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What is an underwriter?
- Underwriting is not a part of insurance; underwriting is insurance.
- The insurance mechanism is impossible without underwriting.
- Only underwriting and claims are unique to insurance
- The word underwriter can be defined in terms of one or more of the many roles underwriters play in their organizations.
Definition 1 - An underwriter is an insurance professional employed to accept or reject risk on behalf of an insurer.
- The most important way in which to define an underwriter is in terms of risk.
* Definition of insurance - is the undertaking by one person to indemnify another person against loss or liability for loss in respect of a certain risk or peril to which the object of the insurance may be exposed, or to pay a sum of money or other thing of value upon the happening of a certain event.
- The critical aspect of the insurance definition is that objects of insurance are exposed to risk, and that entails the possibility of loss or liability for loss for prospective insureds. An insurer assumes that risk on behalf of an insured for a premium.
Definition 2 - An underwriter is an investor of shareholder capital.
- In accepting or rejecting risk on behalf of an insurer, an underwriter is in effect investing the insurer's capital in those risks he or she accepts and declining to invest capital in those risks he or she rejects.
* In contrast with stocks and bonds, an underwriter accepts risk with merely a promise to pay in the event of an insured loss - a promise that the insurer may never have to make good on.
- Provincial and federal regulators hold insurers to those promises by limiting the amounts of the promises according to the amounts of insurer's capital. An underwriter cannot accept an infinite amount of risk on behalf of an insurer, because the insurer does not have an infinite amount of capital.
Definition 3 - An underwriter is an insurance professional employed to implement an insurer's strategic plan.
- To build a profitable portfolio of such insureds, the insurer needs a strategic plan. That plan will involve identifying the types of risk the insurer wants to pursue; the lines of insurance it wants to underwrite; the reinsurance it can arrange; the amounts of insurance it will offer fro risks of different types and size; and the approach it will take to pricing, among other considerations.
"Underwriter Defined"
- An underwriter is an insurance professional who invests the capital of an insurer's shareholders by accepting or rejecting risk to implement an insurer's strategic plan.
- Critical roles - the accepting or rejecting of risk; the investing of capital; the implementation of the strategic plan.
Evolution of Underwriting
- Characteristic form of insurance was a contract of bottomry, which applied to commercial journeys, by land caravan and by sea.
- Bottomry was essentially a kind of loan extended by a money changer or money lender to the owner of goods or ships in transit between ports. If a ship against which the loan was taken out completed its journey, the borrower repaid the loan with interest. If the ship was lost, the borrower kept the amount of the loan, thus being in effect indemnified for his loss as in an insurance contract.
- By the end of the 17th century, marine insurance had been established in Europe for hundreds of years. Most insurance was provided by wealthy merchants who decided for themselves whether to commit themselves to risks from time to time.
- Coffee houses became important centers of social, intellectual, and commercial activity. This would eventually become today's Lloyds of London
Underwriting Process
The Line Guide
- In accepting or rejecting risk, an underwriter is guided by criteria determined by the insurer.
- The criteria are part of the insurer's strategic plan and are often specified in a line guide, along with such considerations as licensing and general operating policies of the insurer.
Licensing
- An important consideration for the underwriter is where the insurer is licensed to accept business.
Types of Business
- Some insurer's seek a broad range of business, such as homeowner's to business.
- Other insurer's have a great deal of expertise in a segment of the broader market and may choose to cater to this niche.
- The underwriter must understand the market that the insurer wants to deal with and seek that kind of business accordingly.
Lines of Insurance
- Insurers offer varying lines of insurance
- There are two elements of the strategic plan: licensing and types of business. Whether the insurer is federally or provincially licensed and the lines of insurance an underwriter is authorized to offer.
Territory
- Geographical area or territory in which a risk is located. Some territories are more prone than others to certain kinds of environmental hazard, such as hail, flood or earthquake.
- Some territories are rural and urban.
- Underwriters must know their territories.
Capacity
- Some risks are more attractive to an insurer than others.
- For any insurer, there is a maximum amount of insurance it will allow its underwriters to commit to the very best of risks.
- The amounts of insurance an underwriter may authorize for risks of varying types are set out in a matrix or table of limits. The amounts are determined by the following criteria:
> Occupancy - the nature of some business pose inherently greater risks of loss or damage than do others.
> Public Protection - the level of public fire protection. Town grades are assigned based on the availability and effectiveness of fire hydrants, water supply and pressure and the expertise and response time of its fire department. TG's 1 - 4 are "protected", TG's 5 - 8 are "semi-protected", and TG's 9 - 10 are "unprotected".
> Construction - the types of construction - statistics show that the chances for a total loss of a building from fire or a natural catastrophe significantly depend on the buildings construction.
** Example of table of limits in Exhibit 1-1 on page 11
Reinsurance
- Closely related to capacity is the matter of reinsurance.
- "Insurance for Insurers"- makes more capacity available to them.
- Facultative is negotiated between an insurer and a reinsurer on an individual risk or policy.
- Treaty is an agreement between insurer and reinsurer to reinsure a block or portfolio of business without the insurer having to submit each risk to the reinsurer.
- Reinsurance treaties are generally negotiated for an insurer by the head office.
Pricing
- An underwriter accepts risk on behalf of an insurer in exchange for premium; it is premium that allows an insurer to survive and make a profit.
- Insurer's vary in the amount of discretion they allow their underwriters over pricing.
- There are endless variations in the lines guides that insurers give underwriters to shape their approach to soliciting, accepting and rejecting of risk.
Applying the Line Guide
- If the line guide expresses the insurer's strategic plan and the underwriter is to implement the strategic plan, then the underwriter's job may be described in one sense as applying the line guide.
- "File underwriter" - responsible for underwriting individual risks
- "Portfolio underwriter" - responsible for underwriting groups of risks
- Increasingly insurer's are "giving brokers the pen" or vesting underwriting authority in their brokers within specified limits. This results in insurer's underwriters increasingly becoming portfolio managers.
Assessing the Risk
- The underwriter's assessment of a risk entails a great many considerations.
* Who is the applicant?
* What kinds of loss might an applicant incur?
* What perils does the risk face?
* What physical hazards does the risk have that make loss of some kind more likely?
* Does the risk present a moral hazard?
* How much information is needed to make a decision?
- An underwriter must distinguish between information he or she wants to know and information he or she needs to know.
Making a Decision
- The decision is not a simple one it is quite complicated. The insurer must seek insured's that pose acceptable risks of loss but avoid insured's that pose unacceptable risks of loss.
- So an insurer's business is to earn premium while minimizing loss. So generally an underwriter will reject a risk only if forced to by one or more of the three considerations:
> Class not permitted
> The market
> The risk is flawed
- There are many tools available to improve a risk: deductibles, premium rates, modifications of coverage, implement loss control recommendations, among many others.
* Decisions of the underwriter is a continual process, with opportunities to reassess the risk when a loss occurs; when a request is made mid-term; and when the policy expires, and the underwriter must consider whether to renew coverage and on what terms.
The Reinsurance Underwriter
- Is concerned with underwriting the underwriter
- Facultative reinsurance underwriter may not have as much information about the risk as the u/w does; the u/w analysis undertaken by both parties is comparable.
- Treaty reinsurance u/w's must consider whole portfolios, therefore, his or her analysis is most concerned with assessing the approach to risk of an underwriter or the team of underwriters employed by the insurer.
- The treaty reinsurance u/w draws conclusions about the judgment and conduct of the insurer's u/w or u/w's from discussions with them, and then has his or her conclusions verified by an audit of the insurer's u/w files.
The Tools of an Underwriter
- The u/w must have a wide range of knowledge and a complex mix of hard skills and soft skills.
Knowledge
- To accept or reject risk, an u/w must understand it.
- A good u/w is a generalist with a natural curiosity and desire to learn.
- Knowledge is important because it helps an u/w to understand the exposures to loss represented by these risks.
- The knowledge an u/w needs are categorized and called the "Big Five"
> The Environment - risk in context - political, social and economic environment
> The Legal System - u/w must have sound understanding of legal system that governs all parties to the insurance contract and to any losses that might be incurred under that contract.
> The Business - u/w should understand as much as he or she can about both the structure and the dynamics of the insurance industry and other industries that produce risk for the u/w to accept or reject.
* The u/w needs to understand the insurance industry to make sense of his or her employer's underwriting policies.
* The u/w needs to understand the industry in which a risk competes.
> The Product - insurer's product is insurance - a promise of indemnity in the event of loss; peace of mind.
- The u/w should know as much as possible about different types of property, liability, auto, or other insurance policies.
> The Risk - the u/w needs to understand as much as possible about the applicant and about the perils and hazards the risk faces.
Skills
- All the knowledge an u/w might accumulate with "The Big Five" will be useless unless the u/w can apply it.
- "Hard Skills" are tangible, measurable skills uniquely associated with a particular job.
- "Soft Skills" are intangible skills that are hard to measure and generally useful in any job rather than only one job in particular.
U/W's hard skills include:
> Technical skills - computer skills, rating and ratemaking, and research. Hardware & software particular to the insurance industry and generic things such as email. They must understand how a premium rate is derived for a risk from loss and other information, and be familiar with the resources at his or her disposal.
> Analytical skills - all the information an u/w obtains about a risk must be sifted, ordered, and weighted to make a decision about the risk possible.
U/W's soft skills include:
> Communication skills - business is done between people.
> Organizational skills - an u/w must have highly developed time management skills to use his or her other skills most effectively. He or she must be able to do what needs to be done with no wasted effort and especially to be able to set priorities.
Other Requirements
- The u/w's work often requires close cooperation with other professionals both inside and outside the insurance company. People skills are needed.
- The u/w must be able to reconcile apparently conflicting environmental considerations, both internal and external.
- U/W is more attractive to and perhaps better suited by people with certain personal characteristics, and are best met by an u/w suited by temperament to be productive and happy in this line of work.
- Among the many personal characteristics that are valuable in an underwriter, the most important is curiosity or "The power of why"
The Power of "Why"
- a good u/w does not approach his or her work mechanically, deciding for or against a risk and what terms are acceptable by simply matching the risk to the appropriate page of the line guide. A good u/w will always seek to understand a risk and its context as thoroughly as time and resources permit. He or she will then be as creative as is possible or necessary to insure the risk on terms acceptable to both the insurer and the insured.
What Comes Next
- Experience, Knowledge, Skills and Flexibility
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