Underwriting is a key factor in the world of finance, significantly affecting the businesses of insurance, loans, and investments. Underwriting services may be provided by large institutions such as insurance companies, banks, and investment houses, each of which guarantees payment in the event of damage or a financial loss occurring.
Since each of these businesses involves the transfer of risk for a fee (or risk-sharing), underwriting is essential in determining degrees of risk through conducting thorough research. It’s only through accurate underwriting that you, as an underwriter, can form an educated opinion as to whether a particular person or entity is a “good” insurance risk, with a good chance of providing your company with a profit through the proposed risk-sharing transaction.
All insurance revolves around the concept of risk. Insurance risk is the potential that an event could occur for which the insurer is indemnifying the insured and thereby risks a financial loss. Typical insurance risks may include:
- Car Insurance – a collision causing injury or death to a third party, property damage, or non-collision losses such as theft, vandalism, fire, or being struck by a falling object.
- Life Insurance – premature death.
- Homeowner’s Insurance – damage or destruction of a home as the result of any of the perils covered by the policy, including liability.
As an underwriter, your number one task is to decide whether or not an insurance policy should be written and if so, to determine a fair and accurate rate to charge for the agreed-upon coverage. You must decide the amount of coverage a policy applicant should receive and how much that coverage should cost in premium.
Evaluating the riskiness of a particular insurance policy comes down to determining the potential of a covered policyholder filing a loss claim that must be paid by your company. If the riskiness of a particular proposed insured is determined to be too great, your options may be to either recommend higher rates, add certain exclusions to the coverage, or deny policy issuance altogether.
Each individual insurance company will have its own underwriting guidelines to follow. These are designed to help underwriters for the company determine whether or not a particular risk is acceptable for coverage. Information used for risk evaluation will depend on the type of insurance coverage being offered. Some examples include:
- Auto Insurance Underwriting – the applicant’s driving record is an important factor, as is the model car/truck being insured. Other factors include the applicant’s age, gender, zip code, credit rating, and more.
- Life Insurance Underwriting – determining factors you may use when underwriting this type of coverage include age, health condition, occupation, and the nature of any risky hobbies such as mountain climbing or speedboat racing.
- Homeowner’s Insurance Underwriting – due to the comprehensive nature of homeowner’s insurance coverage, much is factored into the underwriting process for these policies. In addition to the condition of the home itself, attention must also be paid to the location of the property and significant factors such as typical weather conditions and crime rates in the area. Much needs to be considered, including in-depth background information on the applicant and the existence of any obvious liabilities. A full home inspection is often recommended to aid in accurate underwriting.
Simply put, insurance risks are risks (or perils) that you, as an insurance company underwriter, have agreed to indemnify a policyholder. As explained above, there are a wide range of insurance risks, and each type of coverage has its own specific risks. The amount of premium charged for policy coverage depends on three factors:
- What are the odds that a certain insurance risk will be realized?
- What is the expected severity if that risk is realized?
- How many risks are involved in the coverage for which your company is being asked to provide indemnification in the policy?
The term “underwriting” originated back in the 17th century when sailing ships were commonly traveling across the oceans carrying valuable goods. Facing many potential dangers such as storms, poor ship construction, hidden reefs, pirates, and more, ship owners and those utilizing their services needed a way to share the cost of potential losses of these ships.
The Beginning – Lloyd’s of London
In a London coffee house circa 1686, coffee house owner Edward Lloyd was responsible for bringing together a number of financial backers interested in underwriting a certain portion of the risk faced by a particular sailing vessel on a specific voyage. Each backer would subscribe (underwrite) their name at the bottom of the shared-risk agreement, indicating what percentage of the overall risk they were willing to insure and verifying that the policy was in force.
Because the names were written and signed at the bottom of the agreement, those backers became known as underwriters. They profited by charging a fee for their promise to financially back the voyage and this was the beginning of maritime insurance coverage that basically continues to live on up until today. Lloyd’s, which many may believe is an insurance company, is actually an insurance marketplace where financial backers, both corporate and private, come together in what’s known as syndicates, to pool together and spread out risk among the many members.
The Importance of Accurate Insurance Underwriting
Since the process of insurance underwriting involves the evaluation of the amount of risk to which your company will be exposed when insuring someone’s home, vehicle, health, or life, much information is needed in order to make an accurate determination. Unless there are special circumstances, much of the process may be automated, with data simply entered into a computer program. Situations where you, as an underwriter, may need to become directly involved include:
- The applicant has made several claims in the past
- The applicant has had past payment issues
- The applicant is a new policyholder with your company
- Any other situation that appears to be outside of the norm
As an underwriter, you’re expected to understand various risks and be aware of ways to help prevent them. Your knowledge of risk assessment is used to decide whether someone or something should be insured by your company and, if so, at what cost. You’ll review all available information and decide whether or not the proposed policy is a good gamble for your company. Your company’s objective is to remain profitable. This means writing policies capable of paying for operating costs, administration costs, and future claims costs, with the help of money collected in the form of premiums being profitably invested.
As an underwriter, you’ll:
- Review available information to determine actual risk
- Determine what perils will be covered and under what conditions
- Alter existing coverage through endorsements when needed
- Look for solutions to help eliminate or reduce conditions that could cause future claims
Homeowner’s insurance is one of the most commonly written types of coverage since about 95% of all homeowners have these policies. Insurance Risk Services (IRS), assisting insurance underwriters for 4+ decades in their underwriting efforts, can help you, too. Contact IRS to learn how.