/authorities are usually expressed in terms of various
measures by class of business or product, with specific inclusions and exclusions.
Licences are issued for a set period of time and must be updated/reconfirmed, as
appropriate.
• Good governance requires that a proportion of every underwriter’s work is reviewed.
• A number of groups will conduct audits within the underwriting function from time to time:
internal audit function, external auditors, the regulator and reinsurers.
Chapter 9 Monitoring and operational controls 9/19

Additional reading
Adams, R. (2014) ‘Managing general agents: tightening up’, Post Online, 12 March 2014.
Available on RevisionMate.
Hankin, N. (2009) ‘How underwriting governance is integral to a sustainable strategy’,
1 April 2009. CII technical article (updated 22 September 2017). www.cii.co.uk/15277.*
www.bankofengland.co.uk/PRA, search under ‘Solvency II’ for current information
regarding insurance risk management and governance.
*MyCII login required to access IIL lecture content.

Chapter 9
 Appendix 1
Appendix 1
New Statesman article
on asbestos
UK asbestos-related claims to be around
£11bn for 2009 to 2050
New Statesman

Published 29 January 2010

Total undiscounted cost of UK asbestos-related claims to the

insurance market is expected to be around £11bn for the period
2009 to 2050, according to a research by Actuarial Profession’s
UK Asbestos Working Party

subsequently make a claim for compensation has almost doubled between 2004 and 2008.

2009 to 2040, compared to £4.7bn of the working party’s 2004 estimate for the same
period.

According to Actuarial Profession, the proportion of mesothelioma sufferers that have made
a claim for compensation has increased from around one-third in 2004 to nearly two-thirds.
This change, which was not expected in 2004, has become evident in recent years and
explains most of the increase in total costs.

In addition, the working party has taken into account the Health and Safety Executive’s
statisticians’ revised projections of the number of future deaths from mesothelioma in Great
Britain, released in 2009, in conjunction with other projection models.

Brian Gravelsons, chairman of UK Asbestos Working Party, said: “Insurers will of course
have already noticed the increased number of claims from mesothelioma sufferers, so
these developments won’t be a surprise to them. However, the working party’s projections
will provide the insurance industry with a consistent reference point to help it assess its
asbestos liabilities.

“There is still considerable uncertainty surrounding the future cost of asbestos claims, as
the number of people that will be diagnosed with mesothelioma many years into the future
cannot be accurately predicted. The working party will continue to monitor the emerging
experience and update its projections accordingly.”
 Appendix 2

Appendix 2
Insurance Insider article
on asbestos

NEWS ANALYSIS

Asbestos loss outlook rises

to $100bn for US carriers
Insurance Insider Last year’s level exceeded the long-term The top 30 carrier groups accounted
annual average of $2.5bn, mainly because for about 85 percent of total A&E paid
Published 29 November 2016 Travelers paid $500mn on a Johns losses last year and held 95 percent of the
Asbestos losses for US property and Manville claims settlement. industry’s A&E loss reserves.
casualty insurers may climb to $100bn Reserve strengthening by Travelers, AIG Combined A&E loss payouts rose 14
or higher as a result of increases from and The Hartford Insurance Group added percent in 2015 largely because of claims
“evolving” litigation and longevity almost $1bn to estimated asbestos losses, paid by Travelers ($824mn), Chubb/INA
gains, according to AM Best. AM Best said. ($311mn) and Liberty Mutual ($280mn),
“The industry has incurred $10.5bn in AM Best said.
National P&C carrier Travelers
asbestos losses over the past five years, strengthened its asbestos reserves by The agency continued that the industry’s
while paying out $12.7bn,” the rating $225mn in the third quarter of this year, ultimate exposure to claims from the
agency said in a statement on the new citing “recent payment trends that continue cancer-causing substance is “extremely
estimate. to be higher than previously anticipated”. difficult to quantify”.
The industry incurs about $2.1bn in new The insurer said it had raised its estimate
of settlement and legal costs because of “AM Best believes that the property/
losses annually while paying out $2.5bn casualty industry’s asbestos losses will
on current claims, AM Best added, citing those trends.
continue to be an issue given an unstable
the continued distribution of products that “There remains a high degree of environment faced with evolving litigation,
contain the fibrous mineral. uncertainty with respect to future exposure increasing secondary exposure cases
“While the US no longer produces to asbestos claims,” Travelers said last and an increase in life expectancy,” the
asbestos, it still imports, uses and sells month in a statement about its company said.
asbestos products, including automobile third-quarter results.
The agency also cited the rising number
brake pads and clutches, vinyl tiles and The US commercial P&C segment paid of lung cancer cases related to asbestos.
roofing materials,” the rating agency said. out $2bn in asbestos losses last year, while
it incurred $900mn of new losses, AM Best Asbestos claims have bedevilled P&C
Between losses already paid and insurers for decades, spurring Lloyd’s to
reserves set aside for future claims, the said. The segment accounts for about two
thirds of combined reserves for asbestos create its Equitas vehicle in 1996 to stem
industry has funded about 85 percent of insolvency threats that had spread by then
the new estimated total liability. The latest and environmental (A&E) claims.
to hundreds of members.
projection is 18 percent higher than AM Reinsurers exposed
Best’s previous forecast. By the late 1990s, 94 percent of
While almost 65 percent of net A&E asbestos-related claims had been filed
Reserves for asbestos losses will be reserves are held in the commercial lines by claimants with no sign of asbestosis,
depleted in eight years at current payout segment, reinsurers hold about a quarter of cancer or mesothelioma, according to the
rates without additional strengthening, the industry’s overall exposure, according Insurance Information Institute.
the firm warned in a detailed report that to the report.
examined liabilities from asbestos and It has said that as many as 27 million
other environmental claims. The top 10 insurers accounted for 70 Americans have been exposed to asbestos
percent of all A&E reserves in AM Best’s in the workplace and up to 100 million
Asbestos losses have remained stable new estimate. may have been exposed through products
but are running at higher than expected containing the mineral.
rates, rising by 9 percent to $3bn in 2015.
Asbestos has been a factor in at least 70
bankruptcies since 1976, according to the
US asbestos: estimated industry liabilities as % of ultimate liabilities Institute.
AM Best left its estimates of other
120 120 long-tail net environmental losses facing
Cumulative paids-to-date at year-end ($bn) the P&C industry unchanged, at $42bn.
Carried net reserves at year-end ($bn) The company said that about $40bn of that
100 100
Funded liabilities as % of ultimate liabilities liability has been funded, split between
claims that have already been paid and
80 80 reserves.
$bn

%
US carriers have paid out about $4bn for
60 60 environmental losses while incurring about
£3bn since 2006, AM Best estimated.
40 40 The rating agency said it will continue to
re-evaluate data related to both asbestos
and environmental losses and update its
20 20 estimates accordingly.

0 0
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

Source: AM Best
 Appendix 3
Claims development
triangles: scenario

Appendix 3
analysis and discussion
The purpose of this discussion is not to look for concrete answers but rather to prompt
awareness and consideration of techniques and issues.

The two claims development triangles, in tables A and B below, presented claims numbers
and incurred claims cost data relating to a particular account over the period 2014 to 2019.
For the purposes of this discussion, the nature of the account (class, cover-type or mix) is
unspecified.

A: Number of intimated claims as at 31/12/2019

Development year

Accident year 1 2 3 4 5 6

2014 720 1,010 1,200 1,205 1,205 1,205

2015 514 928 1,178 1,188 1,190

2016 750 1,050 1,250 1,258

2017 729 979 1,115

2018 762 1,065

2019 770

NB: Claims settled at ‘nil’ cost have not been removed from the above.

B: Incurred claims costs (£) = paid plus outstanding as at 31/12/2019

Development year

Accident year 1 2 3 4 5 6

2014 779,040 1,924,050 2,268,000 2,289,500 2,417,230 2,385,900

2015 514,000 1,866,208 2,404,298 2,387,880 2,859,570

2016 936,750 1,899,450 2,755,000 2,893,400

2017 920,727 1,965,832 2,654,815

2018 1,120,140 2,252,475

2019 1,178,100

In this scenario, you are completely unfamiliar with the account which has produced the
above claims experience but you know that you will be asked to forecast the ultimate claims
cost for the period 2014 to 2019. Before considering how best to project the claims cost, you
must assess the data in front of you.
 A3/2 960/December 2020 Advanced underwriting

As noted in the chapter text, claims data must be subjected to quality and consistency
checks:
• Is the data comparable?
• Have all the claims arisen from the same or very similar coverages?
• Regarding the accounts or policies which have generated the claims experience, has
anything of significance changed in the period?
• Have the claims been handled and presented in a consistent manner?
• Have all the claims been updated to a common point in time?
Appendix 3

When actuaries assess huge volumes of claims data, they use computer programs and
statistical techniques to highlight and attempt to explain unexpected values and trends, in
order to validate the data. They will consider whether they have enough data to rely upon
any projections they might make and they will assess the volatility of the data: based on this
data, how credible will the projections be?
Without the benefit of computer programs, what do you notice about the data in triangles A
and B?

Possible answers
Numbers:
By development year 3, the claims numbers appear to be close to a 'final' number but the
experience of accident year demonstrates that new claims may be intimated even in the
fourth year after the year of exposure.
The overall number of claims intimated per year appears to be rising (look at the
development year 1 column). What's happening to exposure?
In development year 1 for accident year 2015 something unusual happened: far fewer
claims were intimated than in other years but by development years 2 and 3 the 2015
number of claims looked more typical. What might have caused this? An internal cause
such as processing delays? External causes?
Incurred claims costs:
Typical incurred claims costs appear to be rising over the period 2014 to 2019.
The incurred claims cost for accident year 2015 in development year 1 looks unusually
low: solely due to the low number of intimations?
Overall the number of claims and level of claims costs do not appear to be particularly
volatile: with the exception of accident year 2015 no obvious signs of very variable
numbers of intimations, year-on-year, or any very large claims.

One of the techniques used to highlight development patterns in claims triangles is to

calculate the differences from one development period to the next.

C: Differences in intimated claims

Development period

Accident year 0 to 1 1 to 2 2 to 3 3 to 4 4 to 5 5 to 6

2014 720 290 190 5 0 0

2015 514 414 250 10 2

2016 750 300 200 8

2017 729 250 136

2018 762 303

2019 770
Appendix 3 Claims development triangles: scenario analysis and discussion A3/3

D: Differences in incurred claims costs (£)

Development period

Accident year 0 to 1 1 to 2 2 to 3 3 to 4 4 to 5 5 to 6

2014 779,040 1,145,010 343,950 21,500 127,730 −31,330

2015 514,000 1,352,208 538,090 −16,418 471,690

2016 936,750 962,700 855,550 138,400

2017 920,727 1,045,105 688,983

Appendix 3
2018 1,120,140 1,132,335

2019 1,178,100

For the number of intimated claims, the ‘differences’ triangle certainly highlights how
unusual the accident year 2015 experience was in development year 1 and the extent to
which a higher-than-average number intimated in development year 2 largely compensated
for this.
Similarly, for incurred claims costs the ‘differences’ triangle highlights the extent to which
costs typically rise in development year 2 (not solely due to the intimation of new claims) and
the variability in experience after development year 3.
Ten new claims were intimated for accident year 2015 in development year 4 but the total
incurred claims cost fell by £16,418. This might suggest that a number of larger claims or a
single large claim was settled for significantly less than expected and the release more than
compensated for the additional cost of the new claims. What happened in the following year:
were one or two of these large claims re-opened or were the two new claims intimated in
development year 5 responsible for the apparently high incurred cost that year?
By this stage in the analysis it is apparent that the use of claims triangles without access to
the underlying claims data is severely limiting. Although the level of total incurred claims
costs does not suggest the presence of any very large claims, there may be a number of
larger claims which, particularly if concentrated in a particular year, could have a distorting
effect.
Nor can the rate of settlement be assessed. By development year 3 or 4, what proportion of
claims are still outstanding? And what relationship does the total outstanding amount bear to
total claims payments? Although the incurred claims costs triangle shows the total cost
generally stabilising after development year 3, if a significant proportion of claims remain
outstanding (or the outstanding amount is particularly high) then the ultimate cost remains
highly uncertain.
For accident year 2014, no additional claims have been intimated since development year 4
and the incurred claims cost fell in development year 6 (which may indicate the settlement of
a larger claim) but all these ‘run-off’ signals could be quite misleading without the
confirmation of separate paid and outstanding claims amounts.
In an attempt to discern and monitor development patterns in claims costs (paid, outstanding
or total incurred), report-to-report or link ratios can be created. The ratios are calculated by
dividing later claims values by earlier values. This is the basis of the chain ladder
technique, which is widely used in projecting the claims cost of individual accounts and in
claims reserving at class/company level.
 A3/4 960/December 2020 Advanced underwriting

E: Link ratios for incurred claims

Link ratios (incurred claims costs)

Accident year 2/1 3/2 4/3 5/4 6/5

2014 2.47 1.18 1.01 1.06 0.99

2015 3.63 1.29 0.99 1.20

2016 2.03 1.45 1.05

2017 2.14 1.35

Appendix 3

2018 2.01

Average 2.32* 1.32 1.02 1.13 0.99

* The calculation of the average ratio reflects the weighting attributable to the total value of claims costs in the
relevant development periods: although 2014 and 2015 have very high year 2:year 1 ratios, 2016 and 2017 have
higher total claims costs (see triangle B). A 'volume' weighted average of 2.32 is therefore more appropriate than
an average of the discrete year 2:year 1 ratios (2.46).

Particularly when a claims development triangle includes data from many accident years, it is
worth considering the ‘average’ factors based on all years (as above), as well as from a
more recent group, say, the last six or three years. This process may highlight relevant
changes or trends over a longer period of time which an overall average might disguise.
It is worth noting that the validity of this technique relies upon the fundamental compatibility
of the data: it assumes that any differences from year to year are caused by random
variations rather than inherent differences.
As regards this particular triangle of link ratios, how useful might it be in projecting ultimate
claims costs?

Possible answers
To provide a reasonably reliable ultimate claims cost, you would want to have at least a
couple of accident years which had produced '1.0' ratios (that is, no change) in
succeeding years, as well as knowledge of the nature of the account: how likely are late-
reported claims? In this example, there appears to be too much variability in the individual
ratios after development year 3. Knowledge of the amounts outstanding might counteract
this impression, if relatively low.
Although weighted, the average ratio for year 2:year 1, at 2.32 still appears high due to
the influence of accident years 2014 and 2015. The average ratios for year 5:year 4 and
year 6:year 5 also appear unreliable due to scant data.

This is, of course, an illustration of the use of a link ratio technique at its most basic form of
application. In reality, not only would actuaries work with far larger claims databases and
examine the data in far greater detail (for example, separating attritional and large losses
and identifying distortions and trends), they also have at their disposal a range of link ratio
techniques which are designed to use the data to best effect and produce more considered,
credible projections.
Actuaries would also look at the development of other, similar accounts as a source of
potential benchmark development factors. For example, if the account in our example had
just been acquired from another insurer and you already had a similar account, with a longer
run of developed claims experience, you might have the confidence to either confirm the
average year 2:year 1 ratio of 2.32 as valid or to amend it, based on ratios derived from the
existing account.
In this particular example, we will use the average link ratios to project a developed – but not
necessarily ultimate – claims cost for the accident years 2015 to 2019 inclusive.
Appendix 3 Claims development triangles: scenario analysis and discussion A3/5

F: Incurred claims costs, actual and projected, using link ratios (£)

Development year

Accident year 1 2 3 4 5 6

2014 779,040 1,924,050 2,268,000 2,289,500 2,417,230 2,385,900

2015 514,000 1,866,208 2,404,298 2,387,880 2,859,570 2,830,974

2016 936,750 1,899,450 2,755,000 2,893,400 3,269,542 3,236,847

2017 920,727 1,965,832 2,654,815 2,707,911 3,059,940 3,029,340

Appendix 3
2018 1,120,140 2,252,475 2,973,267 3,032,732 3,426,988 3,392,718

2019 1,178,100 2,733,192 3,607,813 3,679,970 4,158,366 4,116,782

The figures in bold are the projected claims costs. (For accident year 2019, for example, the
incurred claims cost has been projected to its 2024 level by the use of the ratios 2.32, 1.32,
1.02, 1.13 and 0.99, successively.)
The projection indicates that the IBNR amount for 2015 to 2019 inclusive should be a
minimum of £4,768,301. This was calculated as follows: the sum of the development year 6
projected incurred claims costs for 2012 to 2016, inclusive, LESS the sum of incurred claims
costs for 2015 to 2019, inclusive, as at 31/12/2019: £16,606,661 less £11,838,360 =
£4,768,301.
Based on the available information, it is not safe to assume that accident year 2014 is fully
run-off and therefore an IBNR will be required for development year 7 onwards: hence the
above calculation for accident years 2015 to 2019 should be regarded as a minimum. If more
was known about the nature of the account, we would be able to assess the likelihood of
late-reported or latent claims.
Are you satisfied that the available data has been used as effectively as possible? What else
could be done with the data and what value might further analysis produce?

Possible answers
You could calculate average claims costs. This might provide an indication of the
presence of large claims or an influx of smaller claims; also, an indication of rates of
claims inflation.

G: Average claim (£)

Development year

Accident year 1 2 3 4 5 6

2014 1,082 1,905 1,890 1,900 2,006 1,980

2015 1,000 2,011 2,041 2,010 2,403

2016 1,249 1,809 2,204 2,300

2017 1,263 2,008 2,381

2018 1,470 2,115

2019 1,530

A simple assessment of average costs in development years 1 and 3 would seem to indicate
that costs are increasing by 7 to 8% per annum.
With information on exposure two further forms of analysis may be undertaken: the
calculation of claim frequency and burning cost. The objective of the exercise remains the
projection of a developed or ultimate claims cost for reserving purposes: by examining the
development of claim frequency and burning cost (as well as average claims cost, above),
we may be able to identify impacts and/or trends which will help to refine and validate our
assessment of developed claims costs.
 A3/6 960/December 2020 Advanced underwriting

H: Claim frequency = number of intimated claims divided by exposure units (%)

Development year

Accident year Exposure 1 2 3 4 5 6

units

2014 5,000 14.4 20.2 24.0 24.1 24.1 24.1

2015 5,020 10.2 18.5 23.5 23.7 23.7

2016 5,040 14.9 20.8 24.8 25.0

Appendix 3

2017 5,060 14.4 19.4 22.0

2018 5,080 15.0 21.0

2019 5,100 15.1

The claims frequency triangle confirms that the rise in the number of claims intimations is
due both to a rise in exposure and to an increase in claims frequency. Although year 1 claim
frequency has breached the 15% level in the two latest years, 2018 and 2019, will it develop
in a more typical fashion by year 3?

I: Burning cost (actual and projected incurred claims costs divided by exposure units) (£)

Development year

Accident year Exposure 1 2 3 4 5 6

units

2014 5,000 155.8 384.8 453.6 457.9 483.4 477.2

2015 5,020 102.4 371.8 478.9 475.7 569.6 563.9

2016 5,040 185.9 376.9 546.6 574.1 648.7 642.2

2017 5,060 182.0 388.5 524.7 535.2 604.7 598.7

2018 5,080 220.5 443.4 585.3 597.0 674.6 667.9

2019 5,100 231.0 535.9 707.4 721.6 815.4 807.2

Finally, the burning cost triangle (which also uses the claims costs projected with the
internally derived link ratios) provides a summary of how the claims costs for this account
have developed and may continue to develop, independent of changes in exposure.
As noted above, we are not confident regarding the validity of some of the link ratios derived
from the account and this uncertainty bears most heavily on the projection of accident year
2019 claims costs. If claims inflation is indeed running at 7 to 8% per annum, the developed
cost of accident year 2019 by 2024 (development year 6) will be heavily influenced by how
quickly the intimated claims are settled. Each year’s delay in settling a claim could increase
the outstanding amount by the prevailing rate of inflation.
Would it be helpful to know the written premium for each year from 2014 to 2019, inclusive?

Possible answers
In some instances, written premium might have to substitute for exposure, where no other
suitable measure exists.
In other circumstances, written premium might be regarded as a more sensitive and
comprehensive measure of exposure to risk than other more conventional measures
which focus on a single feature (such as, sum insured or EML).
On the other hand, because other factors – independent of insured risk – affect premiums
(such as competition and the competence of underwriters), written premium could prove to
be a very unreliable proxy measure for exposure, particularly in an unfamiliar account.

No further information will be provided in the time available for your assessment: are you
happy to recommend the use of the projected claims cost figures as they stand (triangle F)?
Appendix 3 Claims development triangles: scenario analysis and discussion A3/7

Possible answers
Before making your recommendation, you must consider the integrity of the process which
has helped you to arrive at these answers:
• Appropriate techniques?
• Sufficient, comparable data?
• Valid assumptions?
• Adjustments based on justifiable and documented considerations?

Appendix 3
Even if the process has had integrity, you may still not be confident in the result.
You must express your reservations to those who may use any projected figures.
In this scenario, the following would greatly enhance the confidence with which the
developed cost – and possibly, the ultimate cost – could be projected:
• knowledge of the nature of the account;
• access to the underlying data or, at least, separate paid and outstanding claims costs;
and
• comparison with similar accounts.
 Appendix 4
Risk premium projection:
scenario analysis and
discussion
The claims triangles used in chapter 6 in the discussion about reserving and projecting the
ultimate claims cost (see appendix 3) can be used to illustrate – in a simplified manner – how

Appendix 4
a projection of risk premium based on historic claim frequency and severity (average claims
cost) might be accomplished.
You have been asked to determine an appropriate risk premium for business written and
renewed in the course of 2020.
• What base period will you choose?
The claims triangles indicate that the best-developed claims experience relates to
accident year 2014: although total claims cost is still changing, no additional claims have
been intimated for two years. As this account appears to have a moderately long-tail
development pattern, the choice of a more recent year as base period would not be
advisable. With over 1,000 claims in the experience for 2014, this represents a
reasonable sample.
On the basis of the available information, the account does not appear to have
undergone any marked changes since 2014 and there is no evidence of any very large
claims or incidents causing marked peaks in claim frequency. Access to the underlying
data would confirm or contradict these assumptions and enable any necessary
adjustments to be made. You have been advised that the cover offered throughout this
period has not changed and the mix of business has changed little.
You are unaware of any external issues which may have affected the account’s
experience or may do so in the future, apart from general trends in claims inflation.
The assumption that the claims experience relating to accident year 2014 is virtually run-
off could be challenged but on the basis of this assumption, it can be seen from claims
triangles G and H that the average claims cost stands at £1,980 and claims frequency
24.1%, as at the end of 2019.
• What will the average claims cost and claim frequency be for accident year 2020,
when business written in that year is at a similar stage of development in 2025?
From claims triangle H, it can be seen that claim frequency appears to have been rising
(particularly obvious in the year 1 column, at an average rate of 0.095% per annum
between 2014 and 2019) and that, irrespective of a few late intimations, the close-to-final
claim frequency appears to be evident by year 3. Based on the experience of accident
year 2014 (a pattern followed by accident year 2016), this account’s claim frequency
appears to increase by around 10% (ten percentage points) from its year 1 level to a
stable developed position.
If the year 1 claim frequency for 2020 is projected to be 15.2% (accident year 2014 claim
frequency at year 1, 14.4 multiplied by 1.00956) and 10% is added, does a final
developed claim frequency of 25.2% look realistic? If the accident year 2014 claim
frequency at year 6 of 24.1 is increased by the same factor (1.0095) over 6 years, the
answer is 25.5%.
 A4/2 960/December 2020 Advanced underwriting

H(p)

Claim frequency = Number of intimated claims divided by exposure units as %

Accident Exposure Development year

year units

1 2 3 4 5 6

2014 5,000 14.4 20.2 24.0 24.1 24.1 24.1

2015 5,020 10.2 18.5 23.5 23.7 23.7 24.3

2016 5,040 14.9 20.8 24.8 25.0 24.6

2017 5,060 14.4 19.4 22.0 24.8

2018 5,080 15.0 21.0 25.0

2019 5,100 15.1 25.3

2020 25.5
Appendix 4

This is clearly not a sophisticated analysis of the rate of change in claim frequency but a
projected figure for 2020 in the region of 25.2% to 25.5% appears reasonable: you decide to
use the higher figure of 25.5%.
Turning to claims triangle G: as in this instance you cannot adjust the average claims cost to
allow for either the presence or absence of particularly large claims in the experience, the
main focus of attention is on the applicable rate of claims inflation for use in the projection.
As previously stated, the year 1 and year 3 averages appear to show a rate of inflation in the
region of 7 to 8% per annum: is this rate consistent with the experience of other similar
accounts? If you use a rate of 7.5% per annum and inflate the accident year 2014 at year 6
figure of £1,980 (1980 multiplied by 1.0756), a projected average claims cost of £3,056 is
derived.

G(p)

Average claim (£)

Accident Development year

year

1 2 3 4 5 6

2014 1,082 1,905 1,890 1,900 2,006 1,980

2015 1,000 2,011 2,041 2,010 2,403 2,128

2016 1,249 1,809 2,204 2,300 2,288

2017 1,263 2,008 2,381 2,460

2018 1,470 2,115 2,644

2019 1,530 2,843

2020 3,056

The risk premium per policy can be calculated by multiplying the claim frequency by the
average claims cost: therefore the projected risk premium for 2020 is (0.255 × 3,056) = £779
per policy.
• How can you check the validity of this projected risk premium?
The account’s burning cost was projected earlier using the link ratios method (see original
claims triangle I) and as no adjustments were made to the underlying data in either the
burning cost projection or the risk premium projection for 2020 (above), any differences
must be result of the assumptions used, the method and/or the projection of the risk
premium amount a further year ahead (from 2019/as at 2024 to 2020/as at 2025).
Based on the same factors used in the previous risk premium projection (1.0095 per
annum for change in claim frequency and 1.075 per annum for change in average claims
cost), the Accident Year 2019 at Year 6 figure would be (0.253 × 2,843) = £719.
This compares with a figure of £807.20 as the projected burning cost for 2019 as at Year 6 in
claims triangle I. A substantial difference – how can this difference be resolved?
Appendix 4 Risk premium projection: scenario analysis and discussion A4/3

This dilemma illustrates why actuaries and statisticians often use several different methods
when considering projections, particularly when there are limitations to the available data. It
was noted in the earlier discussion that the link ratios derived from the account were quite
variable year-on-year and that this uncertainty would have most impact on accident year
2019, as it was least developed. In addition, the assessment of rates of change in claim
frequency and average claims cost were not based on a sophisticated analysis.
You can however test your claim frequency and average claims cost assumptions by
inserting them into the burning cost calculation:
Burning cost = total claims cost ÷ exposure
Claim frequency = number of claims ÷ exposure
Average claims cost = total claims cost ÷ number of claims
Therefore:
Burning cost = average claims cost × claim frequency

Appendix 4
In respect of accident year 2019 at year 6:
• If the burning cost is £807.20 and the claim frequency is 25.3% then the average claims
cost is (807.20 divided by 0.253) = £3,190.
• If the burning cost is £807.20 and the average claims cost is £2,843 then the claim
frequency is (807.20 divided by 2,843) = 0.284 or 28.4%.
The choice of 7.5% per annum may well have underestimated the impact of inflation on
average claims cost. Based on the experience of other similar accounts, a higher rate may
be justified. A rate of 8% would move the 2019 figure to £2,909 or 9% to £3,046. However,
the average claims cost figure derived from the burning cost calculation, at £3,190, still
looks high.
Claim frequency is generally a far steadier reflection of underlying experience and the figure
of 28.4% derived from the burning cost calculation appears excessive in the context of this
account’s past experience.
Without access to the underlying data, the most considered approach may be to increase the
projected risk premium for 2020 above the projected level of £779 per policy, particularly in
respect of claims inflation, but not as far as the level suggested by the link ratio projection of
burning cost.
Points to note:
• Access to and the full use of data is critical in making sound pricing decisions.
• Even with a good sample of data, no one method should be relied upon.
• Judgment must be exercised: the adequacy of the sample, the methods used, the
selection of suitable benchmarks, as well as common sense.
• Are the results credible? If not, why not?
 Appendix 5
Impact of pricing,
expenses and volumes on
profitability: scenario
analysis and discussion
Projected product costings

Per Policy Costings Totals

Volume Gross Claims Variable Contribution Income Claims Contribution to fixed

premium cost expenses to fixed and expenses and profit

Appendix 5
(excl. expenses variable
IPT) and profit expenses

1 100 £100 £60 £30 £10 £10,000 £9,000 £1,000 (Current

costings)

2 85 £100 £60 £30 £10 £8,500 £7,650 £850 (15% reduction in

volume)

3 100 £95 £60 £29 £6 £9,500 £8,900 £600 (5% reduction in

price)

4 ? £95 £60 £29 £6 ? ? £900 (What volume

required?)

150 £95 £60 £29 £6 £14,250 £13,350 £900

For the purposes of this discussion, claims costs are assumed to remain at £60 per policy in
the forthcoming period. Variable expenses include commission at 20%. While total variable
expenses vary with volume, commission also varies with price.
Line 1 shows the current costings applicable to the product in question: the current total
contribution to fixed expenses and profit at £1,000 is regarded as acceptable as fixed costs
are covered, with a small contribution towards profit.
However, renewal premiums are under pressure and the sales department anticipates a 15%
reduction in policy volume if prices are maintained at current levels.
Line 2 illustrates the projected impact of a 15% reduction in volume. Although individual
policy costings remain the same, overall income is reduced, and although overall claims and
variable expenses also reduce, the product’s contribution to fixed expenses and profit is
reduced to an unacceptable level. Senior management advise that the product must make a
minimum contribution of £900.
What are the options? Sales department suggest that current volumes could be maintained
with an overall reduction of 5% in prices (the level of discount could vary between
customers).
Line 3 illustrates the outcome of a 5% reduction in price. Although the absolute amount of
commission paid is reduced, the reduction in price reduces the product’s contribution to £600
– a far worse outcome than the reduction in volume previously anticipated.
But sales department are convinced that much more new business could be sold as a result
of the reduction in price: how much new business would they have to acquire to meet senior
management’s requirement for a minimum contribution of £900 to fixed expenses and profit?
 A5/2 960/December 2020 Advanced underwriting

Line 4 poses this question and illustrates the answer. The required minimum contribution
(£900) is divided by the individual policy contribution (£6): 150 policies must be sold to meet
the minimum requirement. How many policies must be sold to match the product’s current
level of contribution of £1,000?
Answer: 167 policies.
The punchline of this scenario is a question for sales department to consider: how confident
are they that they can achieve a total policy volume of 150 or more in the forthcoming period
(a 50% increase on current volumes)? If they are not entirely confident (and even if they
are), further options should be evaluated which balance smaller overall reductions in
premium (possibly restricted to more limited categories of customer) with an acceptance that
the loss of some volume (ideally less than 10%) may have to be accepted in order to
maintain the level of profitability required by senior management.

Be aware
This type of simple evaluation of options can also be used to consider the impact of price
increases: how far would volume have to fall before a price increase could be regarded as
counter-productive in terms of contribution to fixed expenses and profitability?

Of course, when volumes change markedly the level of variable and fixed expenses are also
likely to change. As volumes grow, better deals may be done when insurers purchase
Appendix 5

external services and current fixed expenses, such as office accommodation, may be utilised
more effectively. Conversely, shrinking volumes will push per policy costs upwards. However
significant changes in variable and fixed expense levels tend to emerge over a longer period
of time and in an uneven fashion and are unlikely to impact greatly the evaluation of pricing
options for the forthcoming period – unless the volume changes anticipated are very
dramatic.
 i

Chapter 1
self-test answers
1 The three statutory objectives of the PRA are:
• a general objective to promote the safety and soundness of the firms it regulates;
• an objective specific to insurance firms, to contribute to the securing of an
appropriate degree of protection for those who are or may become insurance
policyholders; and
• a secondary objective to facilitate effective competition.
2 The ORSA policy is a reference document detailing the processes, data, risk,
measures and limits that make up the risk profile of the firm.
3 The three pillars of Solvency II are:
• Pillar 1 – Financial requirements.
• Pillar 2 – Governance and supervision.
• Pillar 3 – Reporting and disclosure.
4 The CMA's goals are to:
• deliver effective enforcement;
• extend competition frontiers;
• refocus consumer protection;
• achieve professional excellence; and
• develop integrated performance.
5 Cartels are agreements between businesses not to compete with each other.
6 The Insurance Act 2015 reformed:
• duty of disclosure and representation;
• remedy for failing to make a fair presentation of the risk;
• basis of contract clauses (warranties);
• remedy for breach of warranty;
• remedy for breach of terms designed to reduce particular risk types; and
• remedy for fraud.
ii 960/December 2020 Advanced underwriting

Chapter 2
self-test answers
1 An insurance professional's motivation might spring from a range of desires: to
introduce a new product; to achieve better results by avoiding the perceived errors of
existing companies; to exploit new technology or distribution channels; to utilise
specialist knowledge to provide a more tailored service or to take advantage of a
particular stage of the underwriting cycle.
2 After claims costs, the largest business costs generally relate to staff, reinsurance,
commission and ICT.
3 Reinsurers could ask any of the following questions:
• How would you describe the company's underwriting strategy?
• Do you plan to delegate underwriting authority?
• How do you see your product/service offering in comparison with those of your
competitors?
• Describe the typical risks the company intends to write and provide a profile of the
business you plan to accept in the first year (for example, by property sum insured
or limit of liability).
• What is your estimated premium income for each of the four quarters of the year?
• What is the seasonality of the business and its claims?
• What do you think about the current level of pricing in the market (for the business
you plan to write)?
• What is your target loss ratio? What allowance have you made for large claims,
bad weather…?
• What is your survey strategy?
• What is your flood strategy?
• What risks will you not accept?
• What lines of business will you not write or accommodate for a particular customer
or distribution partner?
• Will you accept exposures outside the UK? In which areas/territories?
• What will be the maximum and average exposures (MD & BI)?
• What is your definition of a risk?
• Will your company become a member of Pool Re?
• How will you establish your technical rates?
• What discounts are you planning to use?
• Are your policy wordings finalised and may we see them?
• Who will write the underwriting guide? May we see it?
• What authority limits do you, personally, have and how do you plan to control risk
acceptance?
• What proportion of risks do you expect to be referred to you?
• How are you proposing to select (recruit) underwriters and measure their
competence?
• Who will manage claims?
• What MI do you have access to or is planned?
• What support/constraints does the system provide to underwriters?
• Can individual underwriters amend policy wordings?
• Who can sign off endorsements?
• How will you monitor exposure?
• How do you plan to measure aggregations?
 iii

4 A statement of risk appetite includes information relating to the funding of the

business, its financial and business objectives and its approach. The statement of risk
appetite will become, once the company is authorised to commence business, the
basis of your own underwriting authority as underwriting director.
5 The underwriting audit process will, month by month, build up a picture of relative
competencies, training needs and general issues which require attention.
 v

Legislation
B
Bank of England and Financial Services Act
2016, 1A2

C
Competition Act 1998 (CA 98), 1C2A
Consumer Insurance (Disclosure and
Representations) Act 2012 (CIDRA), 1D2A
Consumer Rights Act 2015, 1D2E

D
Data Protection Act 2018 (DPA 2018), 1D3B,
2I

E
Enterprise Act 2016, 1D2C
Equality Act 2010, 1D2D
Equality Act 2010 (Amendment) Regulations
2012, 1D2D
EU Solvency I Directive, 1B1
EU Solvency II Directive, 1B1

F
Financial Services (Banking Reform) Act
2013, 1C
Financial Services Act 2012, 1A1, 1A3, 1A4

G
General Data Protection Regulation (GDPR),
1D3A, 2I

I
Insurance Act 2015 (IA 2015), 1D2B, 3D4A
Insurance Block Exemption Regulation no.
267/2010 (IBER), 1C2A
Insurance Distribution Directive (IDD), 1C3
Insurance Mediation Directive 2002/92/EC
(IMD), 1C3

L
Law Enforcement Directive (LED), 1D3B

M
Marine Insurance Act 1906 (MIA 1906), 1D2A
Mesothelioma Act 2014, 4C5

T
The Solvency 2 and Insurance (Amendment,
etc.) (EU Exit) Regulations 2019, 1B2
vi 960/December 2020 Advanced underwriting
 vii

Index
A Chapter 11 prohibition, 1C2A
Chartered Insurance Institute (CII), 7A2A
acceptance criteria, 2H2, 3D4, 3D5, 4B2, 4B3 cherry picking, 4B2
access to customers, 3D4 claims
accumulations, 8B catastrophe, 6C2
action planning, 9A3 costs drivers, 9A2
actuaries, 5F1 data, 4B1, 6D2
administration, 4E development triangles, 6C1
adverse selection, 8I2B experience, 7B, 9C
advertising, 3C3 individual, 6A
aggregate management techniques, 8G inflation, 7B2
aggregation of industry data, 7A2A practice, 6D1
alternative risk transfer (ART), 8I, 8I2, 8I2A reports, 6D3
anti-competitive agreements, 1C2A reserving, 6B
asbestos, 4C5 staff, 5F6
asset-side risks, 1B2A validating approaches, 6C4
Association of British Insurers (ABI), 7A2A value, 6C3
assumptions, 5C, 7A2C, 9A4 clashes, 8B
audit, 9D, 9I, 9J classification, 4B1
authorising new insurers, 1A6 combined operating ratio (COR), 3A1, 3F2, 5E,
authority limits, 2F1, 2H, 9I 6A, 7C2
commercial risks, 4B1C
commission, 3C3, 3C3E
B commoditisation, 3D4A
base commoditised, 3C3E
data, 7B2 comparable development periods, 9E
period, 7B1 competition, 1C, 2B, 3C3, 4E
basis risk, 8I2B brand, 3C3A
bespoke pricing components, 7E1B customer service, 3C3D
big data, 7A2D, 7A2F distribution, 3C3C
blind underwriting facilities, 3D2 legislation, 1C2
board approval, 2F2 price, 3C3E
Bornhuetter-Ferguson method, 6C1 products, 3C3B
brand, 3C3A Competition and Markets Authority (CMA),
broker 1C1
portfolios, 4D1E competitive advantage, 3C, 3C3, 3C3F
budgets, 2H4, 5A, 5I, 9A complaints procedure, 2H7
burning cost, 7E compliance staff, 5F2
business conduct risk, 1C
mix, 4D1, 4D1D, 7B2 contingent capital contracts, 8I2A
plan, 2A contract certainty, 4C1
contracts, 4C1
contribution, 7D4
C corporate
culture, 3E
capacity, 3A1, 3C4D, 6D3, 8H, 8I1
governance, 2H6A
capital
strategy, 3A
add-on, 1B2A
costs
asset pricing model (CAPM), 7D3
assessing, 2D1
competition for, 3A1
cover, 3C
cost of, 2H1, 3A1, 6A, 7D3
changes to, 7B2
market solutions, 8I2B
comparisons, 4C4
model, 1B2A
establishing, 4C
requirements, 1B, 2D2
credit or counterparty risk, 8I2B
captives, 8I2A
criteria
cartels, 1C2A
acceptance, 2H2, 3D4, 3D5, 4B2, 4B3
cash flow, 5E
critical success factors, 5A3
catastrophe
cross-subsidisation, 4D1B
bonds, 8I2A
culture, 3E
claims, 6C2
customer
futures, 8I2A
access to, 3B3, 3C3C, 3D3, 3D4
modelling, 8H3C
segmentation, 3C4, 3C4E
categorisation, 4B1
service, 3C3D
change management, 3E, 4A
value, 3C4C
changing requirements, 8H1A
cyber insurance, 2I
Chapter 1 prohibition, 1C2A
viii 960/December 2020 Advanced underwriting

D finite risk solutions, 8I2B

forecasting
data approaches, 6C
appropriate, 4A techniques, 6C
external, 7A2, 7A2C forecasts, 5C, 9A
for pricing, 7A fraud, 3C4G
individual, 7A2B frequency, 7E1
industry, 7A1 full-follow facilities, 3D2
intermediary, 7A2B future
internal, 7A1 costs, 7D, 7D1
interpretation, 8C1 focused, 9F
mining, 9G
presentation of, 9E
deductibles, 4C6B
G
delegated authority, 3D1, 4E, 9K generalised linear modelling (GLM), 7C2
delivery, 2B global insurance programmes, 3B2
demand, 3C1 go-live, 2H
differential pricing, 3D5 governance, 2H6
differentiators, 3C3D government intervention, 4C5
direct insurers, 3D gross written premium (GWP), 3A1
discounts, 4C6C
distribution, 3C3C, 3D
dominant position, 1C2A H
dual pricing, 3D6
high
duty of disclosure and representation, 1D2B
frequency events, 7B2
severity events, 7B2
E volume markets, 4B1C
high-level planning, 5B1
economic evaluation, 1B2A hygiene factors, 3C3D
elasticity of demand, 7A3
emerging risks, 8E
enhanced capital requirement (ECR), 1B1 I
entering and exiting a market, 3A2
incentives, 4C6C
environment, 2B
inclusions, 4C5
estimated maximum loss (EML), 8C1
incurred but not enough reported (IBNER), 6A,
exception reports, 9A2
6B3
excesses, 4C6A
incurred but not reported (IBNR), 6A, 6B3
exclusions, 4C5
individual risk data, 7A2B
expenses, 5D, 7D4
industry loss warranties, 8I2A
fixed, 5D1
Institute and Faculty of Actuaries (IFoA), 7A2A
variable, 5D2
insurance cycle, 3C2
experience rating, 7B1, 7E
insurance derivatives, 8I2A
expertise, 3A2
insurer’s choice, 3C4D
exposure
intermediary, 3D
control of, 8A, 9C
risk data, 7A2B
related issues, 8F
internal
external
costs, 3C3E
environment, 3C1, 8D
data, 3C4B, 4B1
influences, 7B2
exposure data, 8C
research, 3C4A
issues, 9A3
extreme circumstances, 8G1
models, 1B2A
investment income, 5E, 7D2
F investors, 2C

fair treatment of customers, 1A5C

FCA Handbook, 1A5 K
Principles for Businesses (PRIN), 1A5A
key performance indicators (KPIs), 5I, 9B
training and competence sourcebook, 1A5B
key variables, 9A4
financial
knowledge of risks, 3D4
accounts, 5G, 5H
assessment, 4A
measures, 5A4 L
projections, 2D
Financial Conduct Authority (FCA), 1A1, 1A4 lag indicators, 9F
product intervention strategy, 1D1 latent claims, 6C2
promoting effective competition, 1C leadership styles, 3E
Financial Ombudsman Service (FOS), 1A4A legal constraints on cover, 1D
Financial Policy Committee (FPC), 1A1 legislation, impact of, 1D2
financial services regulation, UK, 1A liaison, 5F, 6B3
 ix

limits, 2F1, 4C3 price, 3C3E

liability, 2F1 elasticity of demand, 7A3
policy, 4C3 pricing, 4D1D
reinsurance contracts, 8H3B allocation, 7D1
link ratios, 7E assessment, 7D1
liquidity risk, 8I2B components, 7D
Lloyd’s, 1A, 1B2, 1C2A, 3D1, 6D3, 8E, 8G1, 8I1 premium, 3C3F
local audit, 9I1 Principles for Businesses (PRIN), 1A5A
location, 8C2 product
London Market, 3B, 3B2 design, 4C2
intervention, 1D1
lifecycle, 9F
M mix, 4D1C
management planning, 5B2
accounts, 5H rating structure, 7C
information, 2H5 risk premium, 7C
senior, 5F5 products, 2B, 2H3, 3C3B, 4C1
managing change, 3E, 4A profitability, 7D4
managing general agent (MGA), 3D1 financial, 2D
market dominance, 3C3F projections, 2B
market facilities, 3D2 prospective risk analysis, 7B1
market premium information, 7A2A Prudential Regulation Authority (PRA), 1A1,
marketing, 3C 1A3, 7A2A
measurable targets, 5A3 risk assessment framework, 1A3B
mesothelioma, 4C5 statutory objectives, 1A3
minimum capital requirement (MCR), 1B1, Threshold Conditions, 1A3A
1B2A Prudential Regulation Committee (PRC), 1A2
monitoring, 5G, 5I2
monthly results, 9A1 R
moral hazard, 8I2B
multi-way analyses, 7C2 rating
multinational business, 3B factors, 7C1
issues with, 3B1 structures, 7C
multinational insurers, 3B3 re-categorisation, 4B1A
realistic disaster scenarios (RDS), 8G1
recruitment, 2H6
N referrals, 9I1
new risks, 4B1B regional audit, 9I1
non-admitted business, 3B2 regional planning, 5B3
non-advised sales, 3D4A regulatory constraints on cover, 1D
non-conventional pricing plans, 7E1B reinsurance
claims focus, 8H3C
costs, 7D
O failure, 8H2A
input, 7E1A
Office for National Statistics (ONS), 7A2A
levies, 7D
operational expenses, 4D1C
limits, 8H3B
operations, 3E
procurement, 8H
own risk and solvency assessment (ORSA),
programmes, 8H1
1B2B
recoveries, 7B2
security, 8H2
P sidecars, 8I2A
strategy, 8H
peer review, 9I1 reinsurers, 2F, 9J
people management, 9H perspective, 8H3
personal underwriting authority, 9I renewal
PESTEL analysis, 8E criteria, 4B2
planning discounts, 7D4
issues, 9A3 retention, 3C3
plans, 2F2, 5A, 9A research, 3C4A
policy, 4C1 reserving policy, 6A
limits, 4C3 restricted circulation, 3F4
terms, 4C2 retention levels, 2F
portfolio management, 4D return on capital (ROC), 1B4, 3A
portfolios, 6B2 return on capital employed (ROCE), 3A1, 5A1,
possible maximum loss (PML), 8C1 7D, 9A1
PRA Rulebook, 1A5 review process, 6A
Principles for Businesses (PRIN), 1A5A risk
premium drivers, 9A2 acceptance, 3F1, 8A
x 960/December 2020 Advanced underwriting

risk (continued) U
acceptance limits, 3F1
appetite, 2E, 2G, 3A, 8A ultimate cost, 7B2
categorisation, 4B1 uncertainty, 3C1
classification, 4B1 underlying trends, 6C2
control, 4B3 underwriting
control surveys, 4B3A audit, 2H7
framework, 6C1 cycle, 3C2
improvement, 4B3 governance, 2H6, 3F1, 9I1
management, 2E guidance, 2H2
management framework, 8E issues, 9A3
premium, 7B2 licence, 9I
premium framework, 7C1 manager, role of, 5B
sharing, 8I1 policy, 9L
risks staff, 3C3D, 5F4
evaluating, 2B, 4B strategy, 2H1, 3F, 3F5
external, 8E targets, 3F2
new, 4B1B
V
S
variables, 9A4
sales costs, 7D variance analysis, 9A2, 9I
scheme volumes, 7D4
segmentation, 3C4, 3C4E
service, 3C3D
underwriting, 4E
service, 3F3
severity, 7E1
solvency capital requirement (SCR), 1B2A,
3A2, 6C3
Solvency II, 1B1, 1B2
capital modelling, 1B3
options for insurers, 1B2A
quantitative requirements, 1B2A
reactions to, 1B4
systems of governance, 1B2B
solvency regulation, 1B1
standard formula, 1B2A
start-up insurers
versus established insurers, 2I
statement of risk appetite, 2G
stochastic methods, 6C2
strategic business units (SBUs), 3A
strategy, 2F3
communication of, 3F5
corporate, 3A
distribution, 3D
marketing, 3C
operations, 3E
underwriting, 2H1, 3C2, 3F
surveys, 2F3, 2H2, 3F1, 4B3A
sustainable competitive advantage, 3C3F
systemic losses, 8B
systems, 2H5, 3D4

T
target customers, 2B
target operating model (TOM), 2A
technical underwriting assessments, 9I
technology, 3D6
telematics, 7A2E
time value of money, 6C3
timing, 3A2, 5C1
training and competence sourcebook, 1A5B
trends, 7B2
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