IC-45 Underwriting PDF

IC-45
GENERAL INSURANCE UNDERWRITING

Acknowledgement:
This course has been prepared with the assistance of
P. C. James
B. V. Sastry
A. K. Padhiari
K. G. P. L. Rama Devi
V. Peri
R. Srinivasan
Y. Priya Bharat
B. V. Sastry
A. S. Chaubal
We also acknowledge Get Through Guides, Pune for their contribution in

preparing the study material.
INSURANCE INSTITUTE OF INDIA

G- Block, Plot No. C-46,
Near Dhirubhai Ambani International School,
Bandra Kurla Complex,
Bandra (E), Mumbai – 400 051.
GENERAL INSURANCE UNDERWRITING
IC-45
First Edition: 2010
All Rights Reserved

This course is the copyright of the Insurance Institute of India, Mumbai. In
no circumstances may any part of the course be reproduced.
Published by Sharad Shrivastva, Secretary-General, Insurance Institute of India,

G- Block, Plot C-46, Bandra Kurla Complex, Bandra (E) Mumbai – 400 051 and
Printed at ……
PREFACE
This course is designed for the use of candidates of the Associateship

Examination (non-life) of the Insurance Institute of India.
The course covers the Principles and Practice of underwriting in all classes of
non- life insurance.
Specifically, the course explains the meaning, objectives and process of

underwriting, describes the tools of underwriting and different methods of rate
making and examines the impact of IRDA Regulations on issues of rating,
underwriting, policyholders' protection etc. Finally the course includes Research
and Development and I.T. Applications in underwriting which reflect value
additions to the course.
Although the course covers the syllabus prescribed for the examination, it is
desirable that candidates should read additional material such as text books,
office manuals and operating instructions and insurance magazines etc. This will
enrich their knowledge of the subject.
The candidates are also recommended to collect and study specimen forms used
in offices (e.g. Proposal, Policy, Claim forms and other forms relevant to the
subject). This will provide a practical basis for their studies.
The candidate may also avail of Oral Tuition Service wherever arranged by The
Associated Institutes and the Postal Tuition Service provided by the Institute.
These supplementary aids will help the student to improve their performance in
the examination.
The course should also prove useful to the general reader who desires to have
knowledge of the subject covered.
CONTENTS
Chapter No. Title Page No.

1 Introduction to Underwriting 1
2 Methodology and procedures of underwriting 22
3 Principles of ratemaking 35
4 Rating approaches in Pricing 52
5 File & Use of Regulations 79
6 Applications of File & Use Regulations 101
7 Tools of Underwriting 125
8 Types of Policies 150
Underwriting Profitability & Re underwriting
9 168
Strategies
10 Protection of Policyholders' Interest 187
Research and Development in Underwriting,
11 Rating and Product Innovation – Challenges 198
ahead
12 I.T. Applications in Underwriting 215
Glossary 236
IC - 45 General Insurance Underwriting
CHAPTER 1
INTRODUCTION TO UNDERWRITING
Chapter Introduction
This chapter aims to provide you with an understanding of the concept of
underwriting. You will also learn about the process of underwriting and different
kinds of underwriting decisions.
a) Understand the concept of underwriting.

b) Learn about the process of underwriting.
c) Learn about different kinds of underwriting decisions.
1
1. Understand the concept of underwriting.

[Learning Outcome a]
1.1 Introduction to insurance
Insurance products have gained popularity in recent times as they offer security
to individuals against financial losses that might occur due to some uncertain or
unplanned events.
Insurance is a contract between the insurer and a policyholder/insured, where the

insured pays premium as consideration and insurer promises to pay a certain
amount of money or provide a defined service if an uncertain event covered
under the insurance policy occurs during the policy
term.
Let us first understand the various terms used in this definition:

a) Insurer: refers to a company that designs, endorses and sells insurance
policies to the individuals.
b) Policyholder/insured: refers to an individual or an organisation who
purchases an insurance policy from the insurer by paying premium.
c) Premium: it is the amount that is calculated using actuarial techniques aimed
at ensuring that the insurer earns profit even after payment of certain claims..
d) Uncertain event: the uncertain event has to be covered in the insurance
policy that has been purchased by policyholder. Insurance can be taken
against any of the following uncertain events:
9 Risk of death or disability due to natural or accidental causes
9 Risk of disability and sickness
9 Risk of loss of or damage to property due to natural or unforeseen events
etc.
Insurance can also be defined as follows:
Insurance refers to the risk transfer cum-sharing mechanism, where risk of an

individual is transferred to another, by way of pooling of risks among a group of
individuals who are exposed to similar kinds of risk, in exchange for a premium.
2
Based on the above definition, the main features of insurance can be summed up
as follows:
9 Risk transfer: Risk is transferred equitably among the group of individuals
who are exposed to similar kinds of risk, in exchange for a small contribution
called ‘premium’. The underlying principle is that, in a group, only few
individuals (and not all) would sustain losses due to the occurrence of an
uncertain event.
9 Pooling of Risk: Insurance is created when people pool their contributions
to create a large enough common fund so as to protect themselves from the
effects of a loss which may in turn randomly affect one or a few who have
contributed to the pool. Whether the loss they are attempting to protect
themselves from is loss of life, disability, assets, or whatever, the basic
concept remains the same.
9 Law of large numbers: If the risk of loss can be spread over a large enough
group (the law of large numbers), the financial loss resulting from the loss to
the members can be paid from the premium collected from the pool, if the
premium so collected reflects the risk affecting the group. This is in contrast
to one person bearing the full brunt of economic loss without any financial
backing. Thus, in insurance, a large and uncertain loss is reimbursed for a
small loss by way of premium.
1.2 Introduction to General Insurance

As per IRDA, “Insurance other than ‘life insurance’ falls under category of
general insurance”. General insurance business in India can be broadly
categorised as follows:
9 Insurance of property against fire, theft, etc.
9 Insurance of loss of income such as Loss of Profits or Business Interruption
insurance,
9 Personal insurance such as accident and health insurance
9 Liability insurance that includes legal liabilities
1.3 Introduction to underwriting
Underwriting is a core insurance function which can be defined as follows.
Underwriting refers to the process by which insurability of the ‘risk’ is

evaluated, which helps in taking decisions regarding acceptance or rejection of
the risk.
3
Features of underwriting
The main features of underwriting are as follows:
a) To determine the level of risk presented by the proposer
Underwriting is the process of determining the level of risk presented by a

proposer and deciding whether to accept it for insurance and, if so, at what terms
and at what price.
b) To classifty risk based upon the risk characteristics
Underwriting attempts to classify risks based upon their characteristics so that

each insured in a specific class pays a premium in proportion to the likelihood
that a covered loss may occur.
Understanding the concept of risk sharing or pooling makes it easier to

understand the role of underwriting and risk classification in insurance. The
simple fact is that – ‘not all risks are equal’.
When viewed from the perspective of fairness, proper risk classification becomes
a central obligation of insurers to the policyholders who participate in their risk
pools. This is true regardless of whether the risk being insured is for life, assets
or earnings.
In the field of property insurance, wooden structures are at a greater risk of

burning than stone structures; hence, a higher premium is required to insure a
wooden structure.
An individual who suffers from a serious illness (e.g., cancer, diabetes etc.) is at
a greater risk of premature death than an individual who does not have the
illness. Since all risks are not equal, it would be inequitable if all persons who are
to be insured are asked to contribute equal amounts.
c) To ensure that the insurance business is conducted on sound lines

Underwriting is a methodological approach to ensure that the insurance business
is conducted on sound lines and that risks offered for insurance are evaluated for
loss potential on both frequency and severity over a period of time over which
the liability may flow to the insurer.
4
None of the insurance companies would wish to incur losses in excess of the
amount of premium that they are getting! Each underwriting decision involves
balancing the insurer’s desire to earn premium often in competitive conditions
with margins required to pay claims and expenses and also to ensure compliance
with regulatory requirements.
In case of vehicle insurance, an insurance company might charge higher premium

in the case of:
9 young drivers,
9 old models of vehicles,
9 drivers with a history of accidents
In some cases, the insurance company may refuse coverage to drivers with a
history of accidents.
The underwriter may offer discounts for vehicles fitted with anti-theft devices.
In case of property insurance, an insurance company may inspect propertieswith

respect to their exposure to fire risk, theft risk etc. Accordingly, underwriters
may offer reduced premiums for properties that have safety features such as
sprinkler systems.
1.4 Purpose and Objectives of underwriting
By purchasing an insurance policy, a policyholder transfers his risk to the

insurance company against which he needs to pay a certain amount as premium.
The main purpose and objective of underwriting is deciding level of
acceptability, adequacy of premium & other terms for such a Risk Transfer.
Rajiv Saxena had purchased motor insurance at the time of purchasing a car from
ABC insurance company. As per the terms and conditions of the insurance
policy, the insurance company would pay for the repairs if the car is damaged in
an accident.
Hence, by having an insurance policy, the financial losses that might arise due to
accidents are reduced or eliminated.
5
The insurance company assumes the risk it takes on by charging premiums and
setting deductibles.
9 If premium is kept low: If a company charges too little, it could become

insolvent when large claims, whether by frequency or severity, are filed.
9 If premium is kept too high: If a company charges too much, it will lose
business to its competition, and face regulatory hurdles as well.
Hence, underwriters have the challenge to ensure that they correctly assess the
risk and accordingly charge the appropriate premium.
1.5 Profile of an underwriter
The profile of an underwriter may be understood by what he does in the

insurance organization. Insurance companies are in the business to protect
individuals and organizations from financial loss by assuming risk—risks of
motor accident, property damage, illness and other occurrences.
An insurer may lose business to competitors if the underwriter appraises risks too
conservatively, or it may have to pay excessive claims if the underwriting
decisions are too liberal.
Profile of underwriters
a) Underwriters have to
9 Analyse proposal forms and do background check on proposer.

9 Identify and Assess the level of risk
9 Evaluate the risk of loss
9 Establish who can be given coverage
9 Decide on special terms and conditions that can be offered for accepting the
risk
9 Determine the appropriate premium, and the terms and conditions for
providing insurance cover.
9 Write policy wordings
9 Negotiate with insurance brokers and the proposer
9 Monitor account information
6
b) Underwriters use computer applications to manage the risks they

underwrite more efficiently and accurately. These systems
9 analyse and rate insurance proposals,

9 recommend acceptance or rejection of the risk, and
9 adjust the premium rate in accordance with the risk
With these systems, underwriters are better equipped to make sound decisions
and avoid excessive losses.
c) Role of internet
The internet also plays an increasingly important role in the work being done by
underwriters. Many insurers’ computer systems may now be linked to various
databases on the Internet that allow immediate access to information - such as
driving records in some countries, so that information necessary for determining
a potential client’s risk can be accessed instantly and utilised effectively. Such
access to real time information reduces the amount of time and paperwork
necessary for an underwriter to complete a risk assessment.
1.6 Importance of underwriting
Underwriting is important to different entities from different perspectives.
a) Insurers
For Insurance companies underwriting is a core activity. The underwriting

capacity it has helps to offer value to consumers in terms of
9 Risk reduction,
9 Risk improvement and
9 Risk transfer.
Underwriting is a key differentiator enabling the insurer to stay competitive, and

at the same time, be solvent and profitable.
b) Insured
Underwriting also helps the insured to appreciate the magnitude of risk that is
being proposed to be covered and the suggestions given to reduce the risk, which
if implemented, helps to improve insurability and reduce various hazards.
The underwriter’s opinion may determine how much the proposer has to pay for
insurance, the terms of coverage, exclusions, discounts, and deductions.
7
c) Agents and brokers
Underwriting is important to Brokers and Agents as it will match the needs of

consumers with the standards set by insurers. It helps the intermediary to
appreciate the philosophy of the insurer, help clients to improve their loss profile,
give customer satisfaction and also help in business growth.
d) Society
Efficient underwriting by insurers paves the way for organized and sustained
growth of risk taking in the country which significantly contributes to and
supports the growth of the economy and provides social cushions in case of
losses and catastrophes. It helps to improve the standards of safety and care and
achievement of the economic and social goals of a country.
The underlying principle of _____________ is that in a group, only few

individuals (and not all) would sustain losses due to the occurrence of an
uncertain event.
A Law of large numbers

B Underwriting
C Risk Transfer
D Broking
2. Learn about the process of underwriting.

[Learning Outcome b]
2.1 Important factors in the process of underwriting
As discussed earlier, underwriting is the process of determining whether a risk

offered for insurance is an acceptable risk, and if so, at what rate the insurance
cover will be accepted.
Logically, therefore, insurers may not find it possible to accept every proposal.
An insurer has to ensure that the underwriting process needs to be carried out
meticulously.
8
Some important factors that need to be considered by an insurer in the

underwriting process are:
a) To maintain equity and sustainability
An insurer has a responsibility to its current policyholders to ensure that it will be

able to meet all the contractual obligations of its existing policies. If the
insurance company issues policies on risks that are uninsurable or risks that
require premiums higher than what the insurer charges, the insurer’s ability to
meet its contractual obligations is jeopardized.
b) To protect consumer’s long term interest
An insurer with a profit motive may want to charge very high rates for risks that
do not warrant such high rates. Such practices would result in loss to the
policyholders on their investments in the long term.
c) Regulation
Regulation is another important factor in the underwriting process. In order to

protect consumer’s long term interests and to protect policyholders against
insolvency or other malpractices, an insurer is regulated by an insurance
regulator in many countries. In India, the insurance regulator is the Insurance
Regulatory and Development Authority (IRDA). IRDA, in tune with the best
practices of insurance tradition, expects the insurer to establish reasonable, non-
discriminatory standards for accepting risks. The premium rates for many types
of insurance must be approved or should be within the framework of guidelines
issued by the Regulator.
2.2 Process of underwriting
The process of underwriting involves four basic functions:

a) Selection of risks,
b) Classification and rating,
c) Policy forms, and
d) Retention and reinsurance.
The first three underwriting functions—risk selection, classification and rating,

and policy selection—are interdependent. That is, the underwriter determines that
a certain risk is acceptable upon which he proceeds to classify and rate the risk
and issues the relevant policy.
9
The underwriter also performs a fourth, separate function before underwriting is

complete: reinsurance.
Diagram 1: Process of underwriting
The first three processes are interdependent.

By performing these four functions, the underwriter increases the possibility of
securing safe and profitable distribution of risks in his books.
a) Selection of risks
In this step, the underwriter decides whether or not to accept a particular risk. It
involves
9 securing factual information from the Proposer via the proposal form,
9 evaluating that information, and
9 deciding on a course of action
Underwriting involves examining material disclosures in proposal forms, and

supporting documents such as Inspection Reports, Valuation Reports/ appraisals
or bills that certify the value of property, or medical reports that verify the health
condition of an individual.
b) Classification and rating
Once the risk has been accepted, the underwriter then classifies and rates the
risks.
10
Classification of risk
The purpose of using classifications is to separate risks into homogeneous groups

to which rates can be assigned. Several tentative classifications may be tried out
before a final decision on classifying the risk is reached.
Insurers may have their own classification and rating system compliant with the
guidelines of the Regulator.
Rating
Rate making is the process of calculating a price to cover the future cost of
insurance claims and expenses, including a margin for profit.
To establish rates
9 Insurers look at past trends and changes in the current environment that may
affect potential losses in the future.
9 Insurers utilise the expertise and skills of actuaries, who use the data
collected by the insurer as per the actuary’s requirement and then use the
findings to validate the rates and suggest the right rating practices.
9 Underwriters also use experts such as engineers and surveyors to make site
inspection reports and evaluate the risks through their findings.
9 Upon a thorough examination of all the data, underwriters then decide the
final rates and terms under which a proposal can be accepted.
It should be remembered that ‘Rates’ are not the same as premiums. A rate is the
price of a given unit of insurance. Rates vary according to the likelihood and
potential size of loss.
In earthquake insurance, rates would be higher near a fault line and for a brick
house, which is more susceptible to damage, than for a concrete structure.
Objective of rating
The basic objective of rate makers is simply that the rates should be adequate and
reasonable, both from the point of view of the insurer and the insured.
11
For insurer
From the point of view of the insurer,

9 The rates in the aggregate must be sufficient to provide for the payment of
claims, expenses and taxation and leave an adequate margin for catastrophes
and profit.
9 It is also important that the rates in any class should not be excessive because
the premium should be affordable and equitable to the consumer and the
business should not be lost to a competitor making its own rates on a more
reasonable basis.
Unless these requirements are met, it is impossible to survive and grow in a
dynamic insurance market.
For insured
From the point of view of the insured, reasonable rates imply that he should not
be required to pay more than a sufficient sum to cover the hazards involved,
together with a reasonable charge for expenses, catastrophes and profits.
It is very difficult to determine an adequate amount of premium in principle, let
alone on a case to case basis. There can be numerous factors that might affect
the risk associated with an individual. Hence, it would be very difficult for an
actuary to consider all those factors and accordingly rate them. Also it is
interesting to note that in Life insurance, vast majority of lives are accepted at
rates which involve only one factor, namely, ‘age’, although there are many other
factors which are known to have some bearing on mortality.
A rating structure should not be so complicated that it becomes difficult or
expensive to apply.
9 For classes involving small units, the application of the system must be as
standardised as possible.
9 For a class involving large size of individual units, greater complexities can
be reasonably built in to produce greater rating accuracy.
Fire rates can be considered reasonable if they take into account all major factors
which affect the risk but ignore minor factors which would not result in more
than a small variation in the estimated rate.
12
c) Policy forms
After determining the acceptability of a risk and assigning proper classification

and rating, the underwriter dealing with that particular class of risk, is ready to
issue an insurance policy.
The underwriter must be familiar with different types of policies available as well
as be able to modify the form with additional necessary warranties, clauses, and
special conditions as may be needed to fit the underwriting requirements so that
the policy is issued correctly.
d) Retention and reinsurance
Reinsurance
Reinsurance in simple terms is insurance of insurance. It is a mechanism used by

insurers to spread risks in order to limit their exposure to claims which might
arise on policies of insurance which they have issued. .
Reinsurance ensures that no one insurer is overburdened while offering covers to

policyholders.
Catastrophes, large losses or a series of losses, new and unexpected liabilities,

etc. can create risks & affect profitability of the insurer.Thus, a decision needs to
be taken while underwriting on the amount that will be retained in the insurer’s
books and on the method of appropriate reinsurance for the balance.
Therefore, reinsurance becomes an essential part of underwriting as it is a tool to

help the insurer to:
9 expand its underwriting capacity,
9 maintain earnings stability, and
9 reduce the requirements of creating large reserves
Which of the following is incorrect?
A Rates are the same as premiums.

B A rate is the price of a given unit of insurance.
C Rates vary according to the likelihood and potential size of loss.
D Rate making is the process of calculating a price to cover the future cost of
insurance claims and expenses.
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3. Learn about the different kinds of underwriting

decisions.
[Learning Outcome c]
3.1 Types of underwriters
An insurance company may issue policies for many different types of insurance.
However, most underwriters perform their responsibilities as specialists. An
underwriter may underwrite only property policies, or only liability policies, or in
another case, only motor or retail insurance and so on.
Diagram 2: Types of Underwriters
14
3.2 Underwriting decisions
When evaluating risks, underwriters can take any of the following decisions:
a) Policy to be issued on a preferred basis,
b) Policy to be issued on a standard basis,
c) Policy to be issued on a substandard basis or
d) Proposal to be declined.
Diagram 3: Underwriting decisions in Risk Evaluation
a) Policy to be issued on a preferred basis
If a proposal falls within the lowest risk boundaries of underwriting standards,

the policy is issued on a preferred basis.
Preferred rate represents the lowest rates offered by an insurer for its coverage.
Rates offered on a preferred basis must adhere to the insurance regulations
applicable to them, just as rates offered on a substandard and standard basis must.
Insurance regulators do not want insurers to offer rates that are so low that the
insurer cannot meet its contractual obligations to pay covered claims.
b) Policy to be issued on a standard basis
Proposers who are issued policies with standard rates fall within the normal
boundaries of underwriting standards for that type of policy.
15
Underwriters base their determination that a policy should be issued on a

standard basis on an analysis of the characteristics of the risk represented by the
Proposer.
c) Policy to be issued on sub-standard basis
The decision to issue a policy on a substandard basis occurs when a risk is not
deemed to be outside underwriting standards, but is considered to be of high risk
within those standards. The insurer generally has the following three basic
options when it offers a substandard policy to a Proposer.
9 Issue the policy with a higher premium than would be required for a
standard policy: The insurer may charge a higher premium to Proposers
who are considered to be of higher risk than those who would be considered
a standard risk as long as those higher rates fall within certain parameters.
The rate cannot be discriminatory. The insurer must charge the same rate to
every insured having similar characteristics.
9 Issue the policy with limited benefits: Insurers may respond to substandard
proposers by offering a policy with limited policy benefits or lower policy
limits. Again, the insurer may limit benefits as approved through the ‘file and
use’ guidelines of the Regulator.
Dealing with substandard Proposers by limiting policy benefits is common

in commercial coverage.
9 Issue the policy with certain exclusions: Another option an insurer may
have is to offer a substandard Proposer a policy that excludes coverage for
certain property and insured or operations that are deemed too high a risk for
the insurer to cover. As with the other options discussed, such exclusions
must be allowable under the regulations.
An insurer may offer to provide liability coverage for all business operations
except for that portion that has potential pollution liability that is too high for
the insurer to cover.
d) Proposal to be declined
Insurers decline proposals for insurance when they find that the proposal
represents a risk that falls outside of their established underwriting standards.
16
These underwriting standards take into consideration many items, such as

9 regulations that require the insurer to establish adequate rates,
9 laws that mandate that certain factors cannot be used to decline a proposal, or
9 the proposal is contrary to various insurance principles and practices such as
those of insurable interest, utmost good faith or indemnity
Proposals which are against public good and violate the laws of the country
would also be not insurable.
3.3 Monitoring of underwriting decisions
Once a policy is issued, underwriters continue to monitor the policy from an

underwriting perspective. Such monitoring is done at
9 policy renewal, or
9 at periodical intervals such as every six or twelve months, or
9 as and when a claim occurs.
Depending upon the type of policy and its provisions, rates & terms of cover
may be varied at renewal; or in extreme cases, the insurer may make the decision
not to renew the policy.
Changes in rates or the decision not to renew are only made if allowed by policy
provisions and applicable regulations, if any, made by the Regulator.
If a proposal falls within the lowest risk boundaries of the underwriting

standards, then which of the following decisions can be taken by an underwriter?
A Policy to be issued on a preferred basis.

B Policy to be issued on a standard basis.
C Policy to be issued on a substandard basis.
D Proposal to be declined.
17
Summary
¾ Insurance is created when people pool their contributions to create a large
enough common fund so as to protect themselves from the effects of a loss
which may randomly affect one or a few who have contributed to the pool.
¾ As per IRDA, “Insurance other than ‘life insurance’ falls under the category
of general insurance”.
¾ Underwriting is the process of determining the level of risk presented by a
proposer and deciding whether to accept the risk and, if so, at what terms and
at what price.
¾ The main purpose and objective of underwriting is Risk Transfer. By
purchasing an insurance policy, the policyholder transfers his risk to the
insurance company against which he needs to pay a certain amount as
premium.
¾ Underwriting is a key differentiator enabling the insurer to stay competitive,
and at the same time be solvent and profitable.
¾ Underwriting is important to Brokers and Agents as it will match the needs
of consumers with the standards set by insurers.
¾ The three underwriting functions—risk selection, classification and rating,
and policy selection—are interdependent. That is, the underwriter determines
that a certain risk is acceptable upon which the underwriter proceeds to
classify and rate the risk and issues the relevant policy.
¾ The purpose of using classifications is to separate risks into homogeneous
groups to which rates can be assigned.
¾ ‘Rates’ are not the same as premiums. A rate is the price of a given unit of
insurance. Rates vary according to the likelihood and potential size of loss.
¾ Reinsurance ensures that no one insurer is overburdened while offering
covers to policyholders.
Answers to Test Yourself

Answer to TY 1
The correct answer is C.
The underlying principle of risk transfer is that in a group, only a few individuals
(and not all) would sustain losses due to the occurrence of an uncertain event.
18
Answer to TY 2
The correct answer is A.
Rates are not the same as premiums.
Answer to TY 3

standards, then the underwriter can issue the policy on a preferred basis.
Self-Examination Questions
Question 1
ABC insurance company is a new entrant in the insurance market. As a

marketing strategy, it has decided to accept the risk at lower premium rates as
against the prevailing market rates. What could be the repercussions of this?
A The insurance company will lose business to competitors

B It will face regulatory hurdles
C The insurance company could become insolvent when large claims, whether
by frequency or severity, are filed.
D It will earn profit by maximizing sales.
Question 2
___________ensures that no one insurer is overburdened while offering covers to

policyholders.
A Risk pooling
B Risk sharing
C Underwriting
D Reinsurance
19
Question 3
Which of the following decisions is incorrect when a risk is not deemed to be

outside underwriting standards, but is considered to be of high risk within those
standards?
A Issue the policy with a higher premium

B Issue the policy with limited benefits
C Issue the policy on a preferred basis
D Issue the policy with certain exclusions
Question 4
Which of the following is the insurance regulator in India?
A The RBI
B The IRDA
C The Government of India
D The Department of ministry and finance
Question 5
According to ______________________, if the risk of loss can be spread over a

large enough group, the financial loss resulting from the loss to the members can
be paid from the premium collected in the pool, if the premium so collected
reflected the risk affecting the group.
A Risk transfer
B Risk sharing
C Pooling of risk
D Law of large numbers
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Answers to Self-Examination Questions

Answer to SEQ 1
The correct option is C.
The insurance company could become insolvent when large claims, whether by
frequency or severity, are filed.
Answer to SEQ 2
The correct answer is D.
Reinsurance ensures that no one insurer is overburdened while offering covers to

policyholders.
Answer to SEQ 3

standards, then only the underwriter can issue the policy on a preferred basis.
Answer to SEQ 4
The correct answer is B.
The IRDA is the insurance regulator in India.
Answer to SEQ 5
According to the law of large numbers, if the risk of loss can be spread over a
large enough group, the financial loss resulting from the loss to the members can
be paid from the premium collected in the pool, if the premium so collected
reflected the risk affecting the group.
21
CHAPTER 2
METHODOLOGY AND PROCEDURES OF

UNDERWRITING
This chapter aims to provide you with an understanding about the various steps
involved in the underwriting process.
a) Understand the underwriting procedure.
22
1. Understand the underwriting procedure.

1.1 Underwriting skills
Underwriting needs a combination of various skills. Before the underwriter

accepts the risks, he would be expected to:
9 Visualise potential risks: Clearly visualise the property or interest to be
insured and the variety of potential risks that can cause losses to them
9 Estimate probability of peril operation: Estimate the probability of
operation of peril to be insured in relation to both 'frequency' and 'severity'
of losses
9 Estimate liability: Estimate the extent of liability that may arise due to the
operation of a peril and the claims processing implications
The underwriter can then decide on whether to accept the risk or otherwise. If the
underwriter decides to accept the risk, then the next step would be to decide the
rates, terms and conditions. Here the skills of the underwriter play a vital role. It
is a quality that can be acquired through a continuous learning process, adequate
training, field exposure and deep insights.
The knowledge of causes of fire in fire insurance and the geography, climatic
conditions, port/road conditions, types of risks etc. encountered by goods in
transit or storage in marine insurance and so on.
Once the risk is accepted, the policy, which is a legal document, is to be drafted
without any ambiguity. It would be worthwhile to remember that any ambiguity
in an insurance policy will always be viewed against the insurer, since it is
drafted by him.
1.2 Classification of underwriting of risks
Broadly the underwriting of risks can be classified into the following broad
categories based on the subject matter that is being covered under the policy:
a) Property risks such as a manufacturing plant, machinery and building

b) Business interruption risk
c) Personnel risks such as policies relating to personal accident insurance and
health insurance
23
d) Liability risks like motor third party liability, public liability, product
liability etc.
e) Risks of Householders, Shopkeepers etc. which are covered under Package
policies.
Considering the nature of risks, different methods are followed for underwriting
of new business and renewal business.
Diagram 1: Broad classification of underwriting of risks
1.3 Underwriting of new business
Acceptance of new business is one of the main underwriting functions. This is

done based on the knowledge and skills of the underwriter who is authorised to
do so. Where the insurance is complex or is of high value, senior officer will
either assist or underwrite such risks.
Each insurer has its own manuals of underwriting instructions.
Broadly speaking, these instructions and guidelines may cover the following:
a) acceptance of simple risks irrespective of sum insured;
b) acceptance of certain specified risks up to specified sums insured;
c) acceptance of certain classes of business with prior approval of the
controlling office;
d) acceptance of risks subject to specific underwriting safeguards;
e) acceptance / rejection of sub-standard risks;
f) rejection of risks
24
1.4 Scrutiny of the proposal
A completed proposal form gives:

9 details of the insured,
9 details of the subject matter,
9 type of cover required,
9 details of the physical features both favourable and adverse including type
and quality of construction, elevation, age, presence of firefighting
equipments, the type of security etc.
9 previous insurance and
9 claims history
Diagram 2: Proposal Form
The insurer also may arrange for pre-acceptance survey of the risk depending on
the nature and value of the risk. Based on the information available in the
proposal and in the risk inspection report, additional questionnaire and other
documents which may be obtained, the insurer takes underwriting decisions.
25
1.5 Limit of acceptance
The limit of acceptance is basically the limit of sum insured up to which the
operating office can underwrite the risk without referring to the Controlling
Office. As a matter of precaution, the companies allow their operating offices to
underwrite the class rated products whereas the controlling office may prefer to
underwrite the individually rated and exposure rated products.
Viewed in another perspective, insurers generally allow their operating offices to

underwrite classes of business where the claims experience does not vary to a
large extent unless affected by catastrophic losses. Examples of these classes are
personal line insurances like motor policy, mediclaim policy and householder’s
policy etc.
Limits of acceptance could also be dependent on the type of assets or persons to

be covered or geographical areas where the risks are not normal or standard.
Thus depending on the underwriting standards adopted by each insurer the limits
of acceptance can vary across various parameters.
1.6 Acceptance subject to controlling office approval
Generally speaking, approval of the Controlling Office is necessary before

acceptance of certain classes of business based on the size or complexity of the
business or both. Some of these classes could be:
a) Aviation
b) Fire and Machinery Loss of Profit Insurance
c) Industrial All Risk Policy
d) Public Liability, Products Liability etc.
e) Jeweler’s block beyond a specific sum insured
f) Contractor's All Risk / Erection All Risk etc.
1.7 Acceptance of extra-hazardous risks
Proposals relating to certain risks that are found to be more claims prone owing
to physical hazard may have to be referred to the Controlling Office before
acceptance together with the following particulars:
a) Completed proposal form
b) Risk inspection report, additional questionnaires
c) Other premium income received from the same client and agent separately
for fire, marine and miscellaneous classes
d) Past loss experience
e) Reasons as to why the proposal is required to be accepted
26
There are risks which may be regarded as extra-hazardous. Normally such risks
are to be declined. These risks are commonly referred to as Declined Risks.
Nevertheless, some of these risks are accepted subject to fixing of appropriate
rate of premium and imposing loss minimising restrictive conditions, clauses and
warranties in the policies.
Some examples of such risks in different classes of business are:
a) Fire
9 Ammunition works
9 Camphor boiling works
9 Celluloid and celluloid articles factories
9 Explosive factories and premises
9 Fire wood / bamboos in the open
9 Fireworks factories and premises
9 Match factories and matches in transit
b) Marine
9 Bullion (gold), currency notes over specified limits
9 Bulk cargo on terms wider than I.C.C.(C)
9 Cement in bags on terms wider than I.C.C.(C)
9 Deck cargo on terms wider than I.C.C.(C)
9 Galvanised iron sheets on terms wider than I.C.C.(C)
9 Second-hand machinery against breakage
9 Oil in second hand drums against leakage and contamination
9 Perishable goods and sea foods etc.
9 Salt on terms wider than I.C.C.(C)
9 Sugar against 'all risks' terms
c) Miscellaneous
9 Burglary: Jewelers, dealers in precious stones, curios and antiques, gold
and silver smiths
9 Cash-in-transit: Proposals involving large carrying without adequate
escort arrangement
9 Fidelity guarantee: Employees remunerated on commission basis
9 Workmen’s compensation insurance: Fireworks / gun powder /
explosives manufacturers, collieries and mines of all descriptions,
quarries of all descriptions
27
1.8 Acceptance of risks subject to underwriting safeguards
Certain risks are allowed to be accepted by the operating offices provided certain
loss minimising measures are taken.
9 Special perils (flood etc.) under fire insurance policy may be accepted
subject to inspection of the risk and satisfactory flood prevention measures.
9 Consequential loss (fire) policy may be granted only to clients, whose books
of accounts are regularly audited by a reputed firm of auditors.
9 In motor insurance, acceptance of 'Own Damage' risks is subject to the
specified year of manufacture of the vehicle being acceptable. This
specification varies from one class of vehicle to another. Older vehicles may
be accepted subject to inspection of the vehicle and imposition of excess.
9 Certain types of vehicles may be covered only for 'Act only' risks.
Imposition of exclusions in marine insurance
In marine insurance, acceptance of some types of proposals is subject to

imposition of exclusions. Examples are:
Proposal for Exclusion

Asbestos cement pipes and Breakage is excluded
sheets
Transformers Breakage is excluded and excess imposed on
leakages
Refrigerators and air Denting and scratching are excluded
conditioners
Cargo in paper bags Tearing and bursting of bags is excluded
Glass Breakage, scratching and chipping and
denting is excluded
Sanitary ware Breakage, chipping and denting is excluded
Second hand machinery Breakage is excluded
Oil in second hand drums Leakage and contamination is excluded
Motor spare parts, ball Theft, pilferage and non–delivery is excluded
bearing
Motor vehicles Denting and scratching excluded
28
In marine insurance, the cargo carrying vessel is an important underwriting

factor. Whereas normal rates are charged for cargo carried on vessels which
conform to standards prescribed (e.g. liner vessels not over certain years old),
extra rates are charged if the vessel is over certain years of age (overage) or the
tonnage is below the prescribed limit (under-tonnage).
1.9 New Business Procedure
The procedure dealing with acceptance of business and issue of documents such
as cover notes, policies etc. in all classes of insurance have certain common
features. These features may be considered under the following headings:
Provisional Acceptance
9 Declined risks: The proposals are examined in the light of the standards
adopted for the acceptance of risks by the insurer. Risks which are regarded
as extra hazardous are declined. Each company in their Corporate
Underwriting Policy spells out the list of declined risks.
9 Limits of acceptance: Reference is also made to the limits of acceptance to

ensure that the sum insured accepted is within these limits. These limits vary
according to the type of risks and are determined on the basis of reinsurance
arrangements.
9 Reinsurance arrangement: If the sum insured exceeds these limits, it is

necessary to arrange reinsurance before acceptance. This is done at the
Corporate Office level.
9 Inspection report: At this stage, the question of inspecting the risk is often
considered. If the risk is large or involves complicated features, acceptance is
decided on the basis of an inspection report. Pre-acceptance inspection of
risks is common in fire, burglary, public liability and engineering insurances
etc.
9 Issue of cover note / policy: If the risk is acceptable, the premium is quoted
and, on receipt of the premium, cover notes/policies are issued.
29
Issue of policies
9 Policy preparation and stamping: When complete particulars of the risk

are available the policy is prepared and stamped in accordance with the
Indian Stamp Act.
9 Recording details: The policies are numbered in serial order and entered in
the premium register. The policy number is also entered in the cover note
register against the relevant cover note number, if a cover note has been
issued.
9 In marine open policies, in addition to the policies, certificates serially

numbered are issued which may be required in respect of specific
consignments. The certificate incorporates such information as policy
number, name of the insured, sum insured, terms of insurance and details of
premium etc.
9 In motor insurance, in addition to the policy, a certificate of insurance is

issued. This document is required to be issued under the provisions of the
Motor Vehicles Act, 1988, as evidence of insurance cover in respect of legal
liabilities to third parties compulsorily insurable under the Act.
9 Renewal: The policies are entered in a renewal register or an expiry register

according to the date and month of renewal to facilitate the procedure of
inviting renewal at the appropriate time.
1.10 Underwriting of renewal business
Annual cover: Most non-life insurance covers are granted on an annual basis.
The period of insurance (i.e. date of commencement of insurance and the date of
expiry) is clearly stated in the policy. The insurance contract, unless otherwise
stated, expires at midnight, of the date of expiry.
Renewal is not automatic: The preamble of a policy usually states that the
indemnity thereunder applies during the period of insurance named in the
schedule or any subsequent period in respect of which the insured shall have paid
and the insurer shall have accepted the premium required for renewal of this
policy. From this it is clear that renewal of the policy is not automatic. It depends
upon the consent of the insurers to renew the policy and the payment of
premium.
30
Renewal notice: It is important to note that there may be no strict legal

obligation on the part of insurers to renew the policy or even to invite renewal.
However, as a matter of courtesy and good business policy, insurers issue a
renewal notice to the insured, usually a month in advance of the date of expiry. If
for any reason, they are not interested in the renewal of the policy, they give
previous notice to the insured to that effect.
Renewal methods
Renewal of policies can also be utilised to review underwriting results and take
corrective steps.
¾ There are a number of renewal methods that can be incorporated in policy

conditions such as:
¾ Non-cancelable renewals: Renewals are assured and without any changes
¾ Guaranteed renewals: Changes not usually made in the terms of the policy
but premium rates can vary based on underwriting results
¾ Non-renewable for stated reasons such as on reaching a specified age
¾ Optionally renewable: Subject to re-evaluation of risk by the insurer which
can include review of premium and modification of the terms and conditions.
Many insurance products such as health for instance, are matters relating to the
life and dignity of human beings and hence renewals need to be handled with
great sensitivity. Courts can take an adverse view of practices that appear
detrimental to the protection of the consumer. Weighty reasons, such as those
based on grounds of fraud or misrepresentation and not merely on the basis of
random individualised claim experiences may need to be cited in case of a legal
dispute. Regulations have also come into force in some countries where refusal
of renewal is regulated.
Renewal is normally deemed to constitute a fresh contract and the duty of utmost
good faith is revived, although in many insurance cases a fresh proposal form is
not required to be completed by the insured. Renewal, of course, is effected
subject to payment of premium. A fresh policy is issued specifying the terms and
conditions of the further period insurance.
Under certain types of insurances, adjustment of premium has to be made at

renewal. For example, under money-in-transit insurance, the premium is
calculated on basis of the actual amount of money in transit during the period of
insurance. If premium so calculated differs from the provisional premium then
premium shortfall is collected or excess premium refund is made, as the case may
be. Similar practice is also followed in fire and marine declaration policies and
workmen's compensation insurance.
31
Reinsurance programme: Insurers formulate their reinsurance programme well

in advance for the new financial year and file it with Insurance Regulatory and
Development Authority (IRDA).Within the broad framework of the reinsurance
programme, the insurer operates its day to day reinsurance activities.
(This topic is dealt with in Chapter 7)
(Note: The step by step procedure described above is based on manual

operations. With the use of IT applications, the process is made automatic based
on software design for the purpose).
At the time of underwriting a proposal, the underwriter has to estimate the

probability of operation of peril to be insured in relation to ________.
A Frequency of losses
B Severity of losses
C Both frequency and severity of losses
D None of the above
Summary
¾ Before accepting the risk the underwriter is expected to visualise potential
risks, estimate the probability of peril operation and estimate the extent of
liability.
¾ The underwriting of risks can be classified into the following broad
categories: property risks, business interruption risk, personnel risks, liability
risks, package policies.
¾ The underwriter scrutinises the proposal and may arrange for pre-acceptance
survey of the risk depending on the nature and value of the risk.
¾ The limit of acceptance is basically the limit of sum insured (SI) up to which
the operating office can underwrite the risk without referring to the
Controlling Office.
¾ Generally speaking, approval of the Controlling Office is necessary before
acceptance of certain classes of business based on the size or complexity of
the business or both.
¾ Risks regarded as extra-hazardous are normally declined. These risks are
commonly referred to as Declined Risks.
¾ Certain risks are allowed to be accepted by the operating offices provided
certain loss minimising measures are taken.
32
¾ If the sum insured exceeds limits of acceptance, it is necessary to arrange

reinsurance before acceptance. This is done at the Corporate Office level.
¾ Renewal of general insurance policies is not automatic. It depends upon the
consent of the insurers to renew the policy and the payment of premium.
¾ Renewal methods include: non-cancelable renewals, guaranteed renewals,
non-renewable, optionally renewable.
¾ Insurers formulate their reinsurance programme well in advance for the new
financial year and file it with Insurance Regulatory and Development
Authority (IRDA).

Answer to TY 1
At the time of underwriting a proposal, the underwriter has to estimate the

probability of operation of peril to be insured in relation to both 'frequency' and
'severity' of losses.
Question 1
Which of the following is true for reinsurance programme?
A The insurer needs to formulate their reinsurance programme well in advance

for the new financial year.
B The insurer needs to formulate their reinsurance programme on a half yearly
basis
C The insurer needs to formulate their reinsurance programme on a quarterly
basis
D The insurer needs to formulate their reinsurance programme on a monthly
basis
33
Question 2
Approval of the _________ is necessary before acceptance of certain classes of
business based on the size or complexity of the business or both.
A Branch manager
B Controlling office
C Regional office
D Corporate office
Question 3
Extra hazardous risks that are normally not accepted by the insurer are commonly
referred to as ________.
A Rejected risks
B Forbidden risks
C Declined risks
D Prohibited risks

Answer to SEQ 1
The correct option is A.
The insurer needs to formulate their reinsurance programme well in advance for
the new financial year.
Answer to SEQ 2

Approval of the Controlling Office is necessary before acceptance of certain
classes of business based on the size or complexity of the business or both.
Answer to SEQ 3

Extra hazardous risks that are normally not accepted by the insurer are commonly
referred to as declined risks.
34
CHAPTER 3
PRINCIPLES OF RATE MAKING

This chapter aims to provide you with an introduction to the basic principles of
rate making and related issues.
a) Understand the concept of ratemaking.

b) Learn about the process of ratemaking.
35
1. Understand the concept of ratemaking.

1.1 Underwriting
General insurance is a complex subject. To make it relevant to customers and to
make it profitable for their insurers, underwriters need to examine thoroughly all
the risk factors affecting the subject matter offered for insurance.
Underwriting is the process of

9 classifying the subject matter according to their degree of insurability
9 evaluation of risks to which they are exposed
9 to decide on their acceptance to decide on terms and conditions and
9 charge appropriate rates of premium
1.2 Ratemaking
The purpose of ratemaking is to set the prices of insurance products sold in such
a manner that it will provide sufficient income to pay for
9 the projected claims based on both experience and exposures,
9 all expenses that the insurer will incur in the selling and administration of the
product
In addition insurers would like to build a margin for adverse deviation and a
reasonable return on the capital employed.
There is also another requirement for ensuring proper ratemaking. The rates of
insurers are subject to regulatory review. The regulatory standards in India are set
in the “File and Use” guidelines and other regulatory directions given from time
to time by the insurance regulator i.e. IRDA.
The standard for the regulator is that the rate shall not be inadequate, excessive or
unfairly discriminatory as between risks of similar type and quality.
1.3 Objectives of a premium rating system
There are subsidiary objectives while developing a premium rating system apart
from the above mentioned. These are:
a) Stability: Rates should remain stable over a period of time
36
b) Responsiveness: Rates should respond to changes in loss exposures.
Both objectives appear contradictory but are desirable and can be reconciled
if the price normally remains within predictable bands; and should not swing
too far owing to an unlikely extreme severe event.
c) Contingencies:It should provide for contingencies, whereby some loadings

are built in for the unknown and the unknowable;
d) Incentive(s) to insured: It should offer necessary incentive to the insured,

that is, incentives should be built into the rates to encourage the insured to
avoid losses and in case of a loss to minimise the loss costs.
Diagram 1: Objectives of Premium Rating System
1.4 Types of rating
Rating can be
9 Generic rating: it will be rated as per an internal manual or guidelines

prepared by the insurer for risks of the same class or category, or
9 Individual rating: there can be individual experience based rates or where

experience is not available, based on the analysis of exposure made by the
underwriter.
37
Though ratemaking for risks as per in-company manuals, involves the use of
mathematical and statistical data and tools, it also requires
9 understanding of risks and their behaviour
9 the use of sound judgement acquired through experience and knowledge,
9 the economic, technological, social, political and other factors which had an
impact in the past on the underwriting results and may also influence
possible losses in the future.
Rate makers necessarily need to appreciate that rates which have been adequate
in the past need not be so in the future.
Review of rates
Formulation of rates will need to be subjected to review both from within the
insurer and from outside.
9 Internally the review is required in the light of competitive forces at play in

the market.
9 Externally the review will be done by the regulator. In some cases the
government also may intervene to make the rates acceptable to the public.
1.5 Making the rating structure
All rates are based on various risk exposures that the subject matter of insurance
may be faced with. However the rate for use through a manual begins with the
basic exposure unit, e.g. a residential house.
In fire insurance, there can be various rating factors involved such as

a) the type of construction,
b) the age of construction,
c) the height of the building,
d) the proximity to other buildings,
e) the nature of locality etc.
Rating Factors
9 The relevant elements that are used to add up the rates make the rating plan
and the various specific elements in it are referred to as rating factors.
9 These rating factors can help to reflect the identified differences in loss
propensity.
38
9 By ensuring that all the relevant rating factors are taken into consideration, it
can be ensured that the rates are not inadequate, excessive or unfairly
discriminatory as between risks of similar type and quality.
9 If there is failure to consider the adverse features of a risk, the rate will be too
low. If the competing insurance company’s factor in the negatives and the
insurer’s underwriter does not, then the insurer falls prey to adverse
selection.
1.6 Frequency and severity of losses
While assessing the risk characteristics, the rating plan broadly looks at risks on
two sides of a matrix which has
9 on one side the frequency of losses and
9 on the other the severity of losses
For example, the frequency of losses to buildings may be noted where more
combustible materials are stored or where the building construction and
maintenance is of low standard. Similarly, in case of floods it is related to houses
in low lying areas. In respect of severity persons having high value contents tend
to have larger losses than those residences that have fewer contents and so on.
The regulatory standards in India are set in the ______ guidelines and other
regulatory directions given from time to time by the insurance regulator.
A File and Use

B Fill and File
C File and Upload
D Download and File
2. Learn about the process of ratemaking.

2.1 Process of Ratemaking
The basic method of forming rates generally follows one of the two basic
approaches:
a) pure premium method
b) loss ratio method
39
a) Pure premium method
A simple illustrative example is given below to introduce the concept of pure

premium, followed by mathematical equations in subsequent paragraphs.
In a small town loss experience of 1000 insured cars each valued at Rs. 5 lacs by
theft shows that over a period of say 10 years, on average 5 cars are stolen.
The pure premium is expressed in the formula
L
x 100
V
Where,
L is losses
V is value of all the cars
Losses = Rs. 5 lac x 5 = Rs. 25 lacs

Values = Rs 5 lacs x 1000 = Rs. 50 lacs
25,00,000
x 100 = 0.5%
50,00,00,0 00
The pure premium (i.e. the premium which is sufficient only to pay losses) is Rs
2500/- (0.5% of the value per car)
Pure premium is also known as the “Burning Cost”.
In arriving at the final rate of premium the pure premium is loaded to provide for
the following
9 Business Procurement costs e.g. agency commission, brokerage etc.

9 Expenses of management
9 Margin for unexpected heavy losses and
9 Margin for reasonable profit for insurers
40
Mathematical Equation
The formula for pure premium method is
P+F
R=
1−V −Q
Where,
R= Rate per unit of exposure
P = Pure premium
F = Fixed expense per exposure
V = Variable expense factor
Q = Profit and contingencies factor
b) Loss ratio method
The loss ratio method is used to indicate rate changes rather than rates per se. The
formula for this is
R = A X Ro
Where,
R = Indicated rate
Ro = Current rate
A = Adjustment factor which is equal to W/T
Where W = Experience loss ratio
T = Target loss ratio
The target loss ratio is obtained by the following ratio
1−V −Q
T=
1+G
Where,
G = Ratio for non-premium related expenses to losses
Q = Profit and contingencies factor
V = Premium related expense factor
41
Experience loss ratio is obtained by the formula
L
W=
ERo
Where,
L = Experience losses
E = Experience period earned exposure
Ro = Current rate
If the data is based on consistent assumptions, the results produced by both
methods should normally be comparable. There are, however, differences
between the two methods:
Pure Premium Method Loss Ratio Method

Based on exposure Based on premium
Does not require existing rates Requires existing rates
Gives indicated rates Gives indicated rate changes
It is important that the data and assumptions used are based on logical and
consistent factors. Thus:
a) Selection of the experience period: The most recent loss experience period
must be used. The loss experience period must contain sufficient loss
experience so that the results have the necessary statistical significance or
credibility. Finally where the business is subject to catastrophic losses, the
experience period must be representative of the average catastrophic
incidence.
b) Difference in coverage should be treated separately e.g. in motor vehicle
insurance – private car, three wheelers, taxis, goods vehicles, passenger
vehicles etc.
c) Wherever there are basic limits, the premium needs to be adjusted for the
increased limits, if any, based on the change factors.
d) Where the experience period extends over several years the rate may change
often. However the earned premium underlying the loss ratio calculations
must be on a current level rate basis. Thus past premium must be brought
to the current rating level. This may be done by using good rating software.
e) In general the internal guideline rates should be based on direct premium
that is before reflection of reinsurance commission and loss data.
42
2.2 Trended, Projected Ultimate Losses
Trended, projected ultimate losses are of paramount importance in the rate

making exercise. The projection can be on a pure loss basis or on allocated loss
adjustment basis. However, as often the unallocated loss adjustment data is not
available, such costs are treated as part of the expenses loading. Of significant
importance is the method and techniques for projecting unpaid and unreported
losses to their ultimate settlement values. Usually this is done through what is
known as the loss development method.
The loss development method is based on the assumption that claims move from
the unreported to the reported and from unpaid to paid in a pattern which is
sufficiently uniform so that past experience can be used to predict future
development. Losses are arranged by accident year and accident year age. The
resulting data form a triangle of known values.
Diagram 2: Loss Development Method
In the triangle
9 the horizontal movement to right represents the claims development over

time
9 the vertical line downward represents change in exposure level and
9 the positive-sloped diagonal represent the evaluation data
43
Link ratio
The next step is to make the development history arithmetically. The resulting
ratio is known as age to age development factor or link ratio. The age to age
factors are then multiplied to generate age to ultimate factors which can then be
applied to the latest diagonal to yield projected ultimate values.
Trend in severity
An important trend affecting ratemaking data is the trend in severity. Inflation,

court awards, medical inflation and such other costs are factors, which cause
upward trends in loss severities. Frequency is also subject to trend.
Frequency factors can change due to court interpretations and can also reduce
owing to legislation such as the mandatory use of seat belts in motor vehicles.
Where sufficient internal claims experience is not available, external data can be
used. Various sources of statistical data are available from the industry as well as
from outside.
2.3 Loading Factors

There are expenses such as commission, taxes (service tax) and expenses of
management which are generally paid on the basis of direct written premium.
Profit as an element of insurance pricing relates to the reward expected by the

insurer for doing the business and is determined by
9 company’s profit objective,
9 rate of investment return and
9 regulatory approach to profits being made by insurers
Contingency loading represents a provision for adverse deviation or a risk

loading.
There are two risk elements in ratemaking known as
a) parameter risk and

b) process risk
a) Parameter risk is the risk associated with selection of the parameters

underlying the applicable model of the process. Thus selecting the wrong
development factor can lead to under-pricing.
b) Process risk is the risk associated with the projection of future

contingencies, which are inherently variable.
44
2.4 Individual Risk Rating
Where individual risks are large enough so that their experience is to some extent
‘credible’, individual rating of such risks can be considered.
Individual rating is normally done for various reasons such as

9 the price charged to the large risk is charged more realistically or
9 to encourage and motivate more risk control programs or
9 to reflect the modification, if any, in the design of cover specially provided
Types of individual risk rating systems
There are two types of individual risk rating systems:

a) Prospective and
b) Retrospective
a) Prospective Systems
Prospective systems use past experience so as to determine the costs of coverage

for the future.
b) Retrospective Systems
Retrospective systems use the actual experience of the period to determine the
final cost of that period. Retrospective systems are more responsive to experience
changes than prospective systems. It is less stable as the experience can be more
volatile, but it can motivate the insured to implement additional risk control
programs.
All individual rating systems consider both experience and change in exposure, if
any, when the rating is done. Experience is relevant only when the credibility
factor exits, and where necessary experience is lacking, exposure indicators need
to be used.
2.5 Experience Rating
All large individual risk rating is a form of experience rating as they need to
reflect the entity’s actual experience or the features that may affect the
experience. Experience rating is ideal when, with appropriate adjustments, the
past experience is predictive of the future.
45
Thus losses need to be adjusted to reflect

9 economic and social inflation
9 changes in the number, size and types of units
9 changes in policy limits, terms and conditions
Social inflation means changes in the attitude of society whereby such items as
change in litigation mentality, the change in judicial activism and trend of awards
and legislation by the various Government arms directly or indirectly affect the
frequency and cost of claims.
The experience component must be related to the exposures affecting the entity
rated.
The following combinations are usually used:

a) Actual paid losses to expected paid losses
b) Reported losses and expected losses
c) Projected ultimate losses
d) Projected ultimate losses for the experience period adjusted to the current
exposure and inflation levels
The length of the experience would ideally be 5 years. To reduce the effect of
unusual ranges due to catastrophic losses, experience rating plans limit per
occurrence limits on such losses.
2.6 Composite Rating
Composite rating is a tool to rate large complex risks and where detailed
inspection and audit is carried out. Instead of rating different coverages using
different exposure bases, all applicable coverages are rated using one, composite
exposure base. The composite rate is based on historical exposures. Estimated
exposures are used if exact exposures are not available. The composite rate is
used to determine the deposit premium based on the estimated composite
exposure base and the final premium is based on the inspected/audited composite
exposure base.
Conclusion
Regulators have important concerns relating to rate making which may include
the following:
a) Rates shall not be excessive, inadequate or unfairly discriminatory.
46
b) Normally a rate will not be considered excessive in a competitive market.

Rates will be considered excessive if they are likely to produce a profit that is
unreasonably high in relation to past and prospective loss experience, or if
expenses are high in relation to services rendered.
c) A rate is inadequate if together with the investment income attributable to it,

the insurer fails to satisfy that the rate will cover projected losses and
expenses.
d) A rate can considered unfairly discriminatory in relation to another in the

same class if it inequitably reflects the differences in expected losses and
expenses. Similarly for a risk or group of risks the discounts, credits or
surcharge among the risks do not bear a reasonable relationship to the
expected losses or expenses unfair discrimination may be held against the
rates filed.
e) As to rating criteria due credit must be given for past and prospective loss
and expense experience, to catastrophe hazards and contingencies, to events
and trends, to loadings for leveling rates over a period of time etc.
f) Risks may be classified in reasonably traditional ways.
g) The expense provision included in the rates must reflect the operating
methods of the insurer and its actual or anticipated expense experience.
h) The rates may contain provisions for contingencies and reasonable profit.
In a city loss experience of 1000 bikes each valued at Rs. 75,000 by theft shows
that over a period of say 10 years, on average 2 bikes are stolen.
How much will be the pure premium?
A Rs 15
B Rs 150
C Rs 1500
D Rs 500
47
Summary
¾ Underwriting is the process of classifying the subject matter according to
their degree of insurability, based on the evaluation of risks to which they are
exposed, to decide on their acceptance and to charge appropriate rates of
premium.
¾ Objectives of a premium rating system include stability of rates,
responsiveness of rates to changes in loss exposures, should provide for
contingencies, should offer necessary incentive to the insured etc.
¾ Rating can be generic or individual
¾ Formulation of rates will not end with the rate makers themselves but need to
be subjected to review both from within the insurer and from outside.
¾ While assessing the risk characteristics, the rating plan broadly looks at risks
on two sides of a matrix which has
9 on one side the frequency of losses and
9 on the other the severity of losses
¾ The basic internal tariff or manual method of forming rates generally follows
one of the two basic approaches: pure premium method or loss ratio method.
¾ Pure premium is loaded to provide for the following: procurement costs,
expenses of management, margin for unexpected heavy losses and margin for
reasonable profit for insurers.
¾ The loss ratio method is used to indicate rate changes rather than rates per se.
¾ An important trend affecting ratemaking data is the trend in severity.
¾ There are two risk elements in ratemaking known as: parameter risk and
process risk.
¾ There are two types of individual risk rating systems: Prospective and
Retrospective.
¾ Composite rating is a tool to rate large complex risks and where detailed
inspection and audit is carried out.
48

Answer to TY 1
The regulatory standards in India are set in the File and Use guidelines and other
regulatory directions given from time to time by the insurance regulator.
Answer to TY 2
The pure premium will be calculated as follows:
Loss = 75,000 X 2 = Rs. 1,50,000
Value = 75000 X 1000 = Rs 7,50,00,000
1,50,000
X 100
7,50,00,00 0
0.2%
0.2% of Rs 75,000 will be Rs 150
Question 1
While assessing the risk characteristics, the rating plan broadly looks at risks
based on ___________
A Frequency of losses
B Severity of losses
C Both of the above
D None of the above
49
Question 2
In a small town loss experience of 1000 cars each valued at Rs. 5 lacs by theft
shows that over a period of say 10 years, on average 5 cars are stolen. Calculate
the pure premium per car.
A Rs 250
B Rs 2500
C Rs 500
D Rs 5000
Question 3
The _________ is used to indicate rate changes rather than rates per se.
A Loss ratio method

B Pure premium method
C Both the above
D Neither of the above
Question 4
____________ use past experience so as to determine the costs of coverage for

the future.
A Prospective systems
B Retrospective systems
C Both the above
50
Answer to SEQ 1
While assessing the risk characteristics, the rating plan broadly looks at risks
based on frequency of losses and severity of losses.
Answer to SEQ 2
The pure premium will be Rs 2500.
Answer to SEQ 3
The loss ratio method is used to indicate rate changes rather than rates per se.
Answer to SEQ 4
Prospective systems use past experience so as to determine the costs of coverage

for the future.
51
CHAPTER 4
RATING APPROACHES IN PRICING
This chapter aims to provide you with an understanding of the rating approaches
in pricing of insurance products. You will learn about the different premium
methods that are used by insurance companies.
a) Understand the concept of insurance pricing and its importance.

b) Learn about premium rating methods - the class rating method.
c) Learn about premium rating methods - the individual rating method.
52
1. Understand the concept of insurance pricing and its

importance.
1.1 Introduction
The insurance sector is different from other commercial sectors as it does not
offer any tangible physical product.
9 Insurance companies merely make a contractual promise with the customer
for future payment if a certain event occurs and is covered under the policy
term.
9 In terms of pricing a product, the industrial sector bases it’s pricing on
production and manufacturing costs, whereas in the insurance industry, the
price for insurance products results from the estimate of future obligations.
9 The insurance industry estimates any future payments it may have to make
based on actuarial methods.
1.2 Insurance pricing
Insurance pricing is also known as rate making.
Insurance pricing or rate making refers to the process of determining the rate that
can be charged by an insurance company for providing insurance cover to
policyholders.
Theoretically, the insurance pricing or premium rate should be determined

mathematically and statistically with the principle of law of large numbers and by
using a credible process of loss forecasting based on an analysis of the
probability, frequency and severity of loss for the risk that is to be covered.
Rate
Rate can be defined as the price per unit of insurance against each exposure unit.
53
The business of insurance presumes an exposure to loss. Insurance companies

need to ensure that the rates that are charged by them are able to cover all losses
and expenses and help them earn some profit.
There can be following 2 cases with respect to rate making:
9 No possibility of loss: if there is no possibility of any future loss, then there

will be no need for insurance.
9 Possibility of loss: If an entity does have an exposure to loss, it is desirable

that the cost of transferring that loss, or the risk premium, to another party is
proportional to the expected loss, which is assumed to vary with the
exposure.
Hence, there is a need to devise ways and methods for arriving at the most
appropriate premium rate corresponding to the expected losses.
1.3 Rate adequacy measurement
In insurance business, rate adequacy measurement is quite complicated because

the insurer cannot foresee the actual costs at the time of selling the policy. Price
is estimated through loss forecasting methods based on a sound statistical
framework.
If the insurer fails to achieve the targeted number or volume of business and if
the actual claim costs, especially for catastrophic losses, are more than
statistically projected, the price (premium) received may not be sufficient to pay
all claims and expenses during the policy period.
The rating pattern for general insurance products can vary across products or
portfolios for insurance companies due to:
9 The peculiarities of the individual products themselves,
9 The availability of historical data concerning premium and claims statistics,
9 The nature and characteristics of exposure units that produced these statistics.
1.4 General insurance products as per ‘file and use’ IRDA guidelines
There are different premium methods that have been devised and used in general
insurance. The methods for determining the rate can be quite different for
liability insurance as against property and other insurance due to the peculiarities
of these businesses.
54
Liability insurance: In Motor third party insurance in India, the claim settlement
duration can extend anywhere from 3-10 years. These claims are further exposed
to court award inflation.
Property and other insurance: In insurance like property, Motor Own damage,
Marine Cargo, Personal lines of insurance etc., the loss settlement periods will be
shorter, and at the worst, may not be expected to exceed 12 months.
Hence the benchmark rating principle for arriving at the premium rate cannot be
the same for liability insurance as for normal property insurance.
The file and use guidelines of IRDA classify all general insurance products into
two major categories based on the rating plan that is used in rate making for these
products. These are:
9 Class rated products- include all such insurance products of the insurer, for
which premium is determined via grouping, classifying and loss making
factors that can be easily identified and quantified.
9 Individual rated products- include all such insurance products where

premium is determined based on an individual’s exposure to loss.
Diagram 1: File and use guidelines of IRDA
55
These two major categories of products are further sub-divided under file and use
guidelines as follows:
1. Class rated products: These are further classified as
a) Internal Tariff rated products
All such general insurance products that can be sold by an insurance company
with rates, terms and conditions as per the internal tariff guide of the insurance
company.
Examples of internal tarriff rated products are:

9 Motor insurance
9 Health insurance
9 Personal accident insurance
b) Packaged or customised products
These general insurance products are specifically designed to suit the

requirements of an individual customer. The terms, conditions, rates and scope of
insurance cover etc. are specially customised to meet the individual’s needs.
2. Individual rated products. These are further classified as
a) Individual experience rated products
These include products where rates, terms and conditions, are determined
depending on the actual past experience of the insurance company relating to
claims.
Examples of individual experience rated products are:

9 Cargo insurace
9 Hull insurance
9 Health insurance
b) Exposure rated products
These include general insurance products where rates, terms and conditions are
determined after evaluating the exposure to loss relating to certain risk,
independent of the actual claim experience with that risk in the past.
56
Natural disaster risk such as earthquake, flood, tsunami etc.
a) Insurance of large risks
These include general insurance products that are specifically designed for
individual large clients. The rates, terms and conditions for these policies are
driven by prevalent international market standards. As prescribed by IRDA large
risk includes:
9 Insurance worth a total sum insured of Rs 2500 crore or more at one location
for property insurance, material damage and business interruption combined
9 Rs 100 crore or more per event for liability insurance
Internal tariff rated products is an example of _____________
A Class rated products

B Individual rated products
C Exposure rated products
D Insurance of large risk
2. Learn about premium rating methods - the class rating

method.
2.1 Introduction to premium rating methods
The premium rating methods used by insurers can be classified on the basis of
the approach used for products classified under file and use guidelines of IRDA.
Hence, different premium rating methods include:
a) Class rating method

9 Pure premium method
9 Loss ratio method
b) Individual or merit rating method

9 Schedule rating method
9 Experience rating method
57
Diagram 2: Premium rating methods
2.2 Class rating method
In class rating method, risks with similar characteristics are placed in the same
class and charged the same rate, in line with a pre-defined tariff.
All industries manufacturing textiles are grouped together and will be charged
the same rate, in line with a pre-defined tariff.
Class rating method can be applied only when:
9 Factors that might cause losses can be easily identified and quantified
9 Statistics on these factors is available and is accurate
The accuracy on the estimate of future losses depends upon the accuracy of the
statistics available. If the past data is not reliable, then an estimate on the future
losses would also not be realistic.
Class rating method can be effectively applied for determining the premium for
general insurance products that are sold to individuals, as:
9 Statistical data is easily available for such products.
9 Also, the customer base for such products is large; hence, owing to large
numbers, statistical data will also be more reliable.
58
In India, Motor and fire tariff are the best examples of class rating method where
all the risks are classified into particular categories or classes and rated
accordingly.
9 Motor tariff: All Honda City vehicles in Mumbai will be assigned a single
rate
9 Fire tariff: All cement manufacturing units will be rated as a single unit.
Methods of class rating
The methodology of the class rating method is easy to apply but can be quite
difficult to calculate. Following 2 methods can be used to calculate the premium
under the class rating method:
Diagram 3: Methods of Class Rating
a) Pure risk premium method
Process of determining premium under this method is as follows:
1. Determine the factors that might causes losses
All the factors that might affect the insurance product are selected and their loss
making effect is studied.
In motor/vehicle insurance, the following factors can be selected for rating:

9 The make and model of the vehicle
9 Vehicle age etc.
59
2. Collect data on these loss making factors over a period of time
Collect data for all rating factors over a suitable time period. The time period
should be long enough to ensure that there is adequate data for credible analysis
but it should not be so long that past data is no longer relevant to the future.
3. Calculate pure premium
The pure risk premium is the product of claim frequency and claim severity per
unit of exposure. Hence, pure premium can be calculated as follows:
Pure Premium = Actual loss + Loss adjustment expenses

Number of Exposure units
4. Calculate gross premium
Pure risk premium is then loaded for expenses, inflation, commission, etc. to
arrive at the gross premium that is charged to the customer.
[Gross Premium = Pure risk premium + load ]
b) Loss ratio method
As against pure risk premium method, in loss ratio method, premium is adjusted
on the basis of actual loss experience of the insurance company. Hence, loss
ratio can be calculated as follows:
Loss Ratio = (Losses + Loss adjustment expenses) over the premium charged
2.3 Analysis of class rating method
The class rating system demarcates risks on the basis of loss-producing

characteristics into identifiable, specific classes, representing the average
expected costs (both claims and administrative) for that particular class.
However, it can be seen in real time situations that risks within the same
classification have widely varying loss experiences. Within a class, there may be
sub-classes or favourable or adverse features based on the risk differences.
Hence, the class rating approach for all categories of risk may not be appropriate
to fully describe the characteristics of risks in terms of premium rate. Hence to
overcome shortcomings of the class rating method, insurers popularly use the
Individual rating method.
60
In which of the following methods is the premium adjusted on the basis of actual
loss experience of the insurance company?
A Pure risk premium method

B Loss ratio method
C Experience rating method
D Merit rating method
3. Learn about premium rating methods – the individual

rating method.
3.1 Introduction to Individual or merit rating method
Throughout the world, owing to the vast progress made by information
technology, the current trend is to rate a risk according to its ‘individual merit’ or
based on a ‘small sub-segment of the overall population’.
Individual rating is also based on the class rating method, but the difference is
that the premiums are adjusted according to the actual losses of the individual
customers.
For an insurer, the primary goal of individual risk rating is to price the coverage
provided more accurately than if the rates were based only on manual or class
rates.
3.2 Main features of Individual or Merit Rating Method

Main features of Individual or merit rating method are as follows:
a) Individual risk rating supplements class rates by modifying the group rates in
whole or in part to reflect an individual entity’s experience.
b) An individual risk rating system should appropriately balance risk sharing
and risk bearing
9 The costs for small entities whose experience is not credible should be
determined solely based on risk sharing.
9 Very large entities whose experience is credible might have their
premium costs solely based on risk bearing.
9 Entities in between these extremes should base their costs on a weighting
of risk sharing and risk bearing.
61
c) Individual or merit rating approach was devised to identify and recognize the
individual risk differences in the determination of premium rates.
d) In individual rating, the discovery of the appropriate rate depends on the
claim experience of the specific business applicant. In other words, it
measures the extent to which a particular risk deviates from the average of its
class.
e) Individual rating approach tries to identify the characteristics peculiar to the
risk and modifies the average rate for that particular class based on identified
characteristics like past claims experience.
3.3 Methods of determining individual or merit rating
Individual or merit rating can be determined using the following 3 methods
9 Schedule rating method
9 Experience rating method
9 Exposure rating method
3.4 Schedule rating method
In schedule rating method, the class rate is increased or decreased in the form of
percentage debits and credits, depending on exposure to loss making factors for a
certain individual. These credits and debits are sometimes applied before and
sometimes after experience rating. There may be a limit to the total debit or
credit that an entity can receive. The premium rate that is communicated to the
policyholder is derived only after adding these debits and credits to the premium
for the class.
Schedule rating method can be applied in case of property insurance where each
exposure is individually rated or class rate is modified in view of desirable or
undesirable physical features such as:
9 Location of the property
9 Size
9 Present condition of the property
9 Construction
9 Occupancy
9 Operating Methods
9 Protection or safety measures
9 Other exposures
9 Housekeeping & Maintenance
9 Loss Prevention or control Measures
9 Management outlook and attitude towards Loss prevention / control
measures
62
Schedule rating plan
A schedule rating plan gives

9 Rate credits for good physical and other features of a risk and
9 Loading of rate for risk aggravating or bad features.
The additional characteristics include

9 physical hazards,
9 moral hazard,
9 existence of safety programme,
9 improved technology,
9 management control,
9 compliance of corporate governance and Government regulations etc.
These are applicable to the particular businesses in a specified class.
The main features of schedule rating method are as follows:
a) Schedule rating method is the only individual risk rating system that does not
directly reflect an entity’s claim experience.
b) In theory, schedule rating method recognizes characteristics that are expected
to have a material effect on an entity’s experience which may not have
actually reflected in that experience. These characteristics could result from:
9 recent changes in exposure such as the addition of a swimming pool in an
apartment complex or
9 risk control programmes such as the recent implementation of a new
programme
c) Schedule rating is also used for entities that are too small to qualify for
experience rating.
d) Schedule rating systems usually take the form of percentage credits and
debits.
63
3.4 Experience rating method

It is another type of merit rating method where class rate or schedule rate is
further adjusted upward or downward based on the past loss experience of the
particular client for a reasonable period (generally 3 to 5 years).
In this method:
9 If the insured’s loss experience is better than average for the particular class
of clients, the class rate is further reduced.
9 If the loss experience is worse than the class average, the rate is increased.
64
Experience rating takes both claim size and claim frequency into account for
arriving at the appropriate rate. In determining the quantum of the rate change,
the actual loss experience may be modified for considering exposure changes not
reflected by earlier experience.
Hence, in experience rating method, loss history is used to draw conclusions

about the future loss possibility.
Where can experience rating method be applied?
9 This method can be applied in situations where previous losses, after

adjustments, are representative of the losses that can be expected during the
period to be rated.
9 Experience rating makes sense, only if there is sufficient representative data
for the portfolio being rated to calculate a sensible estimate of the premium.
9 Experience Rating is generally restricted to customers paying large amount
of premium for different classes of businesses for a reasonably long period.
Factors taken into account for arriving at the premium rate
Following factors are taken into account for arriving at the premium rate:
a) rate for a particular insured is first calculated using class rates
b) the class rate is then adjusted up or down based on either:
9 past loss experience of that particular insured; or
9 new exposure characteristics (e.g., loss control measures adopted) of that
insured
Objective of Experience Rating Method
The objective of experience rating method is to determine a more equitable rate

for an individual risk based on the evidence presented by its own experience.
It is recognised that individual risks within a classification are not alike and that
there exist inherent differences such as variations in:
9 plants and premises layout,

9 operating processes,
9 the materials involved,
9 the management of the plant,
9 the morale of employees,
9 loss prevention approaches and
9 in relation to the community in the area of operation
65
These differences are of such nature that it is difficult to label them definitely and
they cannot be associated with conditions measurable in advance. It is known,
however, that variations in experience do exist in a way that definitely precludes
ascribing all of them to chance.
Experience rating method is considered by many as the most practical method yet
devised, or even suggested, for giving recognition to variations produced by such
factors.
Basic mechanics of an experience rating plan
The following example may be used for understanding the basic mechanics of
working out an experience rating plan:
In a group health insurance policy, the premium rating at the time of renewal is
modified in the sense that it is either loaded or discounted based on the claims
experience of the expiring year.
Here, a tolerance limit is set, up to which the premium will remain unchanged.
9 Beyond the limit, the premium is loaded by stipulated percentages, so that
the overall premium-claims ratio is kept at an acceptable level.
9 Similarly, if the claims experience is favourable then a stipulated percentage
of discounts are given.
9 Similarly, while quoting the premium under miscellaneous classes of
business, it is common to modify the base premium depending on the claims
experience over a period of time say, 3 or 5 years.
3.5 Types of experience rating method
The Experience rating method is further classified into two types:

9 Prospective Experience Rating method and
9 Retrospective rating method
Prospective Experience Rating Method
In prospective experience rating, the experience of a risk over a continuous past

period is used to calculate the rate for the period for which cover is being
provided. Usually, a minimum period of either 3 or 5 years is taken for arriving
at the rating plan depending on the type of product and the usual time it takes for
full development of claims under the portfolio.
66
Retrospective Rating Method
In retrospective Rating Method, modification in premium rate is done at

renewal of the insurance policy covering the risk based on experience of the
individual risk that has developed during the policy period.
This type of premium rating approach is used in Group Mediclaim and Group
Personal accident policies.
In a different approach under this rating plan, in the US and some Western
countries, a provisional premium is paid at the beginning of the policy period and
at the end of the period, a final premium is computed based on the actual loss
experience during the period.
Retrospective Rating is widely used in the USA for Workmen's Compensation

Policy, General Liability Policy, Auto Liability Policy, Property damage and
Burglary policy for large firms.
3.6 Basis of Experience Rating Method

Experience rating is based on the existence of variations in inherent hazard in the
risks which come up for rating. Its objective is to measure to a finer degree the
hazard of the individual risk on the basis of the risk's own experience.
Many factors enter into the risk's experience in different combinations and affect
the quality in different degrees. These cannot be classified and recognized so that
they may be given individual consideration in rating. They may, however, be
reflected to some extent by making use of the effect produced by them as shown
in the experience.
In the experience rating process, no distinction can be made between similar

individual accidents which are fortuitous and those which are indicative of the
actual conditions of the risk.
3.7 Applicability of Experience Rating Method

Experience rating is applicable wherever there is a large variation among the
risks within a classification where individual risks are of such nature that they
may be expected to develop individual risk experiences.
9 Casualty Insurance: Many lines of casualty insurance have classifications

that are somewhat non-homogeneous, resulting largely from the meager
experience available and lack of knowledge of the elements which enter into
the composition of hazards.
67
Considering only the qualification of having atypical risks within

classifications, most casualty lines would be subject to experience rating.
The further qualification of having individual risk experiences large enough
to be of appreciable evidential value may be more restrictive.
9 Workmen Compensation Insurance: Workmen Compensation Insurance

can be subject to experience rating, as there is scope for losses to be
controlled, to correct defective conditions and to enforce safe practices
among employees.
9 Third Party Insurance: In third party insurance, the insured generally

cannot control losses to the same degree for, the actions of the third party,
over whom there is no control, also affect the losses.
3.8 Essentials of Experience Rating Method
The essential operation of experience rating consists of:

9 comparing the actual risk experience and classification experience on a
common premium and loss basis,
9 assigning to the risk experience a weight depending on the size of the risk
premium and also assigning to the classification experience the
complementary weight, and
9 deriving a rate therefrom
The adjusted risk rate or experience rate may be looked upon as a weighted
average of the rate indicated as necessary by losses of the risk and the manual
rate, that is, the rate indicated by the classification experience. A comparison
may be made of different plans on the basis of indicated losses, pure premiums,
or premiums.
In Workmen's Compensation Insurance, it is required to:
9 "Modify" the actual experience of the risk to bring it to the level of current
industrial conditions as reflected in the current manual rate level.
9 The procedure then is to determine "adjusted losses", the weighted average of

the risk's modified losses and the "expected losses" which are indicated by
the premium at manual rates to derive the ratio of the adjusted losses to the
expected losses and apply this ratio to the manual rates to obtain the final
rates.
68
9 In determining the adjusted losses, the hazard is divided into "normal losses"
hazard and "excess losses" hazard.
9 The weight or credibility assigned to the risk's experience is less in

determining the adjusted excess losses than in determining the adjusted
normal losses.
Large losses occur less frequently than normal losses and cost much more
individually. The volume of large losses in a given risk's experience is less
indicative of the real degree of hazard, which is inherent in the risk than the
volume of normal losses.
3.9 Disadvantages of Experience Rating Methods
Some problems in Experience rating method are related to the availability of data
required to perform experience rating, and some problems are related to the
methodology. The disadvantages can be summed up as follows:
a) A biased loss trend: Often insurers tend to record individual loss details for
large losses only, i.e. incurred losses that are greater than a certain value
below the attachment point. This portrays a lesser loss trend leading to a
biased loss trend and ultimately a low premium rate obtained from this
projection.
b) Lack of policy information for each claim: Another problem encountered

in practice is the lack of policy information for each claim. If this
information is not available, applying a trend and not capping at policy limit
can significantly overstate the expected loss cost. Similarly, if deductible
information is not available, applying a trend factor to a loss net of the
deductible can significantly understate the expected loss cost.
c) Change in expanding and contracting limits in experience period: If there

have been significant changes in the book of business during the experience
period such as expanding or contracting limits, then each experience period
is on a different mix basis and therefore it is not appropriate to simply
average between years. Furthermore, the projected loss cost would not be a
true projection of the expected loss cost for a future period. When experience
rating a portfolio that has experienced significant changes in the mix of
business, actuaries often load or give credit for these changes in exposure in
their final experience rating results.
69
d) Completeness and Credibility of historical statistical data: The most

important limitation of Experience rating plan relates to “Completeness and
Credibility of the historical statistical data” that is used for arriving at the
premium rate. If historical data is not reliable then premium rate would also
not be reliable.
e) Occurrence of loss is an uncommon event: The experience rating approach

presents another problem when the occurrence of loss is an uncommon event
or where there are very few risks of that class to develop a statistically
supported rating basis. In such a situation, Experience rating is called
Exposure rating.
Diagram 4: Disadvantages of experience rating method
3.11 Exposure Rating Method
Exposure rating method considers the insured risks, i.e. the portfolio
composition, and the premium distribution commensurate to the risk.
9 Under this rating approach, the premium rate is determined by an evaluation

of the exposure to loss in respect of the risk concerned, independent of the
actual claims.
70
9 Sometimes, the exposure rating is derived from rates for similar risks in other
markets or are based on hazard evaluation done for other reasons such as for
risk management.
Overall, exposure rating aims at a premium rate or price based on portfolio

analysis rather than on actual loss experience.
All specialty and liability products and property damage covers beyond certain
sums-insured use this rating approach to arrive at the premium rate.
Objective of Exposure Rating Method
Objective of the exposure rating method is to estimate proportion of the loss for
the underlying policy that is expected in the entire portfolio.
The primary reason for going for this type of rating approach is the general lack
of credible risk data of exposures, premiums and claims with the insurer or in the
entire market. To circumvent this limitation on a logical and systematic basis, the
rating approach tries to correlate and extrapolate the data of similar risks for
arriving at the rate.
Process of Exposure Rating
Exposure rating and experience rating may be applied while rating renewals by
adding weights to each using credibility rating.
9 The insurer identifies the most important identifiable risk factors which can
produce a loss, and the premium rating is done by giving different
weightages to each of the identified risk factor.
9 Then a basic rate is arrived at by taking the premium rate for similar risks in
other developed markets, and each of the identified factors is superimposed
on this basic rate by giving a discount or applying loading based on the
nature of the risk factor being rated.
It is mostly used in cases where there is no (or insufficient) representative claims

experience available to calculate the burning cost. In such a case the insurer uses
exposure rating to look back at the claims experience of another portfolio of the
same kind.
71
This means that the claims experience we are missing can be derived from a
reference portfolio whose claims experience is sufficiently well supported
statistically. However, care should be taken to ensure that while comparing
portfolios, the portfolio which is similar and the nearest possible to the portfolio
under study should be selected.
Exposure curve
In order to be able to use the claims experience of a different portfolio, the

portfolio in question has to be put into a suitable form and represented as a loss
distribution. This presentation of loss distribution in graphical form, in the form
of curves, is known as exposure curve, which is based on distribution models of
claims sizes.
Insurers use this method to arrive at the appropriate premium using these curves.
These curves determine the premium that the insurer ought to charge, to cover
expected losses.
The exposure curves are built using factors like loss degree vs. deductible of
sum-insured or total premium under the portfolio vs. expected losses.
Case Introduction
A general insurer wishes to launch a health insurance policy targeted towards the
general population between the age groups of 3 and 60 years. However, as a new
company, it does not have any statistical data or supportive evidence towards the
likely losses for arriving at the premium to be charged.
In such a scenario:
9 The insurer’s consultant has come out with a World Health Organisation
report of India on the incidence of Stroke (cerebral vascular accident).
9 Similarly, the consultant has come out with incidence rates of Cancer,
Blindness, and Liver & Kidney transplants.
9 The consultant further adds that these are the diseases which result in
maximum hospitalization expenses on account of a single disease to
individuals in general in the Indian scenario.
The insurer, using this data, has prepared premium rating for the proposed health
cover in the following manner which is a good example of Exposure rating.
72
Facts of the case
The following are the important facts that are used in the rating process:
9 As per the WHO report, in India 73 persons per 1,00,000 populations per
year suffer from Stroke (cerebral vascular accident).
However, it has come to the notice of the insurer through the consultant that
as per an independent study conducted in India, the occurrence is between
100 and 268.
The insurer has taken a figure of 200 as justified taking the least and the
highest between the two studies and rounding off to the nearest hundred
conservatively.
9 According to another study, the rate of cancer incidence for all types and of
all organs in India is 631 per million i.e. 10,00,000 people. This gives a
figure of 60 cases per 1,00,000 persons approximately.
9 In case of blindness, the studies reveal that 20 members per 1,00,000 suffer
blindness either from accidents or disease.
9 In case of liver & kidney transplant, it is given as 40 members per 1,00,000

of population.
9 There is no reliable data for age wise occurrence; a general impression from
one of the leading consultant doctors is that these diseases are rare at young
ages and the incidence goes up as age advances.
Hence, for arriving at the appropriate level of premium to suffice the likely
claims and in order to avoid adverse selection, the premium based on the above
factors is taken by the insurer as applicable to the youngest age bracket and the
same premium is gradually loaded for increase of age in bands. He chooses a
limit of Rs 1,00,000/- as the minimum sum-insured and feels that the premium so
arrived at can be applied to the higher levels of sum-insured without any
modification in a proportionate manner.
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Premium Workout
The insurer works out the premium per Rs.100000/- and taking it as the
premium for the entry level i.e. 3-35 years age, as below:
Stroke incidence 200

Cancer incidence 60
Blindness incidence 20
Liver & kidney transplant incidence 40
Total 320
Total claims incidence rate 0.0032 (the number of incidences
per 100,000 insured)
To this the insurer has to provide expenses towards his Marketing cost,
margin for profit, Administrative costs and overheads and he estimates them
as:
Marketing @25%
Margin for profit @ 10%
Administration & overheads @20%
The technical claims incidence rate is 0.0032/0.55 = 0.005818

For a sum insured of Rs 100,000, the Rs 582
technical premium is
The insurer proposes a loading of
9 20% over the above premium which is for age band of 35-45
9 25% on the premium of 35-45 age band for 46-60 years.
This illustration shows how the exposure rating is arrived at based on the facts
related to the loss experience of general population, applying it to the likely
incidence of claims and the cost of premium thereof. However, there are several
methodologies and techniques in exposure rating for calculation of premium rates
but the example helps to understand as to how this operates.
3.12 Conclusion
Overall, whatever may be the method of arriving at the appropriate premium rate,
the main aim and objective in the whole process is to ensure that all losses are
paid out from the premium collected, leaving at least a minimum amount towards
profit margin.
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In order to achieve this and to choose the appropriate method of rating for the
risk(s) covered it is imperative to involve the Appointed Actuary right from
beginning of the exercise of deciding rates, terms and conditions.
Which of the following individual risk rating systems does not directly reflect an
entity’s claim experience?
A Loss ratio method

B Experience rating method
C Merit rating method
D Schedule rating method
Summary
¾ Insurance pricing or rate making refers to the process of determining rate that
can be charged by an insurance company for providing insurance cover to
policyholders.
¾ Insurance companies need to ensure that the rates that are charged by them
are able to cover all losses and expenses and help them earn some profit.
¾ In insurance business, rate adequacy measurement is quite complicated
because the insurer cannot foresee the actual costs at the time of selling the
policy.
¾ If the insurer fails to achieve the targeted number or volume of business and
if the actual claim costs, especially catastrophic losses, are more than the
statistically projected, the premium received may not be sufficient to pay all
claims and expenses during the policy period.
¾ The file and use guidelines of IRDA classify all general insurance products
into two major categories based on the rating plan that is used in rate making.
These are:
9 Class rated products: includes all such insurance products of the
insurer, for which premium is determined via grouping, classifying and
rating loss making factors that can be easily identified and quantified.
9 Individual rated products: includes all such insurance products, where
premium is determined based on an individual’s exposure to loss.
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Answer to TY 1
Internal tariff rated products is an example of class rated products.
Answer to TY 2
In loss ratio method, premium is adjusted on the basis of actual loss experience
of the insurance company.
Answer to TY 3
In Schedule rating method, the individual risk rating system does not directly
reflect an entity’s claim experience.
Question 1
_____________ includes non-life products that are specially designed to suit the
specific needs of clients.
A Class rated product

B Customised product
C Exposure rated product
D Insurance of large risk
Question 2
Which of the following is correct?
A Gross premium = Risk premium + Load

B Net premium = Pure risk premium + Load
C Gross premium = Pure risk premium + Load
D Net premium = Pure risk premium + Load
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Question 3
Which type of premium rating approach is used in Group Mediclaim and Group
Personal Accident Policies?
A Prospective rating method

B Retrospective rating method
C Merit rating method
Question 4
Under which rating approach, the premium rate is determined by an evaluation of

the exposure to loss in respect of the risk concerned, independent of the actual
claims.
A Prospective rating method

B Retrospective rating method
C Exposure rating method
Answer to SEQ 1
The correct option is B.
Customised products include on-life products that are specially designed to suit
the specific needs of clients.
Answer to SEQ 2
Gross premium = Pure risk premium + Load
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Answer to SEQ 3
Retrospective rating method is used in Group Mediclaim and Group Personal

Accident policies.
Answer to SEQ 4
In exposure rating method, the premium rate is determined by an evaluation of

the exposure to loss in respect of the risk concerned, independent of the actual
claims.
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CHAPTER 5
FILE AND USE OF REGULATIONS
This chapter aims to provide you with an introduction to the File and Use
Regulations of IRDA, in relation to global insurance regulations.
The processes are examined further in Chapter 6.
a) List the goals of market conduct supervision for insurance business.

b) Describe the procedures for filing of rates and policy forms for regulatory
review.
c) Explain the basic components in evaluating insurance products.
d) Briefly explain the stage of insurance market in India.
e) Understand IRDA requirements for consideration and review of
insurance products.
f) Classification of products in accordance with the File and Use guidelines
of IRDA.
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1. List the goals of market conduct supervision for

insurance business.
1.1 Introduction
Insurance business is one of the risk management methods for the society, and in
the process of risk-proofing the society against covered perils and losses, the risk
of failure of an insurance company is one which the society cannot really bear.
Insurance regulation has been promoted worldwide with a view to ensure that
there are inbuilt safeguards so that any tendency of the insurer towards market
failure is corrected in a timely manner. Failures can arise from rash or inefficient
financial conduct or unprofessional market conduct which includes behaviour of
the insurers towards customers.
As a measure to ensure that policyholders are given equitable treatment,
competition is introduced in insurance markets so as to serve consumer interests.
However, over-competitiveness and unfair competitive practices can in turn
destabilise markets and eventually lead to insolvencies.
In order to ensure stability in the market performance, the regulator supervises
the market conduct of insurers.
1.2 The goals of market conduct supervision

Specifically, the goals of market conduct supervision of insurance business are
to:
9 promote efficiency in the conduct of insurance business;
9 ensure that solicitation, procurement and servicing of insurance are
performed only by persons and entities with specified requisite qualifications
and practical training and adherence to code of conduct;
9 ensure that persons and entities assisting in the assessment and settlement of
claims adhere to the specified professional qualifications and code of
conduct;
9 protect the interests of the policy holders in matters concerning assigning of
policy rights, insurable interests, fair and prompt settlement of valid claims
and fulfilment of the terms and conditions of contracts of insurance;
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9 ascertain that insurers adhere to approved rates, advantages, terms and

conditions of insurance products that they offer to the general public;
9 encourage insurers and intermediaries to adopt and observe best international
practices on market conduct in their dealings with policyholders and the
general public;
9 gather information by undertaking inspection and conducting enquiries and
investigations;
9 ensure that members of professional organisations connected with insurance
and reinsurance business are duly qualified and competent and that they
adhere to appropriate codes of professional ethics and standards;
To achieve the above goals, the regulator should be cognizant of competitive

forces and take actions that foster a healthy marketplace.
The regulator must be alert for any possible unfair and discriminatory rating and
underwriting practices as well as overly restrictive policy provisions.
Which of the following are the goals of market conduct supervision for insurance
business?
(i) To gather information by undertaking inspection and conducting enquiries

and investigations
(ii) To ensure that members of professional organisations connected with
insurance and reinsurance business are duly qualified and competent
(iii) To ascertain that insurers adhere to approved rates, advantages, terms and
conditions of insurance products that they offer to the general public
A (i) and (ii)

B (ii) and (iii)
C (i) and (iii)
D (i), (ii) and (iii)
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2. Describe the procedures for filing of rates and policy

forms for regulatory review.
Market Regulation includes regulation of insurer’s products, prices and market
practices.
Though the operational systems of monitoring of insurer’s products and prices

vary from country to country and regulator to regulator, the concepts remain the
same. Fundamentally, policy forms need to be filed with the regulator to
conform to maintenance of basic standards which include compliance with
laws and regulations, proper pricing, acceptable customary practices etc.
Filing of rates and policy forms for the regulator’s review ensures protection of
both the consumer and the insurer.
While it is essential to ascertain that the policy wordings are sufficiently sound to
protect the insurer from excessive liabilities that may lead to solvency failure,
there should be equity and fairness towards the interests of the policyholders.
Similarly, the pricing should not be very high or very low, but be commensurate
with the risks, leaving a reasonable profit margin for the insurer.
Some of the international practices that are being adopted in this regard are
briefly stated below:
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Diagram 1: Types of rate regulatory systems
1. Open competition laws / no filing laws / no prior approval: In developed

insurance markets, there may be many players with products ranging from a
single specialist area (e.g. health insurance) to a wide range of covers with
complex ratings. In many of these territories, there is no requirement to file
rates or policy wordings as the regulator relies on market competition to act
as a self-regulating mechanism preventing insurers from over-pricing or
dominating the market.
Under these circumstances, the regulator relies on the competitive forces to

determine the rates based on the market – one example would be the U.K
insurance market.
2. Prior approval: Under prior approval systems, policy forms and rates must
be filed and approval obtained by the state insurance department before they
can be used in the market. The regulators assess the reasonableness of the
documents filed against the standard benchmarks. In case there are any
policy provisions which do not comply with the regulatory requirements, or
other regulations in force, or the product does not appear to be creating the
desired value to meet the specific needs of each entity in the value chain, the
regulator returns the documents and advises the insurers to modify it.
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It is essential for insurers to receive approval for their rates and forms before
they go into effect.
3. File & Use (F&U): Under the F&U system, the insurers are required to file
their rates with the regulator before they go into effect; prior approval is not
required. However, the regulator has the authority to comment on the rates
before they are used, or can disapprove the rates.
“Deemed Approval” : both under Prior Approval system and File &Use system,
a prescribed period of time is stipulated for the regulator to take a decision either
for approval or disapproval which may vary from regulator to regulator
(normally it would be in the range of 30-90 days). The product would be deemed
to be approved if the regulator does not respond to the insurer within the set time
limit.
4. Use and File: In the Use & File system, there is no need to file rates in
advance and the system allows the companies to use the rates before they are
filed. But, the rates must be filed within a specific period after they have
been put to use. However, this system also allows the regulator to
subsequently disapprove the rates/ policy forms in case they fail to comply
with the statutory/standard requirements.
5. Flex rating regulation: It is a law prevailing in the US insurance market

under which insurers are required to obtain prior approval for rates that
exceed a certain percentage above or below the rates previously filed. Here,
floor rates can be fixed based on Minimum Loss Ratio requirements.
In developed insurance markets, there would be a number of players offering a

wide range of products with complex rate filings. Prevalence of competition
prevents insurers from over-pricing or gaining control over the market. In such
cases, there is no need to file rates or policy forms, and in some jurisdictions,
certain lines and rates are exempted from filing or approval requirement. In these
cases, the regulator relies on the competitive forces to determine the rates based
on the market.
The same logic exists between Use & File, Flex Rating or No-file requirement,
where insurers are not required to obtain prior approval for rates before
implementing them. However, they are subjected to stringent Financial
Regulation, which monitors insurers’ financial condition or solvency.
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Whatever may be the mode of regulation, the objective is to maintain a healthy

balance between the market goals and adequate policyholder protection.
Filing of rates and policy forms for the regulator’s review ensures the protection
of ___________.
A The consumer only

B The insurer only
C Both the consumer and the insurer
D Neither the consumer nor the insurer
Which of the following systems represents a compromise between the prior

approval system and the no-file system?
A File and Use Laws

B Flex Rating Regulation
C Use and File System
D None of the above
3. Explain the basic components in evaluating insurance

products.
The basic components in evaluating insurance products are as under:
1. Definition of product
An insurance product can be defined as an insurance policy contract, where there

is acceptance of specified risks by the insurer against a predetermined price
called premium obtained from the client.
It includes any plan of insurance designed to meet the insurance requirements of

a client or class of clients. The contingencies insured under the product should be
clear and provide transparent cover which is of value to the insured.
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2. Product design
Product design is the process by which insurance companies develop their

insurance policies as per requirements of the policyholders.
Based on the prevailing practices, the policy document consists of Preamble,

Recital Clause, Schedule, Operative Clause, Terms and conditions and
Exclusions etc.
3. Pricing
Pricing is the process by which the insurers determine the premium to be charged
from the insured for accepting a particular risk under the insurance contract.
Pricing of insurance products plays an important role in design and development

of the product. It is arrived at after taking into consideration the claim
losses/burning costs, operating expenses, investment income, reinsurance costs
and a margin for profitability etc.
4. Rate
Rate is the price per unit of insurance.
There are three important methods of rating viz.

(i) Class rating: it involves applying various factors to a base rate evolved out
of characteristics of an insured / or a group of homogenous risks.
(ii) Individual risk rating: it can be experience rating wherein the past claim
experience of a person or group is used to adjust the premiums of the future.
Failure to incorporate experience shall result in either loss of business, in
case of good experience, or underwriting losses in case of a bad experience.
(iii) Sometimes, it can be based on exposure to the losses, such as catastrophe
risks. At times, where the quantum of probable losses is very high or risk is
heavy, the rates are driven by reinsurance markets, as the primary insurer is
not in a position to underwrite the risks in his own capacity and needs
support from the reinsurance market.
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In which of the following is the regulator NOT concerned when considering

product evaluation?
A Definition of Product
B Pricing
C Resourcing of Underwriting Personnel
D Design of Product
4. Briefly explain the stage of insurance market in India.

[Learning Outcome d]
It is a known fact that competition can generally ensure more customer choices
and options and also more reasonable pricing. However, perfect competition also
requires adequate knowledge of the product and its intricacies.
In the Indian context, the insurance market is in an ascent stage. The level of
financial literacy is poor in the country, and the awareness levels of insurance
products among the general public are not satisfactory. Hence, the regulator has
adopted the File & Use model for filing of the products, as it gives leverage to
the regulator to review the policy forms and rates and raise objections in case the
product does not meet the regulatory standards towards protection of the interests
of the policyholders.
In an attempt to increase competition for overall development of the market, the
general insurance sector was opened up by removing tariffs with effect from 1st
January, 2007. The de-tariffing was contemplated to be done in a phased manner
to ensure that there is a logical sequence to follow in opening up of the
competition.
To begin with, insurers were not allowed to vary the coverage, terms and
conditions, wordings, warranties, clauses and endorsements in respect of
erstwhile tariff.
A detailed mechanism of the File & Use procedures being practiced in Indian
insurance market is described in the following Learning Outcomes.
In the Indian context, the insurance market is in the ________ stage.

A Developing
B Emerging
C Growth
D Maturity
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5. Understand IRDA requirements for consideration and

review of insurance products.
[Learning Outcome e]
The requirements of IRDA relating to design and rating of insurance products are
as follows:
1. Prudent underwriting
The product design and rating must always be on sound and prudent underwriting
basis.
Prudent underwriting means that the insurer should only offer insurance of risks
that are quantifiable and manageable and where the premium can be properly
assessed.
The cover should be clearly defined and should be of value to the person insured.
2. Simplified language
All literature relating to the product should be in simple language and easily
understandable by the public at large. As far as possible, a similar sequence of
presentation may be followed. All technical terms should be stated in simple
language for the benefit of the insured.
There should be no effort to mislead the policyholder to assume that the product
is offering protection that it really does not, or that it offers such protection
subject to limitations and conditions that are not easily apparent. The limitations
and conditions should be easily capable of compliance.
3. Consistency of terminology
As far as possible, similar wordings for describing the same cover or the same
requirement should be used by insurers across all the products.
For example, clauses on renewal of insurance, basis of insurance, due diligence,

cancellation, arbitration etc., should have similar wordings across all products.
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The policy should provide simple dispute resolution procedures and also state in
simple language the process of arbitration of disputes.
4. Real risk transfer
The product should be a genuine insurance product of an insurable risk with a

real risk transfer. “Alternate risk transfer” or “financial guarantee” business in
any form will not to be accepted.
5. Policyholders’ interests protection
The insurance product should comply with all the requirements of the IRDA
Protection of Policyholders’ Interests Regulations 2002. (See also Chapter 10).
Policies which are normally expected to be renewed e.g. Health Insurance &
Motor Insurance should not be cancelled or refused to be renewed unless there
are valid reasons such as fraud.
In case of adverse claim experience, the insurance company can renew the policy
with higher premium or higher deductible within the range filed and approved by
IRDA. However, when a renewal is refused, there is always a duty to inform the
insured in writing of the reasons for refusal well in advance of the expiry to
enable the insured to find an alternative.
6. Justification of price
The rates filed by every insurer will be reviewed by IRDA based on supporting
evidence. The pricing of products should be based on appropriate data and with
technical justification.
The details are as under:
9 If the proposed schedule of rates is derived from an existing schedule of

tariff / non-tariff rates: there should be adequate statistical information on
the claims experience at current schedule of rates.
9 If the rates are based on the generally prevailing market level of

premium rates: the insurer should be able to demonstrate the reasonableness
of the variation from the currently prevailing level of rates.
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9 If the rates proposed are based on reinsurance market level of rates: the
insurer should be able to demonstrate that the rates of the reinsurance
markets have been properly ascertained and represent rates quoted by
reinsurers of repute.
9 In case the rates are based on non-insurance technical data: the insurer
should be able to defend the logic underlying the establishment of the
estimated claims costs from which the rates are derived.
9 Where statistical support for a particular risk classification is not

available, it can be rated by comparison with rates based on statistics for a
risk of comparable hazard. But, where no statistical basis is available,
arbitrary variation of rates will not be acceptable.
7. Reasonableness
The terms and conditions of cover shall be fair between the insurer and the
insured. The conditions and warranties should be reasonable and capable of
compliance. The exclusions should not limit cover to an extent that the value of
insurance is lost. The time allowed for reporting of claims should be reasonable.
The policyholder should not be required to do things that are onerous after a
claim to maintain his eligibility for protection nor should the policyholder be
prevented from resuming his business expeditiously by the claims process.
8. Margins for management expenses and commissions etc.
Margins built into rates shall be consistent with the experience of the insurer in
respect of commission, management expenses, contingencies and profit.
Insurers will not be arbitrarily allowed to design products at very low margins
merely to beat competition. The margin for commission built into the rates
should be at a level at which commission or brokerage will be paid. The
commission margin should not be unreasonably low because it will distort the
sales process and there will be an incentive to hide payments to agents and
brokers under different heads.
Expenses of management will generally reflect the overall expense ratio of the
insurer in the recent past. However, it is possible to design products at a different
margin for expenses where the insurer can demonstrate that the expenses of
management for that particular product will be different either because of the
characteristics of the potential market or the sales mechanism or administration
of that type of insurance.
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9. No unprincipled activity in the name of competition
Necessary steps should be taken by insurers to ensure that competition will not
lead to unprincipled rate cutting and other improper underwriting practices.
Although this is a statement of the obvious, the fact that an insurer has to provide
such a confirmation should act as an indirect deterrent to improper practices.
If the rates are based on the generally prevailing market level of premium rates:
(i) The insurer should be able to demonstrate the reasonableness of the variation
from the currently prevailing level of rates
(ii) The insurer should be able to defend the logic underlying the establishment
of the estimated claims costs from which the rates are derived
A Only (i)
B Only (ii)
C Both (i) and (ii)
D Neither (i) nor (ii)
6. Classification of products in accordance with the File

and Use guidelines of IRDA.
[Learning Outcome f]
6.1 Classification of products
According to File & Use guidelines of IRDA, all products are classified into two
broad classifications, namely class rated products and individual rated
products.
There is a possibility of one product falling under two categories – class rated or
individual experience rated /exposure rated etc.
In such a case, the insurers can explore the possibility of filing sum insured bands
as basis of rating between an individually rated product and a class rated product.
The products are further classified into the following 5 sub-categories:
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Diagram 2: Classification of products
1. Class rated products
(i) Internal tariff rated products
All rule based underwriting products fall into this category. These are standard
products that can be sold by any offices of the insurer with the rates, terms and
conditions of cover, including choice of deductible where applicable, as set out in
an internal guide tariff designed by the insurance company.
Some of the examples of Class rated products are:

9 Fire insurance up to a certain sum insured or category of risk limitations,
9 Motor insurance other than fleets,
9 Personal Accident insurance other than groups,
9 Health insurance other than groups,
9 Burglary insurance, Fidelity insurance and so on.
(ii) Packaged or customised products
These are products specially designed for an individual client or class of clients,
in terms of scope of cover, basis of insurance, deductibles, rates, terms and
conditions of cover. Sometimes, these products are also described as ‘Special
Contingency Policies’.
These will include insurance packages like Homeowner’s Comprehensive or

Shopkeeper’s Comprehensive or Banker’s Blanket insurance and so on.
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2. Individual rated products
(i) Individual experience rated products
Actual claims experience of the concerned insured and his requirements

determine the designing of the experience rated products, rates, terms and
conditions of cover. These will typically be insurance with a high frequency but
low intensity of loss occurrence.
These will include Cargo insurance, group insurance for PA or Health, Motor
fleets, Hull insurance and so on.
Exposure rated products
These are products where the rates, terms and conditions of cover are determined
by an evaluation of the exposure to loss in respect of the risk concerned,
independent of the actual claims experience of that risk.
Some examples are insurance for earthquake risk, Public Liability insurance for
high hazard occupancies and so on.
Typically, these will be risks where the occurrence of a loss is an uncommon

event or where there are very few risks of that class to develop a statistically
supported rating basis. The exposure rating may derive from rates for similar
risks in other markets or be based on hazard evaluation done for other reasons
such as for risk management.
(ii) Insurances of large risks
These are typically insurance that is designed for individual, large clients and
where the rates, terms and conditions of cover may be determined by reference to
the international markets.
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According to File & Use guidelines, large risks are:
1. Insurance for a total sum insured of Rs. 2,500 crores or more at one location
for property insurance, material damage and business interruption combined;
2. Rs.100 crores or more per event for liability insurance.
However, a product cannot be placed under this category by merely referring to a

reinsurer for the rates and terms. It should genuinely relate to risks that are not
within the underwriting or rating capability of Indian insurers. However, where
insurance covers properties at several locations and one of those locations
qualifies as large risk, insurance of all the locations covered under that policy can
be treated as large risk provided that all the properties are under the ownership of
a single insured and are covered under one policy. Reinsurance is expected to be
placed abroad solely on a need basis and only after satisfaction of the national
retention capacity.
This is the category of risks that is the most susceptible to pressures of
competition and where insurers may take a rather bold stand purely because their
own stake in the risk may be small with most of it being reinsured.
It is expected that in respect of such products, the insurer will quote terms in line
with the terms quoted by reinsurers including the extent of cover and deductibles
or claims conditions. If the insurer varies the terms quoted by the reinsurers while
quoting the terms to the proposer, such variation of terms and any increased
retention that results from it shall be consistent with the underwriting policy and
reinsurance policy approved by the Board for underwriting of business and also
for retention and reinsurance. The insurer shall charge an additional premium
over the rates secured from the international market that is commensurate with
the additional risk carried by it. Such additional premium charged should have
the concurrence of the officer designated by the Board for this purpose.
6.2 Conclusion
The underwriter has to ensure that all aspects of the regulations are implemented
in letter and spirit. This is important as the Indian market is gradually getting
adjusted to competition and the freeing of rates and terms. Once the market
learns to work with competition in prices, variation in the terms and conditions
can follow and thereafter, competition would be in terms of servicing parameters.
This will nevertheless mean that any widening in scope of cover should be
adequately priced. Violations of the regulatory guidelines can lead to market
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failure and harm public interest. Regulatory intervention is thus felt needed in all
markets to avoid market failures, to correct deviations in time and if not, to
minimise the negative effects and improve efficiency of the market.
Within the Class rated Products, which of the following will be considered a
package policy?
A Retail Health insurance

B Burglary insurance
C Office Insurance
D Products Liability
Summary
¾ Regulation of the insurance industry is necessary to maintain insurer’s
solvency, to protect consumers who have inadequate knowledge of insurers
and insurance practices, to ensure reasonable rates, and to make insurance
available.
¾ The various types of rating laws include: prior-approval laws, modified prior
approval laws, file-and-use laws, use-and-file laws, flex-rating laws, state-
made rates, and no filing required.
Framework Description
State Mandated Rates determined by the insurance regulator. Insurers
Rates must use the rate or may file a deviation to charge a
rate below the published rate.
Prior Approval Rates must be filed with and approved by the
insurance regulator before they can be used.
Flex Rating Prior approval of rates required only if they exceed a
certain percentage above (and sometimes below) the
previously filed rates, otherwise a file and use
provision applies.
File and Use Rates must be filed with the insurance regulator prior
(Waiting Period) to their use. A waiting period applies before the rates
can be used. Specific approval is not required but the
regulator retains the right of subsequent disapproval.
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Framework Description
File and Use Rates must be filed with the insurance regulator prior
(No Waiting to their use. The rates may be used immediately.
Period) Specific approval is not required but the regulator
retains the right of subsequent disapproval.
Use and File Rates must be filed with the insurance regulator
within a specified period after they have been placed
in use.
Informational Rates must be filed with the insurance regulator for
File informational purposes. No formal review of the rates
occurs and no supporting documentation is required.
No File Rates are not required to be filed with or approved by
the insurance regulator. However, the company must
maintain records of experience and other information
used in developing the rates and make these available
to the commissioner upon request.
¾ Market regulation encompasses a number of different aspects of insurers’

activities, including:
9 Rates
9 Policy forms and terms
9 Underwriting practices
9 Marketing and distribution
9 Claims adjustments
¾ India is changing fast in so many ways – demographics, income etc. – all
having an impact on insurance and regulation
¾ Product evaluation has to be a consistent process with recognised headings
such as product definition, design, pricing and rating.
¾ Subsequently, product review involves further detail, including prudent
underwriting, simplified language/terminology and looking after the
policyholders’ interests
¾ Classification of products is divided between class rated and individually
rated products – these have their own sub-divisions, including package
policies and reinsurance driven covers.
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Answer to TY 1
The correct option is D.
All the given statements are the goals of market conduct supervision for
insurance business.
Answer to TY 2
Filing of rates and policy forms for the regulator’s review ensures the protection
of both the consumer and the insurer.
Answer to TY 3
File and Use laws represent a compromise between the prior approval system and
no-file system.
Answer to TY 4
The regulator is not concerned with resourcing issues.
Answer to TY 5
In the Indian context, the insurance market is in an emerging (nascent) stage.
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Answer to TY 6
Statement (ii) is incorrect as in the case of rates being based on non-insurance

technical data, the insurer should be able to defend the logic underlying the
establishment of the estimated claims costs from which the rates are derived.
Answer to TY 7
Office policies are a Package contract.
Self Examination Questions

Question 1
Under which of the following systems is a range established for insurance rates?
A File and Use Laws

B Flex Rating Regulation
C Use and File System
D Prior Approval System
Question 2
In a certain state, all insurance rates must be approved by the state insurance
department before the rates can be used. This type of rating law is called:
A File-and-use
B No-filing required
C Flex-rating
D Prior-approval
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Question 3
Insurance companies are subject to many laws and regulations. The principal
areas regulated include all the following EXCEPT:
A Sales practices and consumer protection

B Rate regulation
C The number of policies sold
D Formation and licensing of insurers
Question 4
Which of the following is rule based underwriting of products?
A Individual experience rated products

B Internal tariff rated products
C Exposure rated products
D Packaged / customised products
Question 5
Which of the following products is also described as ‘Special Contingency

Policies’?
A Exposure rated products

B Individual experience rated products
C Internal tariff rated products
D Packaged / customised products
Question 6
In addition to the “promotion of competition so as to enhance customer

satisfaction through increased consumer choice and lower premiums”, what other
key objective the IRDA does not have?
A Design of the Tariffs

B Ensuring the market’s financial security
C Regulating the marketing and distribution of products
D Appointing a qualified actuary
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Answers to Self Examination Questions

Answer to SEQ 1
Under the flex rating system, a range is established for insurance rates and
insurers are permitted to change their rates in both upward and downward
directions within the established range in response to market conditions.
Answer to SEQ 2
The rating law described is a prior-approval law. Under prior-approval, state
regulators must approve the rates before they can be used.
Answer to SEQ 3
The number of policies sold is not regulated. State regulators will, however,
consider the ability of the insurer to discharge any liabilities that may arise from
the policies sold.
Answer to SEQ 4
All rule-based underwriting products fall into the category of internal tariff
products.
Answer to SEQ 5
Packaged / customised products are also described as ‘Special Contingency
Policies’.
Answer to SEQ 6
The regulator is not interested in appointing an actuary.
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CHAPTER 6
APPLICATIONS OF FILE AND USE

REGULATIONS
This chapter aims to provide you with an introduction to the applications of the
file & use regulations within the Indian market, examination of the regulations
and relevant forms that need to be submitted to IRDA.
a) Briefly explain IRDA File and Use requirements.

b) Explain the role of the Board in relation to the underwriting policy.
c) Briefly explain the roles of:
(i) Moderator
(ii) Compliance officer
(iii) Appointed actuary
(iv) Advocate
d) Discuss the practical applications of the guidelines including Form A,
Form B, Form C and Form D.
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1. Briefly explain IRDA File and Use requirements.

For selling any general insurance product in the Indian market, it is essential to
comply with the requirements of File & Use (‘F&U’) guidelines prescribed by
IRDA.
The insurer is not permitted to offer any product for sale until all queries
pertaining to the product have been satisfactorily resolved after filing and IRDA
confirms in writing that it has no further queries in respect of that product.
This requirement will also apply to cases where the underwriting policy under
which the products are designed needs to be filed instead of filing of particulars
of individual product.
However, the authority has the right to question terms and/or issue directions,
suspend a product or withdraw from the market if, at any time, it appears to
IRDA that a product being sold by an insurer is not appropriate for any reason or
does not carry rates, terms and conditions that are fair between the parties or the
documents used with the product are in any way unsatisfactory, notwithstanding
the fact that IRDA may have had no subsisting queries in respect of that product
when it was originally filed.
The insurer needs to justify the rates, terms and conditions of insurance offered to
a particular client or to a class of clients or for a particular product while filing
the product with IRDA.
The insurer is not permitted to offer any product for sale until:
A All queries pertaining to the product have been satisfactorily resolved after
filing
B IRDA confirms in writing that it has no further queries in respect of that
product
C Both A and B
D Neither A nor B
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2. Explain the role of the Board in relation to the

underwriting policy.
Insurance business is the primary function of an insurance company and it is
essential for it to have its underwriting policy approved by the Board of
Directors. The Board approved Underwriting Policy is required to be filed with
the Regulator. Product design, rating, terms and conditions of cover and
underwriting activity shall be consistent with the approved underwriting policy of
the Board.
In case of any subsequent changes made from time to time with the approval of
the Board, the same should be filed with the IRDA without delay. In case the
Board delegates the authority to define and execute the underwriting policy to the
management, it should only be done on the basis of a clearly defined statement of
underwriting policy approved by the Board and the management should work
within the scope of such policy.
Design and filing of products should only be done in conformity with the
underwriting policy approved by the Board.
It is necessary that the Underwriting Policy is placed before the whole Board and
not just a Committee of the Board. The policy should not give unfettered
discretion to the management to quote untenable rates or make inadequate
reinsurance arrangements in respect of large accounts.
All important decisions must require at least two senior executives who are not
directly one above the other in the line of authority, to approve the decision.
Underwriting policy
The underwriting policy placed before the Board should cover the following:
a) The underwriting philosophy of the company in the matter of underwriting

profit expectation;
b) Whether each product shall stand on its own or be cross-subsidized among

products sold to one client - it is important to note that even though a
client’s total portfolio may be profitable overall on gross basis, the position
on net of reinsurance basis can be a loss because different percentages are
reinsured in different classes of business.
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c) Whether the insurer will underwrite any business on a planned underwriting

loss basis and if so, how the Board will control the effect of such
underwriting on the insurer’s solvency margin and the aggregate exposure
to such losses. The Board needs to be conscious of the likely need to further
strengthen the capital of the insurer if underwriting losses continue.
d) The margins that will be built into the rates to cover acquisition costs,
promotional expenses, expenses of management, catastrophe reserve and
profit margin and the credit that will be taken for investment income in the
design of rates, terms and conditions of cover, and how they will be
modified based on the actual operating ratios of the insurer etc. The margins
must have a relationship to the actual operating ratios of the insurer.
e) The list of products that will fall into each of the 5 sub-categories listed in
the File & Use guidelines.
f) The delegation of authority to various levels of management for quoting
rates and terms and for underwriting in each of the above mentioned 5 sub-
categories of products.
g) Appointment of Actuary or Financial Adviser or the Chief Financial Officer
or any other top management executive who does not have any
responsibility for business development, to act as the moderator of rates and
terms that are quoted on individually rated risks that are driven by the
reinsurance market.
h) The role and extent of involvement of the Appointed Actuary in review of
statistics to determine rates, terms and conditions of cover in respect of
internal tariff rated risks and products designed for a class of clients.
i) The internal audit machinery that needs to be put in place for ensuring
quality in underwriting and compliance with the corporate underwriting
policy.
j) The procedure for reporting to the Board on performance of the
management in underwriting the business, including the forms and
frequency of such reports. The reporting forms must be detailed enough to
highlight any emerging problems at an early stage and enable the Board of
Directors to monitor the profitability and spread of business on an ongoing
basis.
Responsibility for the overall compliance vests with the Chief Executive Officer.
There can be a designated senior officer, identified for specially ensuring
compliance of the ‘F&U’ requirements.
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Even where an insurer delegates the authority to design products and set the
rates, terms and conditions of cover to any subordinate office of that insurer, the
Chief Executive Officer will still be responsible for complying with the ‘F&U’
guidelines in respect of filing of products.
The Board approved Underwriting Policy is required to be filed with _________

A The Insurer
B The Regulator
C The Underwriter
D The Agent
3. Briefly explain the role of:

(i) Moderator
(ii) Compliance officer
(iii) Appointed actuary
(iv) Advocate
3.1 Role of moderator
The Appointed Actuary or the Chief Financial Officer or the Financial Adviser is
brought in as a moderator to ensure that the insurer does not act improperly under
the pressure of competition.
The Board in this regard can consider the appointment of the Appointed Actuary
or Financial Adviser or the Chief Financial Officer or any other top management
executive who does not have any responsibility for business development, to act
as the moderator of rates and terms that are quoted on individually rated risks that
fall under large risks as defined in the guidelines.
The insurer needs to demonstrate to the regulator that the rates and terms in any
particular case are determined in conformity with the guidelines and underwriting
philosophy. Moreover, in respect of insurance of reinsurance-driven large risks
where the insurer quotes terms to the client that are different from those obtained
from the international markets, the rates, terms and conditions of cover quoted to
the insured needs to have the concurrence of the Moderator which should state
that the rate is based on sound technical reasons.
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In such cases, the role of moderator is to ensure that the terms are determined on
a sound technical basis and not merely to meet competition in pricing regardless
of logic.
3.2 Role of compliance officer
The “Compliance Officer” is a senior officer appointed by the insurer to ensure

compliance with the requirements of the ‘F&U’ guidelines.
The Compliance Officer shall not be an officer who also holds responsibility for
underwriting. The Compliance Officer should be sufficiently senior in the
organisation to be able to enforce cooperation of the heads of underwriting in all
classes of business.
The Compliance Officer shall be responsible:
(a) to monitor the business activities of the insurer and ensure that all products
being sold by the insurer are in compliance with the underwriting policy as
approved by the Board and also with these guidelines;
(b) to file a complete list of all products falling under categories as defined in the
‘F&U’ guidelines,
(c) to file with IRDA at the end of every calendar quarter, a list of all new
products falling in categories viz. class rated risks and individually rated risks
as defined under the guidelines introduced by the insurer during the quarter
just ended and dates on which the rates, terms and conditions of those
products were filed with IRDA and the dates of confirmation by IRDA that it
has no subsisting queries in respect of those products; and also
(d) file a list of risks underwritten as Large Risks, etc.
3.3 Role of appointed actuary
The Appointed Actuary is a qualified actuary who is appointed or retained by the

Board of Directors of the company to prepare the statement of actuarial opinion.
The Appointed Actuary, in consultation with the underwriters of the insurer, shall
determine the requirements for compilation and analysis of data of sums insured,
premiums and claims at the stage of product design itself and ensures that such
data is captured at the stage of effecting insurance, on claims intimation and on
all claims payments.
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In respect of long-term insurance products, the Appointed Actuary should also

state the basis on which the reserve for unexpired risk will be calculated.
In health insurance for example, the occurrence of a disease is not a random

event and the actuary may develop mathematical models to determine the likely
exposure to certain diseases following a stated number of disease-free years or
following other diseases. These will then influence reserving requirements.
Analysis of data should enable review of rates, loadings and discounts for every
rating factor used in the determination of premium rates and for rating risks on
first loss basis.
The Appointed Actuary, in consultation with the underwriters of the insurer,
should compile various first loss rating schedules and schedules of discounts for
higher deductibles or franchise, for different products based on statistical data.
Such schedules shall form the basis for rating risks on first loss basis or without
condition of average in respect of those classes of business that are normally
underwritten on full sum insured basis and where condition of average applies
and also for allowing discounts for higher deductibles or franchise. This is to
ensure that when the insurer moves on to a different basis of insurance it does so
on a sound mathematical basis.
While filing the product, a certificate by the Appointed Actuary should
accompany every product stating the rating factors for which data will be
captured and that adequate capabilities have been put in place for collection,
compilation and analysis of such data.
This is considered an important requirement by the regulator. The periodicity of

review of emerging claims experience to determine any changes needed in rates,
terms and conditions of cover should also be stated in the certificate.
Where an insurer designs or quotes for new products without reference to
adequate statistical data support for the rates, terms and conditions, the basis of
rating such products shall be recorded in detail and such basis shall be based on
sound and prudent considerations.
In such cases, the Appointed Actuary can act as a moderator and review the
product design, rates and terms from the point of view of logic and
reasonableness.
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3.4 Role of advocate
The advocate plays an important role in ensuring that the product documents are
written in clear unambiguous language that properly explains the nature and
scope of cover, the exceptions and limitations, the duties and obligations of the
insured and the effect of non-disclosure of material facts.
For example while certifying the proposal form, the advocate should ensure that
the proposal form secures information on all matters that are material to the
contract and that it highlights the importance of the proposer providing all
information relevant to the contract and the consequences of suppression or non-
disclosure of material facts.
Further, he has to state in his certificate viz. Form D that the filed documents are
in compliance with the Policyholders’ Protection Regulations and Insurance
Advertisements and Disclosure Regulations etc.
Internal technical audit
In order to ensure that all underwriting is done in compliance with the ‘F&U’
guidelines, it is essential to constitute a Technical Audit Department by every
insurer.
The Department has the responsibility of bringing in self-discipline in

underwriting. The department should have audits as per the direction of the
Board and the reports of the Technical Audit shall be placed before the Board of
Directors.
The role of ________ is to ensure that the insurer does not act improperly under
A Compliance officer
B Appointed actuary
C Moderator
D Advocate
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The _________ is appointed by the insurer to ensure compliance with the

requirements of the File & Use guidelines.
A Compliance officer
B Appointed actuary
C Moderator
D Advocate
4. Discuss the practical applications of the guidelines

including Form A, Form B, Form C and Form D.
Every new product or revision of an existing product in respect of products
classified as Class rated products needs to be furnished with the following
documents.
Diagram 1: Documents to be furnished for the classification of products
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In respect of products classified under individually rated risks, the insurer should
file a statement of underwriting policy that was approved by the Board and
should provide the information in Form A.
4.1 Form A
It is a questionnaire to be completed and signed by the Principal/Designated

Officer furnishing the complete information of the product.
The contents of this form are as follows:
1. Product details
9 Class of Insurance: the class of general insurance refers to the segment

reporting list in IRDA Accounts Regulations viz. Fire, Marine, and Motor,
Miscellaneous etc., under which the product will be classified.
9 Name of Product: the name should not be misleading with regard to the
scope of cover offered under the policy. Except for generic names such as
homeowner’s comprehensive, shopkeeper’s comprehensive, banker’s blanket
etc. the name should not be closely similar to names of products of other
companies.
9 New OR Revision of Existing Product: new products are expected to be

materially different from other products being sold by the insurer.
9 If Revision, Name of Earlier Product: if there were any points of concern

with the earlier product, then it is essential to resolve them satisfactorily at
the time of considering the revisions. In case any product is withdrawn from
the market, the same name should not be used for a subsequently designed
product.
9 Nature of Revision Made: the revisions should make a real difference to the
cover offered. If the changes are insignificant, the reason for making the
revision should be enquired into.
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2. Product features
9 Contingencies Covered: the contingencies covered should be normal

insurable perils. The cover should not be in the nature of a financial
guarantee or “ART” (Alternative Risk Transfer) cover. The covers should not
be of exotic nature or covering contingencies not related to the interests of
the insured under the policy. Indirect insurance products such as insurance
covers in the nature of derivatives may not be allowed. This is because in
addition to issues stated earlier, the basis of reserving for all such covers
cannot be as per the traditional method of calculating reserve for unexpired
risks.
9 Basis of Cover:
Benefit Payment Basis: existence of insurable interest is important under

such policies.
Indemnity Basis with Deduction for Depreciation: the policy should

clearly spell out the basis of deduction for depreciation and whether such
basis is fair.
“New For Old” Basis in Respect of Repair Expenses: the meaning for
“New for Old” as stated in Form ‘A’ is in respect of repair claims on partial
losses where no deduction is made for depreciation should be clearly stated
in the product.
Reinstatement Value Basis for the Property Insured: the policy should
clearly set out the expectation with regard to the proper sum insured for the
risk.
9 Right of Recovery under Subrogation: if there is need to protect the right

of recovery, the steps to be taken on occurrence of a loss, should be clearly
set out.
9 Excluded Perils: whether any peril that is normally covered under such
products is excluded in this product; if so it should be clearly brought out in
product documents.
9 Declined Risks: the list of declined risks should provide a logical

justification for such declination.
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9 Special Features, if any: these will be features not ordinarily found in

insurance products of the type under consideration. Existence of such
features should add value from the insured’s point of view, and should reflect
the underwriting prudence in providing such insurance, in its proper pricing.
3. Marketing
9 Target Market: the appropriateness of the product for the market and the
scope for business should be considered.
9 Sales Channels Planned to Sell the Product: the sales channels should be
appropriate to access the target market and should be cost efficient.
9 Plans and Budget for Sales Promotion: the insurer should make an
assessment of the business expectation for the product, the profit expectation
on the sales and then examine whether the sales promotion costs are
reasonable in terms of profit expectation in the short-term of say, 3 years.
9 Acquisition Cost to be Incurred Including Commission or Brokerage: if

the acquisition costs are pegged too low in relation to the sales channel to be
used, there is likely to be an adverse selection of risks offered for insurance
or the sales targets may not be realized. One basis of comparison will be the
acquisition costs used by other insurers for similar products. However, this
can be lower than the maximum permitted by the law or regulations.
4. Underwriting and claims

9 The Delegation of Authority for Underwriting and for Quoting Rates
and Terms: should be commensurate with the technical and underwriting
skills required.
9 The Delegation of Authority for Processing and Settlement of Claims:

should match the technical skills of the authorized persons. Where the
authority is centralized, one should enquire into any possible delays in
processing and settlement of claims arising from such centralization. It is
reasonable to expect authority to be delegated based on claim amount, to
various levels of officers in the organization.
9 Reinsurance Arrangements Specific to the Product: in case it requires

consultation with reinsurers for underwriting or is controlled by the reinsurer
for settlement of claims, and where reinsurers play an active role in the
process of underwriting and claims, one should be mindful of the problems
that can arise if the reinsurers take a very strict view in dealing with claims.
112
9 Underwriting Manual and Claims Processing Manual in Respect of the

Product: the manuals should provide sufficient guidance to the underwriting
personnel and claims personnel. The instructions given should be consistent
with good underwriting and claims practices. The policyholder’s interest
should also be taken into account sufficiently.
5. Actuarial support
9 Name of Appointed Actuary: the person should be one approved by IRDA.

If not, the insurer should state the reason for proposing a different person’s
name.
9 Risk Factors Used For Rating: all relevant rating factors should be listed
and no rating factor should be discriminatory in nature or impractical of
implementation or could lead to problems if used in underwriting.
9 Margins built into the Rates and Terms for Acquisition Cost, Expenses
of Management, Catastrophe Reserve, Other Contingencies and Profit
Margin: these margins should be realizable and adequate. Where the
insurer’s current expenditure exceeds the margins being built in, the actuary
should evaluate the strain that will result from underwriting the business at
inadequate margins and the expected deficits based on business volume
expected to be underwritten. This evaluation needs to be reported to the
Board and such rating on “planned underwriting loss basis” is to be
sanctioned by the Board. The insurer should also have sufficient solvency
margin to absorb such strain.
9 Whether the IT System will provide Data on Each of the Risk Factors in
Respect of Sums Insured, Premiums and Claims: the IT system should
provide data on each of the risk factors in respect of sums insured, premiums
and claims. If not, the insurer must state how the data to validate the
premium loadings or discounts related to those risk factors will be generated
and how the experience by those risk factors should be monitored.
9 Periodicity of Compilation and Analysis of Data for Review of the Rates

and Terms: ideally, data should get captured as soon as the business is
underwritten, and such data should be automatically available to the Claims
module and statistical module of the database. As soon as a claim is
intimated the Claims module should be able to draw the relevant information
about the risk from the underwriting database, and also keep track of all
subsequent movements in the claims processing. Analysis should be annual
or more frequent.
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9 Basis of Reserving for Unexpired Risks In Respect of Long-Term

Products: where the premium charged covers risks extending over several
years, or where the exposure to loss is not uniformly spread over the duration
of the policy, the reserve for unexpired risks should take into account the
premium required to run the risk beyond the balance sheet date. The proper
reserving basis can be a mathematical formula that takes into account the
intensity of loss exposure over the period of insurance and any factors related
to discounting of premium to take note of investment income. The simplest
formula in respect of a long-term policy with uniform exposure to loss over
the duration of the policy may be, to provide that portion of the premium as
the period of risk beyond the balance sheet date bears to the total period of
insurance.
6. Rates and terms
9 Where the Rates and Terms are in the Form of an Internal Tariff for
Class Rated Risks: if the class of business was based on previous
manual/tariff, the insurer can compare the extent of the variation from tariff
for both rating factors and level of premium rates. If new rating factors are to
be introduced, their relevance should be demonstrated. If some of the rating
factors are to be dropped, the rates should sufficiently reward favorable
hazard features. Where the variation in rates compared to the manual/tariff is
more than 20%, the justification will need to be evaluated critically. It is
possible that the insurer may follow a different categorization of risks for
rating other than the one adopted in the earlier manual/tariff. For the purpose
of checking variation in rates proposed, comparison should be made with
rates as per earlier classification and the proposed rates for those categories.
9 Where the Rates and Terms Quoted to Individual Clients can Vary from
the Internal Tariff Rates and Terms: the details of the criteria and extent
of such variations are required to be provided. This is intended to prevent
arbitrary changes in rates especially to meet competition. The variations in
rates for inclusion or exclusion should be reasonable.
9 Where the Tariff is Used Only as a Guide and the Underwriter has
Authority to Depart from the Tariff: the level of management at which
such departure can be made and the permitted extent of such variation and
the circumstances in which such variation is permitted is to be specified. This
is the discretionary part of the rating formula. The authority to vary the rates
should rest with persons responsible for underwriting and not with persons
responsible for business development. Changes in rates should be for
objective criteria and not merely to match the rates of a competitor.
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9 Where the Insurance is to be Provided on First Loss Basis or with

Deletion of the Condition of Average: in a class that is normally insured on
full sum insured basis and subject to condition of average, the basis of the
first loss rating scale or the basis to dispense with the Condition of average
should be supported by actuarially determined rating scales.
9 Where the Insurance is to be Provided with a Higher than Normal

Deductible or Franchise: the basis on which premium reduction will be
allowed for the higher deductible or franchise should be stated. The discount
scales for deductibles should also be actuarially determined.
9 Where the Product is a “Package” Product Designed for a Specific

Client or Class of Clients: these are products designed for specific
individual/ class of clients. As there are similar individual products, it would
be required to outline the variations that will be made and the basis of rating
such variations.
9 What are the Elements of Insurance put together in the Package: the
elements of insurance put together in the package should be clearly defined.
9 The Package Rate Should be Derived by Adding Together the Rates for
Individual Elements of Insurance; If not, it is Essential to State How it is
Rated: one can accept the package rate to be an aggregation of individual
rates with some allowance for saving in administration cost arising from the
packaging. Any other basis need to be properly justified with technical
support.
9 In the Former Case how is Each Element of Insurance Rated? The levels
of rates for each of the insurance elements in the package should be taken
into consideration. There should be adequate premium for the risks covered.
9 Is there an Internal Guide Tariff or is Each Risk Rated Individually?

Generally, a product designed for a class of clients will carry an internal
tariff. If so, the suitability and adequacy of the rating basis and rate levels
should be assessed.
9 If Each Risk is Rated Individually, at what Management Level are Rates

and Terms Quoted and what is the Basis for Deriving the Premium
Rates? The level at which rating decisions would normally be at a
reasonably high management level and there should be a reasonable logical
basis defined for deriving the rates quoted.
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9 Where the Product is Experience Rated: here the experience of the

particular client or class of clients is only required to be used as a rating
basis.
9 What is the Target Claims Ratio? The target claim ratio is considered and
fixed by the Board of the insurer. However, whenever the target claims ratio
exceeds 80%, there is need to examine the risk at a budgeted level of
underwriting loss and satisfy the regulator on sustainability of the
underwriting model adopted by the insurer.
9 At what Management Level are Rates and Terms Quoted? The

management level should reflect sufficient maturity and also should exclude
persons responsible for business development.
9 At what Level of Management can the Insurer Decide to Ignore the

Experience in Quoting for the Insurance? This should be a fairly senior
level decision because it may involve underwriting business at a known
underwriting loss.
9 How are the Statistics Used for Experience Collected and Analysed? The
system should automatically capture underwriting and claims information
and the analysis should be annual or more frequent. Data should also include
sums insured.
9 Where the Product is Exposure Rated: How is the Exposure Evaluated?

Here, in case the experience is not insurance based, one can also rely on
technical literature on risk exposures and loss experience.
9 How is the Exposure Data Converted into Rating Factors? This can be a
mathematical basis using probabilities of loss occurrence and expected
values of loss amounts. Whatever the basis, it should be clearly defined.
9 If the Rates are derived by Comparison with Other Risks: In such a case,
the basis of comparison should be stated. Here, use can also be made of rates
quoted in other cases of risks of similar hazard or rates used by reputed
reinsurers or foreign underwriters. Adaptation of such rates should be on a
technically sound basis.
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9 Where Rates and Terms are determined by Reinsurers or Other

Underwriters: The level of management at which a decision is made
regarding the acceptance of rates and terms quoted should be mentioned. The
insurer should also have a clearly defined policy with regard to the
acceptance of changed policy wordings and the minimum rates and terms
required for such acceptance. Where rates are quoted based on reinsurance
quotes, it is important to ensure that the terms quoted to the client are the
same as those quoted by the reinsurer. Where the insurer desires to vary
terms from those quoted by the Reinsurer, one should carefully consider the
implications of increased retention exposure and properly price the product
for the increased exposure.
7. Documents
The following documents and certificates are needed to be attached while filing a
product with the IRDA.
a) Documents for class rated products:

(i) Prospectus
(ii) Sales literature
(iii) Proposal Form
(iv) Policy wording
(v) Wordings of various endorsements
(vi) Claim Form
(vii) Underwriting Manual and Claims Manual
b) Certificates
(i) Certificate by the Principal Officer or the Designated Officer in Form B
(ii) Certificate by the Appointed Actuary in Form C
(iii) Certificate by the lawyer of the insurer n Form D
8. Supplementary information
If there is any information other than that provided, it can be filled in this form
and with enclosures as required, so that this supplementary information also can
be taken into account in examining the filing of the product.
The form is required to be signed by the Principal Officer or Designated Officer,

with date and seal of Designation.
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General aspects of product filing

In respect of package policies that were filed earlier and where only the rates of
premium have been changed, it is sufficient to file the proposed rates
immediately with a confirmation that the proposal form, policy and endorsement
wordings remain unaltered and follow up later with filing of a copy of the same
within 3 months of the introduction of the altered product. Where the
Underwriting Manual and Claims Manual is product specific, it should be filed
with the product filing. Where these manuals are of general application, they may
be filed once and reference may be made to it with product filing instead of filing
it every time. Any changes specific to the product being filed should be stated
with the product filing. Any changes to the Manuals in general, should be filed
separately as and when such changes are made.
4.2 Form B
It is the certificate to be given by the Principal Officer or Designated Officer,

confirming that:
1. The rates, terms and conditions of the product filed with this certificate have
been determined in compliance with the IRDA Act, 1999, Insurance Act,
1938, and the Regulations and guidelines issued there under, including the
File and Use guidelines.
2. The prospectus, sales literature, policy and endorsement documents, and the
rates, terms and conditions of the product have been prepared on a
technically sound basis and on terms that are fair to both the insurer and the
client and are set out in a language that is clear and unambiguous.
3. These documents are also fully in compliance with the underwriting and
rating policy approved by the Board of Directors of the insurer.
4. The statements made in the filed Form A are true and correct.
5. The requirements of the revised File and Use guidelines have been fully
complied with in respect of this product.
Further, if any alterations are made in the wording, the implications of such
alterations should be explained.
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4.3 Form C
It is the certificate to be given by the Appointed Actuary confirming that he has

certified the product after studying the requirements of the File and Use
Guidelines in relation to the design and rating of insurance products.
He has to certify that the rates, terms and conditions of the filed product are
determined on a technically sound basis and are sustainable on the basis of
information and claims experience available in the records of the insurer and that
an adequate system has been put in place by insurer for collection of data on sum
insured, premiums and claims based on every rating factor that will enable
review of the rates and terms of cover from time to time.
He should state the periodicity planned for reviewing of the rates, terms and
conditions of cover and confirm that the requirements of the revised File and Use
guidelines have been fully complied with, in respect of the filed product.
4.4 Form D
This is the certificate to be given by the Lawyer of the insurer confirming that he
has carefully studied the prospectus, sales literature, policy wordings and
endorsement wordings relating to the above-mentioned product in the light of the
IRDA (Protection of Policyholders’ Interests) Regulations 2002, and the File and
Use Guidelines and that these above mentioned documents are written in clear
unambiguous language, and properly explain the nature and scope of cover, the
exceptions and limitations, the duties and obligations of the insured and the effect
of non-disclosure of material facts.
Further, he has to state in his certificate that the filed documents are in
compliance with the Policyholders’ Protection Regulations and Insurance
Advertisements, Disclosure Regulations etc.
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Chapter summary
¾ The Regulator can take certain actions even when a policy has been
previously approved. These could include questioning terms, issue directions,
suspend a product, withdraw it from market etc.
¾ The insured must have an underwriting philosophy and policy approved and
agreed at board level.
¾ Overall responsibility lies with the CEO.
¾ There are a number of roles with specific responsibilities including
moderator, compliance officer, actuary, board, lawyer and auditor.
¾ Regulations refer to two Categories of Product – Class rated and Individual
rated.
¾ There are four forms to be completed for Product approval – Form A and
Form B (Principal Officer), Form C (Actuary) and Form D (Lawyer).

Answer to TY 1
The insurer is not permitted to offer any product for sale until all queries
pertaining to the product have been satisfactorily resolved after filing and IRDA
confirms in writing that it has no further queries in respect of that product.
Answer to TY 2
The Board approved Underwriting Policy is required to be filed with the

Regulator.
Answer to TY 3
The role of moderator is to ensure that the insurer does not act improperly under
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Answer to TY 4
The compliance officer is a senior officer appointed by the insurer to ensure

compliance with the requirements of the File & Use guidelines.

Question 1
For certain reasons, the regulator can withdraw products – which of the following
is NOT one of these reasons?
A The product is not appropriate for any reason

B The product does not carry rates, terms and conditions that are fair between
the parties
C It has unsatisfactory documentation
D It is not available in regional language
Question 2
While filing an insurance product with the IRDA, the insurer needs to justify:
A The rate of the product

B The design of the product
C The amount of premium to be charged
D The tenure of the insurance
Question 3
The underwriting policy placed before the Board should cover:

A The list of products that will fall into each of the 5 sub-categories listed in the
File & Use guidelines
B The role and extent of involvement of the Appointed Actuary in review of
statistics to determine rates, terms and conditions of cover
C The delegation of authority to various levels of management for quoting rates
and terms
D All of the above
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Question 4
Which of the following is correct regarding the compliance officer?

A He should hold responsibility for underwriting
B He should be junior in the organisation
C He shall be responsible to file a complete list of all products falling under
categories as defined in File & Use guidelines
D His role is to ensure that the insurer does not act improperly under the
pressure of competition
Question 5
Which of the following is not likely to be the responsibility of the Insured’s

Lawyer?
A Ensuring product documents are written in an unambiguous language
B Ensuring product documents clearly explain the nature and scope of cover
C Ensuring policy documents are in an agreed size
D Ensuring proposal form requests information on matters material to the
contract
Question 6
“Determining the requirements for compiling and analysing data on sums

insured” is the responsibility of:
A The Actuary
B The Lawyer
C The Board of Directors
D The CFO
Question 7
The Appointed Actuary has a responsibility for which of the following

Regulator’s forms?
A Form A
B Form B
C Form C
D Form D
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Answer to SEQ 1
Unavailability in regional language is not an issue.
Answer to SEQ 2
The insurer needs to justify the rates, terms and conditions of insurance offered to
a particular client or to a class of clients or for a particular product while filing
the product with IRDA.
Answer to SEQ 3
The underwriting policy placed before the Board should cover all of the above
mentioned points.
Answer to SEQ 4
Option A is incorrect as the Compliance Officer shall not be an officer who also
holds responsibility for underwriting.
Option B is incorrect as the Compliance Officer should be sufficiently senior in

the organisation to be able to enforce cooperation of the heads of underwriting in
all classes of business.
Option D is incorrect as the role of Moderator is to ensure that the insurer does
not act improperly under the pressure of competition.
Answer to SEQ 5
Options A, B and D are correct with reference to Form D.
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Answer to SEQ 6
The actuary is the person responsible for this action.
Answer to SEQ 7
The Appointed Actuary is responsible for Form C.
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CHAPTER 7
TOOLS OF UNDERWRITING
This chapter aims to provide you with an understanding about the elements of
risk management framework. The chapter also discusses some important tools
used by insurers for effective and results oriented underwriting.
a) Understand the elements of risk management framework.

b) Discuss the tools for effective underwriting.
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1. Understand the elements of the risk management

framework.
1.1 Concept of Underwriting
Underwriting is the process by which an insurer determines:

9 whether or not to accept a risk and,
9 if accepted, the terms and conditions to be applied and
9 the level of premium to be charged
Weaknesses in the underwriting process and in the types and levels of controls
and systems can expose an insurer to the risk of operational losses which may
threaten the long-term viability of the insurer.
An effective underwriter is one, who knows when to say “No” to a risk that is not
insurable under the parameters the underwriter has established, despite the
attractiveness in terms of quantum of premium involved.
1.2 Commercial considerations
The litmus test in underwriting is individual risk profile in relation to potential

for losses and not other commercial considerations, even though it is a known
fact that commercial considerations do weigh depending on the underwriting
philosophy laid down by the Board of the insurer. It is however a fact that
commercial considerations can increase the risks for the insurer and create a
premium deficiency situation which can have undesirable consequences.
1.3 Consistent underwriting decisions
The most desired quality in underwriting decision making is consistency, because

consistent judgment generates predictable results, or at least results that are more
predictable than otherwise. Consistency in underwriting decisions will lead to
improvement of underwriting decision-making processes and produce better
underwriting result. Without the application of consistent underwriting judgment,
companies are vulnerable to competitors who may be more focused, organised
and have better tools and technology.
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To be consistent and profitable in underwriting of risks, we require certain tools

which can help and guide us in achieving desirable underwriting results.
In order to understand the importance of underwriting and the significance of

tools of underwriting, it may be useful to understand the risk management
framework for enabling effective use of these tools in order to be consistent and
profitable.
1.4 Risk Management Framework
The risk management framework typically consists of the following elements:
Diagram 1: Risk Management Framework
a) A statement of the insurer’s willingness and capacity to accept risk: This is

the underwriting philosophy of the insurer as to what, what not and how
much to accept.
`
b) The nature of business that the insurer is to underwrite including:
9 Classes: the classes of insurance to be underwritten;
9 Geographical areas: the geographical areas in which these classes will
be underwritten;
9 Types of risks: the types of risks that may be underwritten and those that
are to be excluded; and
9 Criteria for reinsurance: the criteria for the use of reinsurance in
different classes of insurance business to be underwritten
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9 Retention limits: risk and aggregate concentration of retention limits

and could include things like per event or per risk or per policy or per
class or per type exposures.
c) Details of the formal risk assessment process including:

9 The criteria used for risk assessment;
9 The method(s) for monitoring emerging experience;
9 The method(s) by which the emerging experience is taken into
consideration in the underwriting process
d) The process for nominating the appropriate approval authorities and the
definitive limits to those authorities (including controls surrounding
delegation of power to intermediaries of the insurer).
e) Methods for monitoring compliance with underwriting policies and

procedures such as:
9 Internal audit (where it is established that the internal audit unit has the
appropriate skills and experience to perform such activities);
9 Reviews by areas of coverage or portfolio management;
9 Peer review of policies underwritten (including details of the staff
responsible for undertaking the peer review, the frequency of such
reviews and reporting arrangements for the results);
9 Assessments of brokers’ procedures and systems to ensure quality of
information provided to the insurer and
9 In the case of reinsurers, audits of ceding companies to ensure that
insurance assumed is in accordance with treaties in place.
The underlying theme of the above risk management framework is to identify

and assess the risk properly and effectively in relation to the expected losses and
premium to be charged. This will help to build an efficient process of risk
evaluation and acceptance.
The process of underwriting helps the underwriter in deciding which of the

following?
A Whether to accept the risk

B Whether to reject the risk
C Whether to accept the risk or reject the risk
D If accepted then the terms and conditions to be applied and the premium to be
charged
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2. Discuss the tools for effective underwriting.

2.1 Approaches that can serve as tools for underwriting
Broadly speaking the following approaches can serve as tools for underwriting in
general:
9 The underwriting philosophy of the company
9 The underwriting policy of the company
9 The use of reporting forms on trends emerging on the claims front
9 Stated methods of taking emerging claims experience (both at macro and
micro levels) into account for acceptance and rating of risks i.e. underwriting
process
Diagram 2: Approaches that can serve as tool for underwriting
2.2 Tools for increasing effectiveness of underwriting process

To achieve these risk assessment and management practices in underwriting, the
insurer requires certain tools, which can help in achieving optimum utilisation of
resources with concomitant profitability of the portfolio. The following are some
of the important tools that insurers use in increasing effectiveness of the whole
process of underwriting.
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Diagram 3: Tools for increasing effectiveness of underwriting process
In order to understand these tools and their utility in the process of imparting
effectiveness to the whole underwriting process, let us examine each one of them
for a better understanding of the implications.
2.3 Insurance Documentation
This comprises all documents that evidence the contract of insurance and all
other related matters pertaining to that contract. They consist of the following
Diagram 4: Insurance documentation
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While the basic information on the risk about identification, hazard profile,
identifiable risk features, history of previous insurance/s and loss profile histories
is collected from the proposer in the proposal form, other documents are prepared
by the insurer. However, some of them like reinsurance slip, cover notes,
insurance certificates and renewal notices are provided separately to fulfill
certain obligations incumbent upon the insurer.
i) Proposal Form
Importance of proposal form from view point of proposer
The proposal form is a very important document in insurance. The insurance

contract is based on the principle of utmost good faith, wherein whatever the
facts, as given by the proposer are accepted and no verification is possible by the
insurer at the time of acceptance of his proposal. So, any misstatements or
incorrect information provided in the proposal form can be construed as violation
of the principle of utmost good faith and may result in the denial of claim.
Importance of proposal form from view point of insurer
Similarly, if the insurer has not obtained full information at the time of
acceptance of the risk, then the insurer cannot at a later date claim that the
insured has suppressed material information relevant to the risk. Hence, it is a
very important document both from the point of view of the insurer and proposer.
An insurance policy is an evidence of a contract between the proposer and the

insurer who undertakes to cover the risk for indemnification of losses if any,
subject to the terms and conditions of the policy issued. For this the written
request of the proposer becomes the offer. Acceptance of the offer by the insurer
by receipt of premium is an essential element of the insurance contract.
The printed proposal form contains questions designed to elicit all material
information about the particular risk proposed for insurance and the questions
vary according the nature and class of insurance proposed. A proposal form is
compulsory in all classes of insurance with the exception of marine cargo
insurance. Insurers also depend on their inspection reports for large industrial
risks.
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Common questions asked in a proposal form

Some of the common questions that are asked in a proposal form are:
9 Name and address of the proposer
9 Proposer’s occupation
9 Detailed description of the risk to be covered
9 Location of the risk
9 Value of the risk to be covered or sum insured
9 Previous insurance history
9 Loss experience
9 Any other information relevant to the subject
Diagram 5: Common questions asked in a proposal form
ii) Policy Document, Conditions, Warranties and Exclusions

An insurance policy contains many sections, such as
9 preamble,
9 insuring agreements,
9 schedule/s containing various details of the insured and the property or
interest covered etc.,
9 exclusions,
9 conditions,
9 special endorsements,
9 warranties, if any
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The policy document becomes a legally binding contract between the proposer
and the insurer specifying each others obligations under the contract. Any error
in the policy document can have an adverse impact on both the parties to the
contract, more so on the insurer.
Contra Preferentum
Insurance policies are also called contracts of adhesion, because of the unequal
knowledge and lack of bargaining power that the insured may have vis-à-vis the
advantages of knowledge and power enjoyed by the insurer and therefore any
ambiguity will be construed against the insurer. The legal phrase ‘contra
preferentum’ is used in this regard, which means that any ambiguous provision in
the policy is construed against the person who drafted the contract.
Policy Terms and Standardised Wordings
Every insurance policy is issued subject to certain terms, which limit the
operation of insurance or levels of indemnification that the proposer can avail.
All insurers have standard policy wordings for each class of business they
transact. These wordings have evolved after a process of development. The
advantage of such wordings is that they are tried and tested as policy drafters
have responded to claims experience and court decisions over many years.
Conditions
Conditions are the specific requirements imposed under the contract, the
violation of which can lead to adverse effect on the policy liability for a loss.
These are terms to be followed compulsorily for the performance of the contract.
Warranties
Warranties are special conditions based on the statements made by the insured.
These are imposed under the policy, which are to be adhered to by the proposer
for performance of the contract.
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However, in case of violation of these warranties, the insurer has the right either
to accept or reject the claim.
The cumulative effect of terms, conditions and warranties that form part of the
contract of insurance is that the performance of the insurance contract to
indemnify a loss depends on their compliance.
Exclusions
Exclusion is a clause contained in an insurance policy which describes the

condition or type of loss that is not covered by the policy. A policy can have
multiple exclusions.
Exclusion is an exception to the general statement of coverage contained in the

policy.
A motor insurance policy typically states that it will pay for damage to the
automobile arising out of an accident to the vehicle.
Exclusion in the policy shall provide the following: There is no coverage if the
driver of the vehicle is found under the influence of intoxicating drugs or liquor
at the time of the happening of the accident.
In a fire policy there can be:

General exclusions: war and allied perils
Specific exclusions: subterranean fires
The insurance policy can also have certain exclusions that could be removed if
additional premium is paid (e.g. spontaneous combustion).
iii) Endorsements
Any changes/amendments in the policy details like changes in the subject matter,
personal details, coverage details or cancellation of cover are carried with
endorsements under the policy.
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9 A change in the state of the subject matter may or may not adversely affect
the risk perception of the insurer. The insurer would always like to know of
any changes that have occurred in the risk, whether material or not for the
sake of better control and efficient risk coverage.
9 If the change in the risk profile alters the risk potential then the insurer might
charge additional premium and/or alter conditions and cover the risk.
9 If the change in the risk profile does not alter risk potential from what
existed, at the time of inception of the policy, the insurer may accept the
change simply by way of entering the change in his books without charging
any additional premium.
Under the contract of insurance if the insured fails to intimate about the changes
in the risk profile to the insurer, it may result in either repudiation of a claim
reported or reduction of eligible claim amount depending on the nature of
variation in risk profile.
What will happen in a fire insurance policy if the location of the stock covered is
changed and the same is not informed to the insurer?
When a claim is made for a loss at the new location, the insurer will decline the
claim
9 as the location is not the same as mentioned in the policy and further
9 as the insured has failed to intimate the change in location to the insurer
Hence, endorsements speak of changes in the risk either since inception or during
the period of the policy.
Apart from the above there are certain other endorsements which are used and
attached along with insurance policies specifically stipulating the restrictions
imposed on the coverage as given in the policy terms and conditions.
Traditionally there were several endorsements to the motor insurance policies

like IMT 26, IMT 11 etc. of the erstwhile motor tariff, which may still be used
without the nomenclature.
Similarly, specific standard endorsements were attached to the employer’s

liability insurance or workmen’s insurance policy depending on the nature of
industry in which the workmen are employed. These endorsements either restrict
the coverage or impose additional conditions to be met by the insured or
workmen for availing the benefit under the policy.
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In nature, these endorsements are akin to the warranties imposed under a fire
policy, whereby the insurer puts in an additional condition either restricting the
processes carried out at the workplace or avoiding risks altogether under certain
circumstances. However, the endorsements are an important part of insurers
operation for effectively dealing with risks and enforcing tests of admissibility of
claim.
iv) Reinsurance Placement Slip
This is a very important document pertaining to risks which are reinsured on a

facultative basis. The re-insurance broker prepares the slip containing the
9 terms,
9 conditions,
9 deductibles and
9 premium rates for the risk proposed
Each of the reinsurers accepting the risk signs the slip indicating the percentage
of risk accepted by him. The lead reinsurer or the insurer accepting the maximum
percentage of the risk will issue the reinsurance document detailing
9 terms,
9 conditions,
9 deductibles,
9 premium rates and
9 names of the other reinsurers along with their percentage of acceptances of
the risk
This is done as a temporary record of reinsurance arrangement for which

coverage has been effected, pending replacement by a formal reinsurance
contract by the lead insurer.
v) Insurance Certificate
In some classes of insurances like motor insurance, the companies issue a

certificate detailing the identification of the subject matter of cover and the
period of insurance. It does not contain the full set of terms, conditions and
warranties but merely certifies the insurance coverage to satisfy the Motor
Vehicle Act.
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vi) Cover Note
Cover note is a temporary document evidencing the receipt of premium and

acceptance of the risk by the insurer, pending preparation and issuance of fully
worded insurance policy.
Features of cover note
9 Temporary period of 30 days: Usually the cover note is issued for a

temporary period of 30 days and has to be replaced by a fully worded policy
document.
9 Evidence of risk cover:For the insured it is the evidence that the risk he
proposed for insurance is covered against the perils he desired.
9 Issue of fully worded policy document: The insurer issues the fully worded
policy once he receives full details required for underwriting the risk,
including documents like completed proposal form and all other relevant
information required in documentary form like inspection reports etc.
vii) Renewal Notice
Renewal notice is the intimation given by an insurer to the insured, informing

him of expiry date of the existing policy and date before which he should renew
his policy by paying premium mentioned in the notice.
Renewal notice also requires the insured to intimate any changes in the risk
covered under the original policy. Even though it is not mandatory and
compulsory to issue renewal notices, insurers issue renewal notices due to the
reasons of continuing relationship and for the sake of good order, and as a
healthy business practice.
2.4 Deductibles
Deductible or Excess is an amount which the policyholder agrees to bear in any

claim.Only the loss amount that exceeds the deductible is payable by the insurer.
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The deductible could be either

9 a compulsory deductible or
9 a voluntary deductible
A voluntary deductible is one that is voluntarily accepted by the insured in return

for reduction in the rate.
Benefits of deductibles
(a) Cost reduction through deductibles
The reason for adopting the deductible as an underwriting tool by insurers is that
typically a large number of claims are small, and since the administrative costs of
settling a claim can be quite high, the ability to eliminate small claims as a result
of a deductible can lead to significant reductions in the cost of doing business for
the insurer. This, in turn, will generally lead to lower premiums for the insured
with a deductible clause than without the deductible clause.
(b) Elimination or minimising the possibility of moral hazard
Furthermore, since a deductible would require the insured to bear part of a loss,
this helps in elimination or minimising the possibility of moral hazard as the
insured finds it worthwhile to make an effort to prevent and/or control a loss.
Thus, a deductible is advantageous to both the insurer and the insured; the cost of
doing business is lowered for the insurer while the insured pays a lower
premium. The reduction in the premium, typically, would not be directly
proportional to the size of the deductible but would reflect the decreasing
probability of larger losses.
Types of deductibles
There are many types of deductibles that are prevalent in insurance contracts.
The following three types of deductibles are among the most common.
9 Straight deductible: A straight deductible is expressed as a specified

amount. For example say the policy mentions Rs.10000 as the straight
deductible. In this case any loss that is less than the deductible amount of
Rs.10000 will not be paid. If the loss exceeds Rs.10000, the insurer pays the
loss amount over and above the straight deductible amount of Rs. 10,000. ]
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9 Percentage deductible: A percentage deductible is expressed as a

percentage of the loss amount. For example say the policy mentions 10%
deductible. In this case it would mean the insurer would pay 90% of the loss
amount.
9 Combination of straight and percentage deductible: The deductible is

expressed as a percentage of the loss or sum insured, subject to specified
minimum or maximum amount. This type of deductible is common in
property and miscellaneous insurances.
Diagram 6: Types of deductibles
2.5 Co-insurance
The term co-insurance has different meanings or practices in different parts of the
world.
In the original insurance contract there will be a lead insurer, who issues the
policy for the risk as proposed by the insured. The shares of the various other
insurers participating in the insurance as co-insurers will be given by way of a
co-insurance clause in the policy.
Thus co-insurance refers to the joint assumption of the risk between various
insurers.
This helps the insured to keep relations with various insurers and get the benefit
of their service. All the insurers in the transaction will share the premium and
claims, if any, in the same proportion of the premium.
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Concept of co-insurance in US and some other western countries
In the US and some other western countries co-insurance means the percentage
of the total risk that the proposer or insured is made to bear in case of a claim.
Under this arrangement, the insurers would like the insured to be insurer for a
part of the risk, so as to avoid moral hazard, if any. A majority of health
insurance policies in the western countries are issued with a co-insurance clause,
whereby the insured is made to bear stipulated percentage of the claims made.
2.6 Reinsurance and Appropriate Levels of Retention of Account
Reinsurance is a mechanism which insurance companies use to spread the risks

assumed.
Reinsurance is a contract of insurance between a primary insurer and a reinsurer

whereby the primary insurer transfers a part of its business to the reinsurer in
return for a commission called the ceding commission.
Benefits of reinsurance
Reinsurance is often used to smooth out the peaks and valleys of a primary
insurer’s profits and losses. By reinsuring some of its risks, the primary insurer
can plan for a steady flow of profits.
A small insurance company that wishes to enter a new and unfamiliar category of
business may choose to supplement its own underwriting capabilities with those
of a reinsurer who already has experience in that area. Since the reinsurance
underwriter has to evaluate the underlying risk anyway, that expertise will be
shared with the underwriter of the primary policy. This benefit can be multiplied
by choosing multiple reinsurers with expertise in different areas.
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Diagram7: Reasons for an insurance company to go for reinsurance
Retention by primary insurer
Reinsurance agreements involve a transfer of loss exposures assumed by the

primary insurer to the reinsurer. However, the reinsurer does not assume all the
exposures to which the primary insurer is exposed. The reinsurance agreement
requires that a portion of the exposure, known as retention, be retained by the
primary insurer. Therefore, before a primary insurer enters into any reinsurance
contract, the first and foremost decision he takes is the “retention”. It is the
amount of each and every risk which the insurer would like to retain for his own
account before ceding it to a reinsurer. This is the limit upto which the primary
insurer wishes to pay for the losses, out of its own account by retaining
proportionate premiums.
Retention Limits: Neither too high nor too low
If the retention is too high, then the insurer may end up in losses due to the fact
that the losses are beyond the limit upto which the insurer can absorb. On the
contrary if the retention is too low, then the insurer will be ceding unnecessarily
to the reinsurer a premium which would have helped to maximise the profit of
the insurer. Hence, the retention limit should be judicious so that neither it is set
too high or too low.
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The amount of retention to be decided is not easy, but at the same time it is of
paramount importance for the survival and profitability of the company itself.
The retentions are fixed for each individual classes of insurances and will form
the basis for the reinsurance treaties to be entered with the reinsurers.
Factors for deciding amount of retention
The amount of retention a company can have for any risk depends on factors like
9 paid up capital and free reserve,
9 expected gross premium,
9 class of business,
9 spread of risk,
9 composition and size of the portfolio,
9 past experience in a portfolio,
9 classification of risk,
9 geographical location and concentration of risks,
9 cost of reinsurance and type of reinsurance,
9 foreign exchange regulations and
9 inflation in the country etc.
Features of reinsurance programme
9 Once a decision is taken, the insurer negotiates with possible reinsurers of

repute for the treaty reinsurance depending on the estimated turnover and
quantum of business, class wise and portfolio wise.
9 Generally, the treaties are arranged in layers depending on the reinsurance
program of the company.
9 Normally, every insurance company enters into negotiated agreements for
the ensuing year 60 days prior to the commencement of the ensuing financial
year.
Treaty Slips
Once, the necessary premium modalities are complied with, the reinsurer binds
the agreement by issuance called as treaty slips indicating the
9 terms,
9 conditions,
9 deductibles,
9 commissions payable,
9 various warranties that are applicable and
9 method of settlement of accounts
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Later the treaty slips are replaced with fully worded reinsurance treaties or
policies by the reinsurer.
Bordereaux
The ‘bordereaux’ is an important document in the process of reinsurance. It is a

statement provided by the primary insurer or reinsured to the reinsurer, consisting
of premiums ceded and claims reported, paid and outstanding which are relevant
to the reinsurance arrangement. Basically, this is a statement of account for the
period referred in the bordereaux.
2.7 Portfolio Management
This is the technique and process of effectively protecting the insurer’s balance
sheet and financial stability by managing each of the portfolio of risk that the
insurance company underwrites. In practice, no insurer would like to have steep
peaks and slopes in the profitability of the portfolio which he underwrites.
Instead, the insurer would like to have more stable profitability with averaging
out of peaks and slopes in the overall portfolio.
Concept of Portfolio
9 Motor Portfolio: The term portfolio means in the case of motor vehicles
insurance of any kind as part of the motor portfolio.
9 Fire Portfolio: All the risks falling under the basic fire insurance comes
under fire portfolio.
9 As mentioned above the same goes for other categories such as the marine
cargo portfolio, marine hull portfolio, engineering portfolio and
miscellaneous portfolio.
How is portfolio management effected?
Portfolio management is effected through deciding an effective portfolio mix like

deciding on issues like
9 individual risk versus institutional risk,

9 single peril versus multi-peril,
9 individual insurance versus group insurance,
9 project insurances versus operational insurances etc.
Along with the above, constant monitoring of the portfolio is required to check
for adverse results against the projected results.
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Role of reinsurance in portfolio management
One of the ways in which the insurance company manages its portfolio is through
effective reinsurance. Even though reinsurance plays a vital role in portfolio
management, the primary insurers have the responsibility of managing the
portfolio as any adverse results in the portfolio might have disastrous effect on
the profitability or even on the very survival of the company itself.
Portfolio management primarily depends on the value at risk, portfolio mix and
finally the overall approach of the insurer on profitability, for each portfolio.
Hence, a good, efficient and well managed portfolio is the cornerstone for
success and survival of any insurance company. The documentation associated
with it will be in the form of board approved policy for underwriting, risk
management and financial stability.
Conclusion
These tools have been traditionally used by underwriters for decades and have
been found to be effective and result oriented. However, these tools are not
exhaustive but are the more important ones among those commonly used by
insurers. These tools help us in ensuring that the underwriting policy as
determined by the company is carried out effectively for generating an
underwriting surplus.
Before opting for reinsurance, insurance companies decide on keeping some risks
underwritten with them. This business portion which is kept by the insurance
company is known as _________
A Withholding Limit
B Retention Limit
C Detention Limit
D Preservation Limit
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Summary
¾ Underwriting is the process by which an insurer determines: whether or not
to accept a risk and, if to be accepted, the terms and conditions to be applied
and the level of premium to be charged.
¾ Commercial considerations can increase the risks for the insurer and create a
premium deficiency situation which can have undesirable consequences.
¾ The risk management framework typically consists of the following
elements:
9 Willingness and capacity to accept risk
9 Nature of business to underwrite
9 Details of formal risk assessment process
9 Nominating the appropriate approval authorities and their definitive
limits
9 Monitoring compliance with underwriting policies and procedures
¾ Approaches that can serve as tools for underwriting
9 Underwriting philosophy
9 Underwriting policy
9 Use of reporting forms on trends emerging on the claims front
9 Stated methods of taking the emerging claims experience
¾ Insurance documentation comprises all documents that evidence the contract
of insurance and all other related matters pertaining to the insurance contract.
¾ The proposal form is very important from the point of view of both, insurer
as well as the insured.
¾ Conditions are the specific requirements imposed under the contract, the
violation of which can lead to adverse effect on the policy, the liability for a
loss.
¾ Warranties are special conditions based on the statements made by the
insured. These are imposed under the policy, which are to be adhered to by
the proposer for performance of the contract.
¾ Exclusion is a clause contained in an insurance policy which describes the
condition or type of loss that is not covered by the policy. A policy can have
multiple exclusions.
¾ Changes or amendments in the policy are carried out by the insurer by
issuing endorsements under the policy.
¾ Reinsurance placement slip is a very important document pertaining to risks
which are reinsured.
¾ Cover note is a temporary document evidencing the receipt of premium and
acceptance of the risk by the insurer, pending preparation and issuance of
fully worded insurance policy.
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¾ Renewal notice is the intimation given by an insurer to the insured,

informing him of the expiry date of the existing policy and the due date
before which he should renew his policy by paying the premium mentioned
in the notice.
¾ Deductible or Excess is an amount which the policyholder agrees to bear in
any claim. Only the loss amount that exceeds the deductible is payable by the
insurer.
¾ Types of deductibles include: Straight deductible, percentage deductible or a
combination of straight and percentage deductible.
¾ Co-insurance means sharing of the same risk by multiple insurers or sharing
of some portion of the risk by the insured.
¾ The reinsurance agreement requires that a portion of the exposure, known as
retention, be retained by the primary insurer.
¾ Portfolio management is the technique and process of protecting the insurer’s
balance sheet and financial stability by effectively managing each of the
portfolios of risk that the insurance company underwrites.

Answer to TY 1
The process of underwriting helps the underwriter in deciding.

¾ whether or not to accept a risk and,
¾ if accepted, the terms and conditions to be applied and
¾ the level of premium to be charged
Answer to TY 2
Before opting for reinsurance, insurance companies decide on keeping some risks
underwritten with them. This business portion which is kept by the insurance
company is known as retention limit.
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Question 1
Warranties are special conditions based on the statements made by the ________.
A Insurer
B Insured
C Underwriter
D Broker
Question 2
___________ is a clause contained in an insurance policy which describes the

condition or type of loss that is not covered by the policy.
A Exception
B Exemption
C Exclusion
D Omission
Question 3
Changes in the state of the subject matter that are accepted and incorporated by
the insurer in his book are called __________ under the policy.
A Endorsements
B Modifications
C Variations
D Amendments
Question 4
A cover note is valid for how many days?
A 15 days
B 30 days
C 45 days
D 60 days
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Question 5
i) In some countries co-insurance means sharing of the same risk by multiple

insurance companies.
ii) In some countries co-insurance means sharing of some portion of the risk by
the insured
Which of the following statement is correct?
A Only statement i) is correct

B Only statement ii) is correct
C Both statement i) and ii) are correct
D Both statement i) and ii) are wrong
Answer to SEQ 1
Warranties are special conditions based on the statements made by the insured.
Answer to SEQ 2
___________ is a clause contained in an insurance policy which describes the

condition or type of loss that is not covered by the policy.
Answer to SEQ 3
Changes in the state of the subject matter that are accepted and incorporated by
the insurer in his book are called endorsements under the policy.
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Answer to SEQ 4
A cover note is valid for 30 days.
Answer to SEQ 5
Both the statements are correct

In some countries co-insurance means sharing of the same risk by multiple
insurance companies
In some countries co-insurance means sharing of some portion of the risk by the
insured
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CHAPTER 8
TYPES OF POLICIES
This chapter aims to provide you with an introduction to different types of
policies offered by insurance companies.
a) Classification of Insurance Covers.

b) Named Peril Policy.
c) All risk insurance cover.
d) Package Policy and Customised Insurance Policy.
e) Special Covers.
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1. Classification of Insurance Covers.

The insurance companies classify different types of insurance covers offered to
policyholders in many ways. Broad classification of such insurance covers is as
follows:
1. Insurance of Property: This relates to assets covered based on either market

reinstatements/new replacement value or any other valuation basis. All types
of property can be insured which have fundamental financial value and the
basis of valuation can vary based on requirements.
2. Insurance of Earnings/Profits: This type of insurance is becoming more

common. This is also known as Loss of Profits (LOP) or Business
Interruption (BI) insurance or consequential loss insurance.
3. Insurance of Liability: Liability arises from the law of tort and may arise
owing to the insured’s negligence, causing personal injury and damage to
property of others. Liability also may be without negligence i.e. ‘no fault’
basis in regards to handling of hazardous substances under Public Liability
Insurance Act 1991.
4. Insurance of Persons: This type of insurance covers persons where the

indemnity is not followed in the strict senses, and most insurance is in the
form of fixed benefits.
Broadly speaking, property insurance policies are on indemnity basis and all
policies on human life are benefit ones.
Classification by Class of Business
The Insurance Act 1938 classifies non-life insurance business into Fire, Marine
and Miscellaneous classes. Thus the financial statements of general insurers are
drawn into 3 classes of business. As general insurance began to cover specialized
risks, the need for further classification was necessary for insurers to develop
prudent underwriting practice for each class of risk.
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Diagram 1: Sub classification by type of insurance cover
The reason for classification is because insurance policies cater to various

sections of markets like householder, small trader, large corporate house and
different types of service organisations, whose risk perceptions are different from
one another and have to be addressed with different insurance coverages.
No matter what the basis of classification, the insurance policy covers a peril or
combination of peril. A peril can be the cause of injury, damages or loss.
Classification by Type of Insurance policy
Insurance policies underwritten in non-life insurance can be broadly classified on

the basis of perils covered such as:
a) Named Perils Cover

b) Multi Peril cover
c) All Risks cover
d) Package/Customized cover
e) Special Cover
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An insurance policy covers perils which can be cause of __________.
A Damages
B Injury
C Loss
D All of the above
2. Named Peril Policy.

Named peril policy provides only coverage on losses incurred to property from
perils or events named in the policy. It contains conditions which cover what the
insurer thinks is the most likely perils.
9 It provides coverage for all direct loss or damage caused by specific perils
mentioned in the policy.
9 It can be either a single peril or a multi-peril policy.
9 Under the named peril policy, if the damage or loss occurs by a peril not
mentioned in the policy, then there is no coverage for it. The policy has
standard terms, exclusions, conditions and deductibles.
9 Standard Fire & Special perils policy, Motor Comprehensive insurance etc.
can be examples of named perils policy.
9 Named perils policies can be further classified as those with basic covers and
those with add-ons.
A basic Standard Fire and Allied perils policy excludes perils of earthquake; an
insured may decide to cover delete such exclusions on payment of additional
premium, in order to obtain earthquake cover.
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9 A discount on premium is offered if perils are deleted from the standard

policy.
Exclusions of riot and strike perils in Standard Fire and Allied Perils policy gives
benefits for discount in premium.
9 However, there are some type of exclusions such as war, nuclear risk etc.
which cannot be deleted even upon payment of additional premium. Such
exclusions are called ‘absolute exclusions’.
9 The burden of proving that the loss is due to the covered peril is on the
insured. If the loss is on account of the specified exclusion relating to the
covered peril, the burden shifts to the insurer.
Other examples of named peril policies:
Marine Institute Cargo Clause ‘B’and ‘C’

Motor Package Insurance Policies
Burglary Policies
Critical Care Illness policies that cover specific tertiary care contingencies.
Named peril policy providing coverage for direct loss can be either a ________
or a ______.
A Package policy; Special policy

B Single peril policy; Multi peril policy
C Basic policy; Cover policy
D None of the above
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3. All Risks insurance cover.

1. An “All Risks” insurance policy covers any risk which the contract does not
specifically exclude. "All Risks" insurance policy covers direct physical loss
or damage to the property insured unless the policy specifically excludes or
limits the coverage.
2. In “All Risks” insurance policy, it is not necessary to name or list the insured
perils since the intent is to cover all risks of damage or loss due to accidental
circumstances.
Some examples of all risks policy:

9 All Risks cover for personal jewellery, valuables, works of art
9 Institute Cargo Clauses “A”, Inland Transit Clauses “A” in Marine Cargo
class of business
9 Electronic Equipment Insurance, Erection All Risks, Contractors All Risk in
Engineering class of insurance business
9 Industrial All Risks Policy etc.
3. One of the common perils responsible for property damage is the accidental
fall of the property or some other object falling upon the property. This peril
is usually not covered in the Named-perils policies.
4. The history of ‘All Risks’ insurance can be traced to Marine insurance

covers when policies were issued to cover ‘perils of the sea’. Over the period,
the “All Risks” policies were designed to cover unique objects of art,
jewellery, and other valuable items.
5. The burden of proof is mostly upon the insurer. This means that the insured
need not demonstrate the precise cause of loss but has the burden of proving
that some loss or damage has occurred and that the loss was not excluded by
the policy.
6. The loss must be fortuitous, in other words, it must have happened

accidentally, in an unforeseen manner. The burden of proof then shifts to the
insurer to prove that loss was caused by an excluded peril.
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7. Though the terminology “All Risks” is catchy and used by insurers from a
marketing angle, it may confuse the buyer of insurance into thinking that
there are no exclusions. The distinguishing characteristic of ‘All Risks’
policies is a comprehensive set of exclusions, which need to be elaborate as
otherwise the underwriter will be faced with a loss which was not intended to
be covered. There may be different set of exclusions for each type of policy
depending upon the risks covered.
8. Some interesting exclusions and their relevance under “All Risks” policy for
jewellery, cameras, works of art etc. are discussed below:
9 Breakage, cracking or scratching of crockery, glass, cameras, lenses,

musical instruments and similar articles of brittle or fragile nature, unless
caused by fire or accident to the means of conveyance. Since such fragile
items are prone to losses due to regular usage, there is a need for such
exclusion. Hence, in spite of the 'All Risks' nature, the coverage for
fragile articles is restrictive as losses in the nature of wear and tear are
not considered coverable.
9 Loss or damage caused by mechanical or electrical

derangement/breakdown of any article unless caused by accidental
external means. This means if the proximate cause of loss is a
“breakdown”, the same is excluded. However, if the subject matter
accidentally falls and in the process suffers a breakdown, the same is
covered. This exclusion is applicable to traditional items like radio,
watches etc.
9 Damage caused by any process of cleaning, dyeing or bleaching,

restoring, repairing or renovation or deterioration arising from wear and
tear, moth vermin, insects or mildew or any other gradually operating
cause. The intention being that the cause of the loss should be direct
accidental physical loss.
9. A few underwriting areas of “All Risks” Insurance covers are:
9 Unlike the traditional named perils policy, where the covered perils are
listed in the policy, an “All Risks” cover is open-ended, in the sense that
the covered perils are not specifically listed. Hence, insurers may
exclude certain specific perils in addition to the standard exclusions, if
they do not intend to cover such perils based on the risk factors.
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9 It is for an underwriter to decide if any exclusion can be added or waived

and determine the premium, deductible or imposition of any special
condition.
9 Absolute exclusions like war and allied perils, nuclear risks can not be
deleted.
9 Some of the usually excluded perils like mechanical/electrical/electronic

breakdowns, riot, strike, malicious and terrorism perils may be held
covered on extra premium and special conditions. Such peils are termed
as ‘buy back’ covers.
9 Policy must be clear as to the geographical jurisdiction of the subject

matter of insurance since an “All Risks” cover is also sought for
property carried as an accompanied baggage/apparel.
9 Another confusion the word “All Risk” denotes is that all of the property
concerned is covered. In case the intention of the policy is to cover only
specific items, the list of such items has to be collected along with the
proposal form; otherwise, the insurer becomes liable for all or any of the
property up to the value of the sum insured. If such a list is not possible,
a per article limit may be imposed in the policy to take care of high
valued items.
10. Since there are now various types of All Risk policies, underwriters would
have to understand them in their separate contexts. There could also be
apparent contradictions between what is available in the all risk policy, and
something wider could be apparently available in a named perils policy. The
pricing of an All Risks cover presents its own details for the underwriter in
view of the unknown perils not specifically excluded.
11. More importantly, All Risks insurance policies in the personal lines of
insurance may involve high degree of moral hazard and hence acceptance
limits of the lower level underwriters are normally kept low.
The policy that covers any risk which the contract does not specifically exclude
is called:
A All Risks inurance cover

B All purpose cover
C All peril policy
D None of the above.
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4. Package Policy and Customised Insurance Policy.

4.1 Package Policy
A policy which combines two or more types of insurance covers into one policy
is called ‘Package Policy’.
Commercial insurers also sell insurance covers separately and offer policies that
combine protection for major property and liability risks in one package.
Generally, package policies are created for businesses that face same kind and
degree of risk. Package policy could be applicable to various segments of
customers and include home package (Householder’s Comprehensive policy),
shop package, office protection shield policy etc.
Important features of Package policy:
9 Various ‘individual policies’ that are already available with the insurer are
bundled into various sections and underwritten as one policy document.
9 Basic premium of the individual section usually would be the same as the
premium applicable for ‘individual policy’. But some discounts are offered
on the number of sections chosen by the insured, since the costs involved for
the insurers in issuing & servicing multiple policies is reduced. Thus the
benefit of having a package policy is that it reduces the cost.
9 Advantage for the insured is that there is no need to deal with various
insurers and different renewal dates.
9 Some package policies provide for extra covers that may not be available in
an individual policy marketed by the insurer.
9 The package policy lists out all the terms and conditions for each individual
section either in a common set or individually as may be required.
One of the disadvantages is that a package policy may include covers whether
they are needed or not. Sometimes, the insured may end up paying premium for
certain covers that may not be strictly desired by him. Most insurers may,
therefore, offer choice of sections to be covered for the insured.
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4.2 Customised Insurance Policies

The needs of the policyholders keep changing and vary with different
professional and economic status they hold. They look for optimum insurance
coverage as they pay premium for perils perceived by them. In order to respond
to such needs, the insurers take special measures to customize insurance needs of
the policyholders by developing tailor made insurance policies for the risks
exposed. Such policies are called by different names like Customized Policies,
Special Contingency Policies or tailor made polices. The need for such policies
also arises when existing products of insurers do not meet the insured’s
requirements.
1. These policies are basically individually rated risks as per the ‘File and Use’
guidelines of the IRDA.
2. The underwriting of customised policy involves specialised risk assessment
as from the view of limited experience and non availability of readymade
pricing formula.
3. The underwriting of customised insurance covers for property damage calls
for collection of extensive data like:
9 Nature of property (machinery, whether fragile etc.)
9 Highest value per location
9 Limit per accident/ per policy period
9 Basis of valuation
9 Need for such an insurance (whether standard types of covers are not
available)
4. A risk analysis has to be done based upon risk profile of the insured. The
probability of a loss occurring and financial effects of the same are to be
precisely analysed. The perils covered need to be clearly listed in the policy.
5. There are different contingencies under which a policy is customized:

9 Those risks not covered in the list of standard policies available with
insurer.
9 New covers needed to be insured in addition to standard existing covers

such as Standard Fire Policy supplemented by peril of ‘Accidental
External Damage’.
9 Event insurances like that for a cricket match where any of the ‘man-
made’ or ‘Acts of God’ perils may result into personal injury, property
damage as well as loss of revenue.
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9 Personal forms of customised polices such as covering a footballer’s legs

or a pianist’s fingers and hands.
9 Tailor made Health Insurance Policy.
6. The underwriting of customised policy requires high level of knowledge and

experience and therefore is usually reserved for the insurer’s senior
underwriters.
7. Pricing of customised insurance policy is usually linked to premium under a

readymade policy for a similar risk duly modified by requirements.
When the insurer makes a policy according to the needs of the policy holders by
developing a policy tailor made to the risk exposed is called _________
A Customised Insurance Policy

B Package policy
C All risk policy
D None of the above
5. Special Covers.
[Learning Outcome e]
5.1 First Loss Policy
A first loss policy is a property insurance cover in which the policy holder
arranges cover for an amount below the full value of items insured and for this,
the insurer agrees not to penalise him for under insurance.
1. This policy is mainly used in circumstances where occurrence of total loss is

virtually impossible.
In case of burglary risk, a total loss is practically impossible in respect of heavy

machinery and bulk commodities stored loose like sulphur rock phosphate etc.
2. The burglary policy is issued with a sum insured expressed as a percentage of

the full value e.g. 25% of full value of Rs. 100 lakhs.
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Diagram 2: Underwriting Safeguards for a Burglary insurance Policy

on First Loss Basis
3. An additional underwriting measure called ‘partial average’ condition may

be incorporated which provides that if the total value of stocks is more at the
time of loss than the total value declared for the purpose of insurance, an
average condition will be applied only a rateable share of loss is paid.
4. Following rating factors are considered:

9 Maximum probable loss due to the nature of stock.
9 Full value of stock
9 Percentage of full value as sum insured
9 Normal rate for full value of insurance.
5. Following table is an illustration of a simple rating method:
Cover for Rate

75% of full value 90% of full value rate
(Note: It is to be noted that according to “File and Use” guidelines of

IRDA, the rating schedule for first loss policies has to be vetted by
an Actuary)
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5.2 Fire Declaration policy
9 This policy is issued on stocks which are subject to marked

fluctuations in quantity.
9 The insured is required to take the policy for the highest sum insured
that he predicts during the year and pay a provisional premium.
9 The policyholder has to declare periodically the actual values of stock.

These values are added on the expiry of the policy and premium
calculated on average of the values with provision for adjustment of
premium.
9 Refund of premium is subject to retention of 50% of provisional

premium (minimum premium).
5.3 Floating policies
1. Fire floating policy is issued when the insured is not able to declare separate
value of stock in each godown but is able to declare the total value of all his
stocks in various specified godowns. The policy, therefore, covers in one sum
insured, stocks stored in different specified godowns.
2. A combined Declaration and Floating policy can also be issued if needed.
Diagram 3: Underwriting Safeguards for Fire Floating policies
162
3. The policy may be subject to extra premium as the exposure to hazard is

higher.
4. Along the same lines, Declaration and floating policies can also be granted
in burglary insurance.
5. For Marine cargo insurance, merchants who are involved in regular import
and export trade or who are sending consignments regularly by inland
transportation can avail of a declaration policy (also known as open policy or
floating policy).
6. This policy is valid for one year and all shipments and consignments as the
case may be, declared during the policy period are automatically covered
under the policy. There is no need for issuing specific policies for each
shipment or consignment.
7. The policy is issued for an amount representing the insured's estimated

annual turnover of shipments/ consignments until the sum insured is
exhausted when it can be reinstated. For each declaration, a certificate of
insurance which may be needed by banks is issued.
8. Under Fidelity Guarantee insurance a number of specified employees can be

covered in the floating policy not for individual amounts but for a specified
sum of guarantee applicable to the whole group. This sum insured should be
fixed by the insured to ensure that it should be adequate to cover the largest
single loss that may arise as a result of any one employee or more employees
acting in collusion.
9. Recently, such floating policies have come into vogue to cover all the
members of a family under one sum insured in Medical insurance.
10. Valuation of property is another area of concern in underwriting. Claims

under policies are settled on the basis of the basic value of the property
(value of a similar property on the day of loss less depreciation).
11. In case of jewellery, it would be prudent that the sum insured is fixed after
valuation of the property by a professional jeweller. Such a valuation reckons
wear and tear element towards usage up to the point of valuation.
12. It still does not mean that the sum insured would be automatically paid in the
event of a loss.
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5.4 Valued Policies
1. In Fire insurance, valued policies can be issued on properties whose market

value cannot be as ascertained e.g. works of art, curios, manuscripts, obsolete
machinery etc.
2. Fire insurance is subject to the valuation certificate being submitted and

found acceptable by the insurers.
3. In Motor insurance,' agreed value' policies are issued on vintage cars which
are over a specified age and certified to be in good working condition by an
Automobile Engineer/Inspector. It is not easy to determine their current
market value.
4. In the event of a total loss, the motor insurance policy pays a specified sum
as the value of the vehicle, and no depreciation is deducted.
Under a Fire Declaration policy, refund of premium is subject to retention of

____ provisional premium.
A 25%
B 65%
C 50%
D 75%
Summary
¾ Liability arises from the law of tort and may arise owing to insured
negligence, causing personal injury and damage to property of others.
¾ A peril can be the cause of injury, damages or loss.
¾ A discount on premium is offered if perils are allowed to be deleted from the

standard policy.
¾ The unique characteristic of ‘All Risks’ policies is that the scope of cover is
determined by exclusions, which need to be elaborate as otherwise the
underwriter will be faced with a loss which was not intended to be covered.
164
¾ A policy which combines two or more types of insurance covers into one
policy is called ‘Package Policy’.
¾ First Loss Policy is mainly used when total loss is virtually impossible to
occur.
¾ A valued Fire insurance policy is subject to the valuation certificate which

should be accepted by insurers.

Answer to TY 1
A peril can be the cause of injury, damages or loss. No matter what the
classification is, the insurance policy covers a peril or combination of perils.
Answer to TY 2
A named perils policy can cover either one or more than one specified perils
Answer to TY 3
Answer to TY 4
The needs of the policyholders keep changing and are different from each other;
thus special measures are taken to understand the insurance needs of the
policyholders and give them custom made insurance policies.
Answer to TY 5
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Question 1
Which of the following is a not named perils policy?
i. Motor Package Insurance Policy

ii. Burglary Policy
iii. Industrial All Risks policy
iv. Marine Cargo policy on Institute Cargo Clauses ‘B’ & ‘C’
A ii, iii
B i, iv
C iii
D iii, iv
Question 2
When the insured is unable to declare separate value of stock in each godown but
is able to declare the total value of all his stocks in various godowns, he can take
insurance cover of:
A Fire floating policy

B Fire declaration policy
C First loss policy
D None of the above
Question 3
When the total value of stocks is greater at the time of loss than the total value
declared for insurance purpose, this additional condition is called:
A Minimal Loss Coverage

B Partial Average Coverage
C Customised Coverage
D None of the above
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Answer to SEQ 1
Answer to SEQ 2
Fire Floating policy covers in one sum insured stocks stored in different specified
godowns.
Answer to SEQ 3
167
CHAPTER 9
UNDERWRITING PROFITABILITY AND

REUNDERWRITING STRATGIES
This chapter aims to provide you with an understanding of the concept of
underwriting profit and loss. The chapter also explains what should be the
underwriting philosophy, underwriting profitability ratios used by insurers, areas
where adverse results can appear. The chapter also focuses on the concept of
reunderwriting, loss cause analysis and the corrective actions that can be taken,
underwriting audits and recommendations.
a) Learn about underwriting profit / loss.

b) Learn about areas where adverse results can appear.
c) Discuss about reviewing the underwriting policy or reunderwriting.
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1. Learn about underwriting profit / loss.

1.1 Underwriting Profit / Loss
Underwriting profit or loss is the amount of money that an insurance company

gains or loses owing to its operations excluding investment earnings.
Underwriting profit
Profitability is required in underwriting of risks so as to ensure

a. increasing financial strength for the insurer
b. capability to assume more risks and
c. pay claims and meet all liabilities in case of unforeseen catastrophes
Owners of the capital who have invested in the company would also be looking
forward to returns on the capital invested. In simple terms profit can be measured
as follows
[Profit = Premium Amount − Losses (claims) − Expenses Incurred ]

Therefore if the premium underwritten is more than claims paid and expenses
incurred then the underwriter has made a profit.
Underwriting loss
However making easy profit is not that simple for the underwriter. There can be
number of reasons for the insurer not making desired profits. Some of these
reasons include:
a) there is a need for rate approval from the regulator,
b) the rate war among competing insurers is to be factored in at the time of
pricing,
c) the sales force of the insurer may not be as effective as desired / expected,
d) the underwriting cycle may be indicating very soft rates etc.
The losses reported may balloon on account of large catastrophes or owing to

unforeseen legislation or court verdicts and the social milieu in the country
especially relating to law and order may cause more than expected losses.
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1.2 Underwriting philosophy
The steps towards planning for underwriting profitability include
9 Step I: to have a proper underwriting philosophy developed by senior

underwriters of the insurance company,
9 Step II: get it duly vetted by top management and actuary of the company
9 Step III: Get it formally approved by the Board
The underwriting philosophy will result in drafting underwriting policies of the

company and practices to be followed through underwriting manual and rating
tables.
Decisions based on the underwriting approaches of the company, an insurer has

to factor in the following:
a) Lines of business to be written
b) Competitiveness of the rating
c) Comprehensiveness of the covers offered
d) Segments and areas where the products are to be sold
e) Intermediaries that may be used and the commissions offered
f) Reputation for service and especially in claim service
g) Management expense ratio
Diagram 1: Factors to be considered
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1.3 Written premium Vs. Earned premium
9 The estimation of underwriting profitability of an account begins by

determination of the earned premium and not by the written premium.
9 Earned premium is that part of the premium in a policy which is being earned
as the risk period progresses and therefore can be measured on any given
date within the policy period in proportion to the total period of the policy.
Example: A policy starting on January 1st for a period of one year and
expiring on 31st December is taken as a reference. The earned premium on 1st
July will be 50% of the written premium and on 31st December it will be
100%.
9 A comparison of the written premium and earned premium can indicate the
dynamism of the insurer in premium growth.
9 In periods of rapid growth the earned premium will be low. In times of poor
or no growth, the earned premium in comparison with written premium will
be high.
1.4 Computation of losses
After having analysed the earned premium in comparison with written premium,
the losses need to be analysed. Losses can be computed by looking at the three
elements that constitute incurred losses, namely
a) paid losses
b) change in loss reserves to reflect unpaid but incurred losses and
c) loss expenses
1.5 Underwriting profitability ratios
There are a number of ratios that insurers use to measure profitability of their
underwriting operations. There are three ratios that are commonly used.
a) Loss ratio: The formula for calculating loss ratio is as follows
Incurred losses x 100

Loss ratio =
Earned premium
This ratio is indicated by incurred losses divided with earned premium for the
period desired.
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If the loss ratio of an insurer is 75%, it indicates that for every Rs. 100 the insurer
earns, it pays a loss of Rs. 75.
b) Expense ratio: The second ratio is the expense ratio. The formula for
calculating the expense ratio is as follows
Underwriting expenses x 100

Expense ratio =
Written premium
This ratio takes into account the expenses incurred by the insurance company for
business purpose.
c) Combined ratio: The third ratio is the combined ratio. The formula for
calculating the combined ratio is as follows
[Combined ratio = Loss ratio + Expense ratio ]
Combined ratio represents the overall profitability of the insurer. A combined

ratio over 100% indicates an underwriting loss and if the ratio is below 100%
profitability is indicated. The combined ratio needs to be calculated with care as
insurers have to maintain large reserves which are payments that need to be made
in future for losses that have already occurred. If these reserves are not accurate
the loss ratio will not reflect the true profitability. The combined ratio normally
considers only underwriting profits. The investment profit that the insurers make
is not factored in.
An insurer can improve underwriting profitability by taking necessary decisions

on any of the above referred three primary elements that affect underwriting
performance.
1.6 Underwriting restrictions
Profitability can be increased by raising the rates or by ensuring that more

premiums per policy are written or by underwriting more risks. However it is
often found that by merely underwriting more policies the loss ratio may not
necessarily be controlled. Therefore insurers re-examine the underwriting norms
and go for better selectivity of risks for underwriting. Underwriting restrictions
can be imposed across all lines or specific lines and certain segments of insureds
may not be offered cover and so on.
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Insurers can also move to segments where there is less competition and rate
cutting, segments which are less price sensitive or where the moral and physical
hazards are proven to be less and so on.
The method of coverage may also need to be re-examined for instance, if the
focus is on certain types of group policies, such policies may show more
volatility than individual policies or sales through a particular type of
intermediary may show more losses than through other intermediaries.
Increasing premiums
Playing with rates is another option. Rates can be raised to get additional
premium or can be lowered to get more volume. Rate increase can be through
slow increases in stages or a sudden large increase, with various consequences
among customers. Another option is without touching the rates, reconfigure the
policy terms and conditions so that effective coverage is reduced. All such
actions relating to rates, terms and conditions need approval of the regulator.
The loss ratio can be decreased by a more careful examination of claims and
claim assessments. Claims can also be reduced by placing more restrictions in the
policies underwritten. The underwriting guidelines could be enforced more
strictly and if they are found ineffective, they should be reviewed and
strengthened.
The expense ratio can be reduced by looking at the outflow of expenses, whether
they are creating necessary value and whether any of the costs incurred are due to
historical needs not relevant now and so on. Costs once analysed can be
rationalised appropriately. Thus all the three factors singly or in combination can
help to turn underwriting losses into profits.
1.7 Underwriting audits
To ensure that premium and loss exposures match in the proportion desired,
underwriting guidelines are prepared, underwriters suitably trained and given
necessary experience. Whenever unacceptable loss ratios emerge the compliance
of underwriting policies and guidelines needs to be checked through an
underwriting audit. The audit should be carried out regularly. Special
underwriting audits also can be carried out for more focused study of
underwriting results.
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Which of the following statement is correct for measuring the profitability of an

insurer?
A Profit = Losses (claims) – Premium Amount – Expenses Incurred

B Profit = Premium Amount – Losses (claims) – Expenses Incurred
C Profit = Expenses incurred – Losses (claims) – Premium Amount
D Profit = Premium Amount – Losses (claims) + Expenses Incurred
2. Learn about areas where adverse results can appear

The following are the areas where adverse results can appear:
1. Rating
Premiums are inadequate to cover the loss exposures. The needed response is
to increase rates, but the same is fraught with difficulties. The new rates need
to be filed with the regulator for their nod and has to compete in the market
with other insurers. Moreover the premiums are to be earned and therefore
the profitability will only emerge in the future.
2. Underwriting
If the underwriting guidelines are not being correctly applied or are

ineffective, then the remedial steps lie in enforcing more discipline among
underwriters, sales force and other intermediaries, training them and so on. It
may also be that the guidelines may require review and updating. These
revisions may take time for redrafting, implementing and training of the
underwriters and others in the sales process.
3. Policy wording
If the interpretations in the policy wording are open to larger risk coverages
than anticipated, more claims or larger claims will get paid resulting into
underwriting losses. Therefore the policy wording will need to be revised.
There are two ways of doing this:
9 by way of endorsements in the policy and
9 by revising the entire policy wording
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The latter can be onerous, time consuming and costly as all old unused policy
copies need to be withdrawn, new ones printed. Even after these, it cannot be
certain that policy interpretations will be benign.
4. Reserving
Loss reserves are not correctly computed. The reserving guidelines need to
be revised and the employees concerned have to be trained to assess these
accurately.
5. Claim processing
There is inefficiency in claim settlement and possible frauds and over-

payments are not being eliminated. This requires tighter control on claim
assessors and more oversight on the patterns of claims being lodged to
understand any leakage that may be taking place owing to moral hazards and
/ or physical hazards not considered by the underwriters. There could also be
unnecessary claim expenses leading to adverse results.
6. High Exposures
9 Introducing deductibles or increasing them

9 Introducing sub-limits for certain types of losses
9 Imposing compliance with safety measures and codes such as building
codes
9 Avoiding high risk concentrations or geographical areas
9 Re-rating loss prone segments
7. High Expenses
Controlling expenses has positive effects on profits. It reduces the combined

ratio and the reduced expenses can be passed on to insureds by lowering the
rates, which may result in high premium volumes and goodwill. Expenses
can be controlled by increasing efficiency and productivity of the insurer’s
employees as also through training and experience build up. Secondly by
technology upgradation and resulting ease of doing business can help to
reduce costs.
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3. Discuss about reviewing the underwriting policy or

reunderwriting
3.1 Reunderwriting
Reunderwriting is the process by which the profitability of a portfolio is managed

and the claims that take place are duly examined for identifying the loss
exposures and taking necessary correction for implementation.
Each insurance portfolio has goals and these are monitored for variances against
the planned goals and corrective action is initiated as may be necessary.
The insurer has a significant amount of data in its books, but this data needs to be
organised so that the patterns that are likely to emerge indicating deterioration in
the underwriting process can be identified. The computer systems available today
enable insurer to sort the data and obtain various reports. The report may indicate
9 unusual frequency: more number of claims than were estimated or
9 more severity: more amounts to be paid out than was the expected norm
The understanding in insurance practice is that:

9 if the loss frequency is more the problem lies in the policy selection and
9 if the severity of losses is beyond estimation it indicates a rating inadequacy
problem
3.2 Claims Analysis
9 In a situation of deteriorating claim results, the claim database need to be

analysed as to whether there is a pattern in the losses.
9 Reports culled from claims data can indicate useful patterns from analysis of
the cause of loss in conjunction with the location where loss has taken place.
9 Losses also can be examined under various other heads such as the category
of the insured, the type of physical risk covered (whether class I, II or III as
may have been classified by the insurer), or intermediary wise loss analysis
and so on. In Motor insurance, for instance, there could be a spurt of theft
claims and the manner, time and location of the loss may indicate a pattern in
the theft of vehicles.
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The loss experience can be viewed month wise to see whether the loss numbers
are accelerating or decreasing. The loss profile can be viewed on year to year
basis to see changes in the pattern of claims. Causewise analysis of claims can
reveal major losses that arise in the portfolio and what action needs to be taken
for those losses which are the most frequent. When these losses are compared
with the location of loss or the workshop where these repairs take place or the
type of intermediary that sold these policies etc. clear patterns may emerge that
can be considered for corrective action. Similar analysis can be made for severity
of losses as well.
3.3 Loss cause analysis
After the losses have been analysed it is possible to review the claim files
themselves to go deeper into the cause of loss and to find out whether
9 the loss was preventable or
9 took place because of negligence or carelessness of the insured or
9 whether the loss arose owing to poor maintenance or housekeeping or
due to larger issues like a downturn in the local economy or country or social
unrest etc.
3.4 Corrective actions
Once the causes of losses have been duly identified, it is possible to look at
possible corrective actions. The corrective approach to be implemented
effectively can vary from simple to complex and easy to hard. Some issues may
have to deal with physical hazards, others with moral or morale (carelessness
owing to having taken a policy) hazards. There can also be situations where
adverse selection may be unknowingly permitted by the insurer owing to certain
laxness in analysing claim patterns in the earlier review of underwriting norms.
The corrective actions can be implemented by one or more of the following

steps:
1. Non-renewal of all policies which has an undesirable loss exposure

especially those policies displaying moral or morale hazards.
2. Cancel the policies midterm if material misrepresentation has been made

in the proposal.
3. Modification of coverage by various methods available such as increase in

deductible, modification of terms and conditions through endorsements or
warranties and so on.
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4. Examination of adequacy of sums insured in the policy to avoid

underinsurance and increase premium per policy.
5. Upgradation of assets and revaluation may not have been informed to the
insurer by the insured and market trends in these aspects can be discovered
by proper discussions with loss assessors, based on the trends seen in the
claim files and revision may be required in sum insured and collection of
additional premium.
6. Modify risk profile of the portfolio as a whole. Thus, for example, if the
underwriting guidelines allow coverage in areas where buildings are situated
in congested markets, such a concentration of coverage may have an adverse
result during times of social unrest, then such risks may be discouraged for
acceptance in future. The selection of the insured for underwriting can thus
be made more stringent even though the guidelines may be silent on such
strictness, so that the underwriting experience is made to fall within the claim
ratios planned for.
7. Modify the underwriting guidelines: Subject to approval of the regulator

the guidelines for underwriters and acceptance of business can be suitably
modified. This will enable the insurer to modify discounts offered or to
increase rating factors and deal with all the other aspects which increase
losses but were not factored in the earlier guidelines.
8. Modifications based on changes in the environment: In the Motor

Insurance market, for instance, the pattern of vehicles manufactured or sold
may change. If sale of scooters in India has decreased, while that of
motorcycles increased rapidly, such changes can have substantial effect on
the claim patterns. Review of such changes whether for better or for worse
has to be monitored.
9. Legislation and court verdicts can have dramatic effects on claim outcome
and suitable remedial measures need to be taken so that the claim ratios
come back to planned level.
10. Modifying the pricing: This decision can be fraught with many unforeseen
consequences. Insureds with very favourable claim ratios may leave if the
rate increase is perceived to be against their interests.
They may either stop insuring or go to competitors. This will have disastrous
consequences on profitability. One method to modify rates that may be more
acceptable is to consider tiered rating, where insureds can be divided into
segments within the portfolio.
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Rates are then applied based on tiers of risk exposure as elucidated in the
revised underwriting manual based on claim experience and the analysis by
the insurer’s experts.
9 Lower than standard rates are offered to better class of insureds
9 Average rates offered to median class and
9 Loaded rates offered to ‘less than standard’ segment of insureds
These tiers will apply to insured on the basis of risk profile and will be
modified later on with the insured’s claims experience or further disclosures
made at the time of renewal.
11. Discontinue the portfolio: This is a very drastic action, which requires
approval of the regulator, can generate consumer objection particularly if all
insurers redline such policy or class of insureds. Therefore all efforts should
be consciously made to improve the portfolio before approaching the
regulator to discontinue the product or portfolio.
Diagram 2: Corrective actions
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3.5 Implementation of corrective actions
After all the corrective actions have been analysed, selection of the corrective
actions has to be made. Such actions should normally begin with implementation
of the easiest and for those policies that will generate the highest desired
improvement. This is necessary as otherwise there could be mounting expenses
9 in changing the rates, terms
9 in training the underwriters and sales wings
9 to obtain necessary approvals and
9 communicate changes to the customers
The changes can also anger or confuse customers and may therefore require
skillful communication to reassure the insureds.
The insurer also will need to reconcile to the fact that there are possibly long lead
times before the underwriting changes can show necessary effect on profitability.
This is owing to the need to comply with various regulatory requirements, the
full year time required for the renewal cycle to be completed and so on. Thus
changing direction of the results in a portfolio can be a lengthy process.
3.6 Cause of underlying problems
The entire review process requires a thorough understanding of the special

characteristics of relevant portfolio, regulations that concern that portfolio and
competitive position of the insurer in the marketplace. Thus there is a need to
understand the underlying problems which can arise from
9 deficiencies in underwriting policy,
9 changes in economic conditions of the area concerned,
9 technological or demographic changes,
9 new requirements of regulatory process,
9 actions of competitors in the marketplace
9 actions of legislatures, courts and consumer interest action groups
So far as underwriters are concerned, understanding of the special characteristics

of relevant portfolio and realigning it to realities of the market place will obtain
planned results. Thus Motor insurance has to factor in changes in technology
where, for instance, individual parts are now replaced by assemblies in case of
repair, and repairs are now not done and replacements of parts are found more
economical in terms of time costs as well as efficiency and customer satisfaction.
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3.7 Underwriting Audit
The purpose of underwriting audit is to give feedback to the underwriter and to

the management on the appropriateness of implementation of underwriting policy
and interpretation and use of the underwriting / rating manuals. The deviations
are reported so that the underwriter and the company may be helped to improve
underwriting process as outlined in underwriting philosophy adopted by the
Board.
The audit team will examine underwriting process of a department or an office

on a structured basis to examine the spirit of compliance, the individual judgment
exercised by the underwriter and the results generated thereby. The auditor will
examine the environment for profitable underwriting based on special conditions
of the area of operation and steps taken by the underwriters to adapt to changing
conditions not envisaged in the underwriting manual. The audit may report both
the success factors as well as deviations or failures that caused losses or can
cause future losses.
Re-underwriting of portfolio or portions of portfolio
Underwriting audit is normally based on a sample of policies drawn and

examined individually as also overall analysis of the portfolio based on various
underwriting reports that can be generated. The audit report may advise the
department to review and begin to re-underwrite the portfolio or portions of the
portfolio that has deviated from planned results.
Audit recommendations
The audit process compares trends seen in underwriting with underwriting

guidelines of the insurer. The audit process notes actual risk profile of the
portfolio that is being examined and makes relevant detailed notes on deviations
which are currently causing losses or are likely to cause losses against the
planned results. Accordingly suitable recommendations are made for
improvement by the concerned department. The department that is being audited
may accept or reject the report or parts of it and justify their actions or may
accept the same and make necessary changes as suggested. The higher
management as well as the Board Committee would be apprised of findings of
audit department, compliance by the concerned office and corrective action at the
company level, to take care of deviations in a timely manner.
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3.8 Review of claims and special events

Deteriorating loss ratio when not related to a catastrophic event or series of
events can cause a difficult situation to the insurer to unravel the correct reasons
for the losses. Nevertheless the insurer's various concerned departments must
begin to collect and sift the evidence so as to reach right conclusions and
eliminate root causes of deterioration. Review of claims can be cause-wise and
size-wise and be compared on month to month or year to year basis. Review of
claims can also be on the basis of
9 consumer segments,
9 sales channels used or repair establishments
9 loss assessor wise
9 geographical area wise
Such analysis will begin to show patterns that can be useful for going back to the
underwriting norms that may need review to correct the slide in the claims ratio.
Catastrophe
Similarly in the event of a large catastrophe like a severe flood in a metro city,
many lessons can be learnt on how to manage the underwriting to take care of
flood risks in general and for concentrations in a metro city in particular. Since
such catastrophes can happen owing to various rare events like tsunami, super
cyclones, earthquakes, breach of canals and dams; insurers need to take adequate
safeguards in taking care of risk concentrations and risk mapping to offer special
guidelines for vulnerable areas.
Conclusion
a) Underwriting profitability: The profitability of underwriting is a basic
requirement for sustenance of insurance business on sound lines and insurer
has to take this task with utmost seriousness in view of competitive scenario
and regulatory requirements. While the focus is on increase of premium
income, easy underwriting can generate volumes but not profits and
therefore, the focus has to be on very scientific approaches to appreciate the
risk exposures across locations, customer and asset segments and in the
context of competitor’s rates / policy terms for comparison.
b) Frequency and severity of claims: The second area of focus is to see that
claim outgo both on counts of frequency and severity are within the planned
limits. Claim reports on various parameters can help to bring out the patterns
of claims and help to stem losses quickly by better claims control as well as
by bringing necessary corrective action in underwriting.
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In this, strategies need to be developed for review of underwriting or

reunderwriting and aligned with competitive and regulatory requirements.
c) Reduction in combined ratio: Finally the costs of the insurer need to be

reduced to bring the combined ratio down and if possible to pass on the
benefits of lower costs to insureds so as to win more market share and
customer goodwill. The role of underwriting audit in generating underwriting
profitability cannot be underestimated and a properly set up underwriting
audit department can be great boon to underwriters, the top management and
the insuring public.
Which of the following is the correct way of revising policy wording?
A Only by way of endorsements in the policy

B Only by revising the entire policy wording
C Either by way of endorsements in the policy or by revising the entire policy
wording
Summary
¾ Underwriting profit or loss is the amount of money that an insurance
company gains or loses owing to its operations excluding investment
earnings.
¾ The profitability of an insurance company is measured as follows
Profit = Premium Amount – Losses (Claims) – Expenses incurred
¾ Some reasons for the insurer not making desired profits can be: regulator not
giving the rate approval, rate war among competing insurers, sales force not
being effective& soft underwriting cycle.
¾ Steps towards planning for underwriting profitability include: Have a proper
underwriting philosophy developed, get it duly vetted by the top management
and actuary and get it formally approved by the Board.
¾ Earned premium is that part of the premium in a policy which is being earned
as the risk period progresses.
¾ Losses can be computed by looking at incurred losses, namely: paid losses,
change in loss reserves to reflect unpaid but incurred losses and loss
expenses.
¾ Common ratios that insurers use to measure profitability of the underwriting
operations are: Loss ratio, expense ratio and combined ratio.
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¾ The loss ratio can be decreased by a more careful examination of claims and
claim assessments.
¾ Whenever unacceptable loss ratios emerge the compliance of underwriting
policies and guidelines needs to be checked through an underwriting audit.
¾ Areas where adverse results can appear include: rating, underwriting, policy
wordings, reserving, claim processing, high exposures, high expenses
¾ Reunderwriting is the process by which profitability of a portfolio is
managed and claims are duly examined for identifying loss exposures and
taking necessary correction for implementation.
¾ The corrective actions can be implemented by one or more of the following
steps: non-renewal, cancellation of policies with material misrepresentation,
modification of coverage, examination of adequacy of sum assured, modify
risk profile of the portfolio, modify underwriting guidelines, modifications
based on changes in the environment, modifying the pricing, discontinue the
portfolio.
¾ Corrective actions should begin with implementation of the easiest for those
policies which will generate the desired improvement.
¾ The purpose of underwriting audit is to give feedback to the underwriter and
to the management on correctness of implementation of the underwriting
policy and interpretation and use of underwriting /rating manuals.
¾ Based on the audit report, auditors may advise the department to review and
begin to re-underwrite the portfolio or portions of the portfolio that has
deviated from planned results.

Answer to TY 1
The following statement is correct for measuring the profitability of an insurer
Profit = Premium Amount – Losses (claims) – Expenses Incurred.
Answer to TY 2
Policy wording can be revised by way of endorsements in the policy or by
revising the entire policy wording
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Question 1
The underwriting philosophy developed by senior underwriter needs approval
from which of the following?
A Only Actuary of the company

B Top management of the company
C Top management and Board of the company
D Top management, Actuary and Board of the company
Question 2
The estimation of underwriting profitability of an account begins by

determination of the _________.
A Earned premium
B Written premium
C Both are one and the same
D None of the above
Question 3
Which of the following is correct for combined ratio?
A It is combination of loss ratio and miscellaneous ratio

B It is combination of loss ratio and expense ratio
C It is combination of expense ratio and miscellaneous ratio
D It is combination of profit ratio and miscellaneous ratio
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Answer to SEQ 1
The underwriting philosophy developed by senior underwriter needs approval

from the top management of the company, the actuary and the Board.
Answer to SEQ 2
The estimation of underwriting profitability of an account begins by

determination of the earned premium.
Answer to SEQ 3
Combined ratio is combination of loss ratio and expense ratio.
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CHAPTER 10
PROTECTION OF POLICYHOLDERS’
INTERESTS
This chapter aims to provide you with an understanding about the provisions of
IRDA (Protection of Policyholders’ Interests) Regulations, 2002.
a) Understand the Protection of Policyholders’ Interests Regulations issued

by IRDA.
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1. Understand the Protection of Policyholders’ Interests

Regulations issued by IRDA.
Introduction
Insurers have the duty of protecting interests of policyholders. Such a duty is also
cast on the underwriter whilst underwriting. Apart from the File & Use and
related guidelines from the regulator, an important regulation to be complied with
particularly by technical wing of the insurer is the Protection of Policyholders’
Interests Regulations, 2002.
This regulation is intended to ensure, among other things, that insurance is

provided on equitable terms and conditions. The insurers need to fulfill their
obligations in accordance with these terms and conditions. Insurers ought to
support and equip consumers through enhanced disclosures. It is the duty of each
and every insurer to promote greater market discipline.
The rights of policyholders to make informed choices regarding their selection of

insurance products and service providers need to be respected and preserved.
These are articulated by way of various regulations by the Regulator who has the
duty to ensure that the insurers comply with the obligations cast on them.
Insurance Regulatory and Development Authority (Protection of

Policyholders’ Interests) Regulations, 2002
The regulations lay down various stipulations to be followed by insurance

companies with regards to:
9 point of sale
9 proposal for insurance
9 grievance redressal procedure
9 matters to be stated in a life insurance policy
9 matters to be stated in a general insurance policy
9 claims procedure in respect of a life insurance policy
9 claims procedure in respect of a general insurance policy
9 policyholders’ servicing
9 other general guidelines
The above regulations are applicable to life and general insurance companies. In
this chapter we will restrict the discussion to regulations applicable to general
insurance companies
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Diagram 1: IRDA (Protection of Policyholders’ Interests) Regulations, 2002
1.1 Point of Sale
Prospectus: A prospectus of any insurance product shall clearly

9 state the scope of benefits
9 state the extent of insurance cover
9 explain warranties, exceptions and conditions of insurance cover
9 clearly spell out the allowable rider or riders on the product with regard to
their scope of benefits
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Diagram 2: Contents of the prospectus
a) Complete disclosure
An insurer or its agent or other intermediary shall provide all material

information in respect of a proposed cover to the prospect to enable him/her to
decide on the best cover that would be in his or her interest.
b) Dispassionate advice
Where the prospect depends upon advice of the insurer or his agent or an
insurance intermediary, such a person must advise the prospect dispassionately.
c) Declaration
Where, for any reason, the proposal and other connected papers are not filled by
the prospect, a certificate from the prospect may be incorporated at the end of the
proposal form to state that the contents of the form and documents have been
fully explained to him and that he has fully understood significance of the
proposed contract.
1.2 Proposal for insurance
a) Proposal form
A proposal for grant of cover, for general insurance business, is necessary

(except in case of a Marine insurance cover where current market practices do
not insist on a written proposal form).
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b) Where proposal form is not used
Where a proposal form is not used, the insurer shall record information obtained
orally or in writing and confirm it within a period of 15 days thereof with the
proposer and incorporate this information in its cover note or policy.
The onus of proof shall rest with the insurer in respect of any information not so
recorded, where the insurer claims that the proposer suppressed any material
information or provided misleading or false information on any matter material
to grant of a cover.
c) Processing of proposals
Proposals shall be processed by insurer with speed and efficiency and all
decisions thereof shall be communicated in writing to the proposer within a
reasonable period not exceeding 15 days from receipt of proposals by the insurer.
1.3 Grievance Redressal Procedure
a) Grievance redressal mechanism
The regulations stipulate that every insurer shall have in place proper procedures
and effective mechanism to address complaints and grievances of policyholders.
The grievances shall be addressed efficiently and with speed.
b) Insurance Ombudsman
The information in respect of Insurance Ombudsman shall be communicated to

the policyholder along with the policy document and as may be found necessary.
The system of Insurance Ombudsmen has been put in place in terms of the Rules
for Public Grievances, 1998 notified by the Government of India. The
Ombudsman entertains grievances pertaining to personal lines insurance. His
jurisdiction and powers are as spelt out in the Rules.
1.4 Contents of a General Insurance Policy
a) Insured details: A general insurance policy shall clearly state the name and
address/es of the insured and financiers, where applicable.
b) Property details: It must contain a full description of the property or interest

insured and details of the location or locations of the property or interest
insured along with appropriate values.
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c) Period of insurance: The period of insurance has to be mentioned in the

policy.
d) Sum insured and premium details: The details of sum(s) insured ought to
be given. So also whether there is any deductible / franchise. The policy must
contain details of premium payable and where the premium is provisional,
whether it is subject to adjustment and if so, the basis of adjustment.
e) The policy terms and conditions must be clearly stated.
f) It must also contain details of obligations of the insured under the policy
etc.
Diagram 3: Contents of a General Insurance Policy
1.5 Claim Procedures
The regulations prescribe obligations of a general insurance company as well as

the insured in respect of claims. An insured or claimant shall give notice to the
insurer of any loss arising under the contract of insurance at the earliest or within
such extended time as may be allowed by the insurer.
On receipt of such a communication, a general insurer shall respond immediately

and give clear indication to the insured on the procedures that he should follow.
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Role of the Surveyor in Claim Processing

a) Appointment of surveyor: In cases where a surveyor has to be appointed, it
shall be so done within 72 hours of the receipt of intimation from the insured.
b) Submission of report: A surveyor shall communicate his findings to the
insurer within 30 days of his appointment. In special circumstances he may
seek an extension but in no case shall take more than 6 months from the date
of his appointment to furnish his report.
c) Discharge of claim: An insurer shall dispose of a claim within 30 days of
receipt of the survey report. Any delay in discharging the claim, once the
offer of settlement has been accepted by the insured, shall attract interest at a
rate which is 2% above the prevailing bank rate.
1.6 Policyholders’ Servicing

The regulations prescribe various requirements relating to policyholders’
servicing.
a) Any communication received from a policyholder shall be responded to
within 10 days of its receipt. Such communications may relate to
9 recording change of address,
9 issuance of a duplicate policy,
9 issuance of an endorsement under a policy noting a change of interest or
sum assured or perils insured,
9 financial interest of a bank etc.
b) These ought to be carried out and responded to within the set time frame.
c) An insurer shall also give prompt guidance on the procedure for registering a
claim.
1.7 Mutual Obligations

It is to be borne in mind that the regulations not only cast obligations and duties
on an insurer but on an insured as well. The requirements of disclosure of
‘material information’ regarding a proposal or policy apply to both the insurer
and the insured.
Responsibility of the insured
A policyholder shall furnish all information that is sought from him by the
insurer and also any other information which the insurer considers as having a
bearing on the risk to enable the latter to assess properly the risk sought to be
covered by a policy. The policyholder has the duty of assisting the insurer in
prosecution of a proceeding or in the matter of recovery of claims which the
insurer has against third parties.
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1.8 Policyholder awareness
Protecting policyholders not only entails laying down of regulations and

monitoring the companies and/or agencies involved for compliance with the
provisions but also a proactive role by way of enhancing awareness among
policyholders regarding their rights and duties. The insurers, the intermediaries
and all other stakeholders have a responsibility in ensuring that the customers get
educated in insurance matters so that they may take informed decisions. While
the IRDA has its own publicity programmes from time to time, the insurers and
intermediaries too have their respective publicity policies and programmes. There
have to be concerted efforts on the part of all stakeholders.
1.9 Disclosures by Insurers
The IRDA stipulates various disclosures - financial and others, which have to be
complied with by insurers. There are regulations for advertising that have to be
complied with by insurers as well as intermediaries.
File & Use
The 'File & Use' procedure of the IRDA requires products to be filed with the
regulator as per procedure laid down, before they are launched / sold. The
prospectus which becomes a primary source of information about the product for
the policyholder has to be transparent and complete. Hence it is necessary for the
insurer to file this with the regulator along with other relevant document.
On the pricing front, it is necessary for insurers, in the interest of the

policyholders, to strike a balance between reasonable and equitable pricing
without jeopardising their solvency margins.
The insurer shall communicate all decisions to the proposer within a reasonable
period not exceeding _______ from receipt of proposals by the insurer.
A 3 days
B 7 days
C 15 days
D 30 days
194
Summary
¾ IRDA has issued the Insurance Regulatory and Development Authority
(Protection of Policyholders’ Interests) Regulations in 2002.
¾ Prospectus of any insurance product shall clearly state the scope of benefits
and extent of insurance cover, explain the warranties, exceptions and
conditions of insurance cover and clearly spell out allowable rider or riders
on the product with regard to their scope of benefits.
¾ Where the prospect depends upon advice of the insurer or his agent or an
insurance intermediary, such a person must advise the prospect
dispassionately.
¾ Proposals received shall be processed by the insurer with speed and
efficiency and all decisions thereof shall be communicated by it to the
proposer in writing within a reasonable period not exceeding 15 days from
receipt of proposals.
¾ Every insurer needs to have in place proper procedures and effective
mechanism to address complaints and grievances of policyholders.
¾ Insurance Ombudsman details shall be communicated to the insured along
with policy document and as may be found necessary.
¾ A general insurance policy document shall contain details of insured,
property, period of insurance, sum insured, premium, policy terms and
conditions and obligations of the insured under the policy.
¾ On receipt of a claim communication, a general insurer shall respond
immediately and give clear indication to the insured on procedures that he
should follow.
¾ An insurer shall dispose of the claim within 30 days of receipt of the survey
report.
¾ Any communication received from a policyholder shall be responded to
within 10 days of its receipt.
¾ The IRDA stipulates various disclosures - financial and others, which have to
be complied with by the insurers.
¾ On the pricing front, it is necessary for insurers, in the interest of the
policyholders, to strike a balance between reasonable and equitable pricing
without jeopardising their solvency margins.
195

Answer to TY 1
The insurer shall communicate all decisions to the proposer within a reasonable
period not exceeding 15 days from receipt of proposals.
Question 1
In claims where a surveyor has to be appointed, it shall be so done within _____
of the receipt of intimation from the insured.
A 24 hours
B 48 hours
C 72 hours
D 96 hours
Question 2
Any delay in discharging the claim once the offer of settlement has been
accepted by the insured, shall attract interest at a rate which is ______ above the
prevailing bank rate.
A 1%
B 2%
C 3%
D 4%
Question 3
Where a proposal form is not used, the insurer shall record the information
obtained orally or in writing and confirm it within a period of ________ thereof
with the proposer and incorporate this information in its cover note or policy.
A 7 days
B 15 days
C 30 days
D 45 days
196
Question 4
Any communication received from a policyholder shall be responded to within

______ of its receipt.
A 10 days
B 15 days
C 30 days
D 45 days

Answer to SEQ 1
In claims where a surveyor has to be appointed, it shall be so done within 72

hours of the receipt of intimation from the insured
Answer to SEQ 2
Any delay in discharging the claim once the offer of settlement has been
accepted by the insured, shall attract interest at a rate which is 2% above the
prevailing bank rate.
Answer to SEQ 3
Where a proposal form is not used, the insurer shall record the information
obtained orally or in writing and confirm it within a period of 15 days thereof
with the proposer and incorporate this information in its cover note or policy.
Answer to SEQ 4
Any communication received from a policyholder shall be responded to within

10 days of its receipt.
197
CHAPTER 11
RESEARCH AND DEVELOPMENT IN

UNDERWRITING, RATING AND PRODUCT
INNOVATION – CHALLENGES AHEAD
This chapter aims to provide you with an understanding of new areas where
challenges are occurring in the field of insurance. The chapter also discusses
product innovation.
a) Understand new areas where challenges are occurring in the field of

insurance.
b) Understand reasons due to which underwriting errors can occur.
c) Learn about product innovation.
198
1. Understand new areas where challenges are occurring in

the field of insurance.
1.1 Need for research and development in the field of insurance
a) Need for research and development: in the field of insurance, in particular

with reference to underwriting and rating, product innovation cannot be over-
emphasised in view of the dynamic nature of changes in the profile of risks
offered for insurance, expectations of customers and innovations coming into
the field.
b) Challenges for the underwriter: The challenges in this area are

considerable for the underwriter due to
9 continuous flux in the risk fields being dealt with,
9 new and emerging profile of losses,
9 unforeseen catastrophes that take place intermittently and
9 changes in the economic, environmental, technological, legal and social
landscapes in which the insurer operates
c) Role of emerging technologies: There are many emerging technologies that

may aid loss minimisation such as connectivity anytime/ anywhere,
increasing use of Global Satellite Positioning Systems (GPS), ability to carry
out complex analysis, modeling and so on.
d) Genetic changes: A wide variety of genetic changes are being contemplated

for human life betterment, which all have implications in the area of life and
health insurance. Underwriters are looking at these and other innovations to
monitor risks as well as remedies for reducing and pricing existing and
emerging risks.
1.2 New areas where challenges are occurring
a) New potential hazards: These are the unforeseen risks resulting from rapid
innovation and change. The world is changing on a continuous basis, with a
rate of scientific advance that is simply unparalleled. Many new products,
whether pharmaceuticals, consumer goods, automobiles or food products - to
name but a few - are coming to market faster in many innovative forms than
ever before.
199
With innovation, R&D and rapid introduction of new products in market,

new and completely unforeseen problems emerge. A fast business cycle
implies more insurance requirements in untested areas for risk management.
b) New vulnerabilities with hazards remaining the same: Activities in the

world are becoming highly interlinked. When something goes wrong in one
place, the whole inter-connected system goes haywire globally in
unanticipated ways. Certainly, the danger of linkages have been seen in
failures of large organisations like Enron and such losses only portend new
potential vulnerabilities and liabilities that continue to emerge. Today, many
companies are linking their strategic domains like financial systems into
electronic supply chains with their partners. This results in a massively
interconnected industrial financial system.
A skillful insurer spots an opportunity when one network problem

somewhere brings down an entire inter-connected industry supply chain.
There is need for insurance against resultant manufacturing delays, assembly
lines, plant shutdown and lost sales.
c) Untested insurance: An ever-increasing number of new challenges are

surfacing, which no one was able to predict years ago. New forms of genetic
risks pose ever increasing challenges. Previously unseen new environmental
challenges threaten to damage, dislocate, and destroy lives, assets,
opportunities and progress.
Risks arising from catastrophes like Hurricane Katrina of 2005 in the USA or
the earthquake and tsunami in Japan, floods in Thailand etc. have outdone
large catastrophes seen earlier. Insurance coverage is something that can no
longer be taken for granted and each peril has to be specifically insured – be
it flood, storm surge, tsunami, terrorism, earthquake or pandemics in respect
of health or life insurance and so on.
d) Growing need for international insurance coverage: A form of insurance

is emerging that involves need for international coverage such as in Aviation
or Marine hull insurance. The prospect is suddenly being confronted with
problems imposed by fellow humans of the world in areas like viruses,
hacker attacks and larger global problem of terrorism etc. Concepts like
probable maximum loss are becoming redundant to assess such catastrophic
risks by the insurers. Human ingenuity is needed to respond to such issues in
the insurance domain, starting with ad hoc solutions and transitional
techniques.
200
It is becoming increasingly necessary for underwriters to be attuned to rapid

changes taking place as the issues relating to risk are becoming more and more
complex. New concepts of coverage such as parametric insurance offers new
techniques, which may not indemnify pure losses, but agree ex ante to make a
calibrated payment upon occurrence of a triggering event. The triggering event
may be a catastrophic natural event, which may ordinarily precipitate a loss or a
series of losses.
This has considerable advantages such as

9 absence of moral hazard,
9 immediate possibility of payment on the occurrence of the trigger event,
9 saving of claim investigation and assessment costs,
9 waiver of considerable time consuming documentation and so on
It is because of these new types of risk solutions that the insurance industry has
to realise that the nature of the industry is changing. Underwriters would do well
to expand their imaginative capability while preserving their prudential approach
and conservative pricing skills. There is a need for underwriters to continuously
upgrade their skill and encourage innovation in the quest of consumer relevance
in the area of change and increasing perceptions of risk.
Diagram 1: New areas where challenges are occurring
1.3 Innovative Rating Programmes
Rate Making
Underwriters and actuaries have begun to construct more complex risk classes by
considering various additional differentiating factors.
201
In motor insurance, factors such as
9 yearly mileage driven,

9 number of other drivers in the household,
9 use of a garage,
9 additional anti-theft devices etc.
can obtain different rates
Despite this, the basic model still remains the same - that customers sharing the
same risk features are categorised together into one rating group and then
separated out on the basis of their accident behaviour. One major implication of
this approach is the fact that among new customers without driving history, good
drivers will subsidise bad drivers for some time, until the premium reduction of
the good drivers takes effect, which may be a slow process extending over years.
Similarly, the rate increase for new bad drivers will lag their actual loss costs.
Regulatory requirements: There are also compounding factors such as common

regulatory requirements on the industry, attempting to make sure that insurance is
affordable. This will limit the maximum amount of premiums that can be asked
of customers, irrespective of their accident behavior. Therefore, even when
considering long standing customers it is unavoidable that good risks or drivers
subsidise bad risks or drivers to some degree.
De-tariffing: While this may be socially desirable, the recent de-tariffing and
competition has made it possible for insurance providers to offer innovative rate
structures geared towards attracting and rewarding good customers while dealing
with bad customers individually on merits as much as possible. Detariffing
enables an insurer to shift from ‘rule based’ to ‘risk based’ underwriting and
rating. These rate structures differ from the traditional ones by considering many
more risk factors than before.
Data Mining: Data privacy and regulatory requirements may, however, prevent
widespread use of some of these data, but many more differentiators will begin to
be used in rate making than has traditionally been the case. Data mining is the
method of choice for managing the complexity introduced by using additional
variables. Using predictive modeling, major determinants for accident behavior
can be found, producing much smaller and more homogeneous subgroups of
drivers or insurance customers in general. Rate making will involve
determination of many niches of good and bad customers and result in rules that
can characterise these various groups.
202
This shifts the emphasis of the industry from the problem of “determining
optimal premium” to the issue of “improving customer relationship” by:
9 identifying low risk customers,

9 adjusting their premiums in order to win their loyalty,
9 improving customer retention and
9 increasing market share
Data mining is also the method of choice to monitor effectiveness of these goals
as well as performance of various rules developed for setting insurance
premiums.
1.4 Data, Concepts, Terminology
Availability of appropriate data
Like for any other data mining task, the most fundamental requirement is
availability of appropriate and credible data.
In the context of insurance policies, this requires information:

9 on the policyholder,
9 on the risks covered,
9 on cumulative risk behavior and
9 optionally on a variety of additional factors that may be relevant
Setting of rates for new and existing customers
The primary question to be addressed with data is setting of rates for new and
existing customers. Several of the variables may not be available for new
customers, in particular data on premiums, costs, and profitability. Data on
previous accident behavior may be incomplete or entirely missing, e.g. when
dealing with a newly licensed driver. In order to predict a rate in these cases, care
must be taken to exclude these variables from any rate-predicting model.
Rate Monitoring
In addition to rate setting, there is also the issue of "rate monitoring", i.e.
dynamically managing the rate structure for existing customers. This involves
analysing profitability of various risk classes and may result in taking corrective
action in case of under-performance or in the face of competitive pressures. It
may also involve a change in the "bonus malus" system.
203
The bonus malus system is the system of penalising or rewarding of customers

based on their yearly accident claims.
Pure Premium
The basic concepts, which are used in rate setting and rate monitoring, are the
"pure premium" and the "loss ratio".
Pure premium is the premium that would be sufficient to offset all accident claim
costs.
For any given customer, it can be estimated as the product of:

9 the likelihood of submitting a claim and
9 the expected size of claim
The pure premium is "rock bottom" of any premium structure: at that level an
insurance company would not generate a profit, but ideally, would not lose any
money either.
In practice, of course, there are many operating expenses in a business, including

buildings, equipment, and personnel, that need to be taken care of, irrespective of
number and size of claims that may occur.
None of these costs are included in the pure premium - neither are underwriting
costs, such as commissions to agents and brokers included.
The actual premium therefore is always substantially higher than the pure
premium.
1.5 Why underwriting matters?

Underwriting activity faces intense pressure in a deregulated market for various
reasons such as
9 industry competition,
9 overcapacity,
9 customer pressure and
9 other relevant factors
204
Diagram 2: Why underwriting matters?
Every company faces the dilemma of volume vs. profitability.
Poor underwriting can actually worsen the problem in both cases:

9 bad underwriting can initially destroy profitability in unseen manner and
9 can destroy volume in due course
Without necessary capital or return on risk assumed, further volume build up will
not be permitted.
The underwriter has the challenge to meet two difficult targets,

9 one, how to carry out a proper risk assessment and pricing, and
9 second, how to convince the client that the price quoted is the best value for
money
In case of Motor insurance, other things being common, which of the following
factors can lead to the prospect getting a lower rate compared to other prospects?
A Yearly mileage driven

B Number of other drivers in the household
C Additional anti-theft devices
D All of the above
205
2. Understand the reasons due to which underwriting

errors can occur.
Reasons due to which underwriting errors can occur
2.1 Faulty information collection
9 The insured or the intermediary may not disclose information other than
asked for.
9 In a dynamic risk situation it would be essential for the underwriter to ensure
that real risk factors are fully exposed and that all relevant information is
called for.
9 Once relevant information is available, careless processing or understanding
of the information can also affect proper underwriting.
9 Research and development in insurer’s systems need to be strengthened and
underwriter needs to be kept updated on changes that need to be understood
so that correct information is sought for and obtained.
2.2 Exposure Measurement
Once information is obtained, exposure measurement is a matter of skill of the

underwriter and the tools he uses to evaluate it.
Exposure measurement can be on various parameters such as:

9 frequency
9 severity
9 extent of concentration and
9 similar other considerations
2.3 Coverage Structuring
The cover that is to be structured must offer value to the customer and at the
same time must be correctly priced.
Underwriters, instead of deepening their expertise, may resort to either:

9 short changing the customer by trying to offer a lower cover than what is
sought or
9 leading the insurer to under pricing by short charging the premium
206
Structuring the cover is an option that helps to secure a negotiated balance

between the need for the widest cover desired by customer and obtaining a fair
price for it.
2.4 Wrong Pricing
Rate setting is a challenging task and needs to take into account:

9 industry level claims experience,
9 expertise of the Head Office underwriting team,
9 book experience of the office concerned along with
9 specific client experience
Rating plans are normally designed to ensure that underwriting profit is obtained
on a portfolio of similar risks. Rating naturally follows the assumption that there
is a high degree of accuracy in exposure measurement and coverage structuring.
Pricing divergence from what is required can often happen if there is a false
belief in superiority of the underwriter’s personal judgment, as also to execution
errors and infatuation of meeting market pricing measures.
Aggressive Pricing: Underwriters can no doubt aggressively price better than

average risks within a class, but then take care to load or conservatively price
worse than average risks, as otherwise the portfolio will suffer price erosion.
Underwriters, if knowingly or unknowingly, are judged only on the basis of
premium growth and not on profitability can legitimise their pricing decisions
using clever methods to use only selective information collection and this creates
long term problems and compromises data integrity. Winning in the market
should not damage the long term chance of surviving in the market.
Poor underwriting and rating: These can set off a negative spiral. First of all
profitability begins to fall and then, on analysis, it is found that the information
contained in the proposals and policy folders is inaccurate and unreliable. As a
result, the actuaries and Head Office underwriters begin to build loadings on to
premium manuals due to prevalence of systemic under-pricing, poor data quality
and anticipated errors in underwriting execution.
This begins the process of rates becoming increasingly disconnected from

realities in the market and leads to loss of confidence in underwriting and pricing
abilities of the insurer. Meanwhile, the unit underwriters may feel that the
actuaries and senior underwriters are out of touch with ground realities, and they
begin to disregard the filed rates and follow their own judgment, which can be
subjective or follow some ad hoc rules or patterns for pricing the risks that come
before them.
207
Diagram 3: Reasons due to which underwriting errors can occur
3. Learn about product innovation.

Product innovation
Product innovation process involves the following
Diagram 4: Product innovation process
208
Insurers identify the need for new products and services or for changes to
existing ones by collecting information from internal and external environments.
In addition, insurers monitor key indicators within a portfolio of policies. When
changes are identified in key indicators, the analysts will determine reasons and
make necessary changes to the products. New products and services or changes
to existing ones are undertaken only after significant research.
3.1 Identifying customer needs
This is done by monitoring:
a) Internal staff reports

9 Intermediaries’ feedback
9 Surveyors’ reports
9 Underwriters’ reports
Insurers need to create an easy system for reporting of information from the
above sources as part of their regular activity. They should develop a system for
collecting and analysing the reported data. An efficient and meaningful analysis
will facilitate identification of potential need for development of new products /
changes to existing products.
b) Current customer trends
The current customer trends can be studied from changes seen in the economy,
technology trends, consumer buying and so on. These will be reported in various
media.
Examples of this can be rapid rise of tourism and travel trade, steep penetration
seen in the sale of mobile phones, two wheelers etc.
c) Emerging trends
The identification of emerging market trends require projections and assumptions

based on environmental scanning.
d) Market research
Insurers perform marketing research to determine whether the assumptions made

about customers’ needs and trends, as well as about any proposed products and
services are correct.
209
3.2 Identifying the need for changes in existing products

Insurers monitor their portfolios and identify key indicators of problems or
opportunities for new policy developments / changes to existing policies.
The key indicators that can trigger need for changes in product are:
9 changes in number of new policies sold,
9 number of existing policies renewed,
9 loss ratio,
9 changes that can increase or decrease risk profile of the portfolio
3.3 Determining reasons for changes in portfolio

Based on changes identified in the key indicators, insurers ask additional
questions, make assumptions and perform investigations to determine reasons for
the changes. While some insurers take an analytical approach by collecting and
analysing data in sequential steps, other insurers take a more intuitive approach
by asking questions and by investigating likely reasons for changes.
A losing portfolio may be failing to compete in the basic insurance marketing

features: product, price or service.
3.4 Determining cost and benefits of new products & product changes
A study made by insurers that compares the likely costs of a product or service
with likely benefits, both:
9 to the customer (meeting the customers’ needs) and
9 to the insurer (meeting the profit and growth objectives)
3.5 Making corrective changes

After studying reasons for changes in the portfolio, the insurer may address
problem areas by making suitable corrective changes in respect of:
9 Policy wordings (contract clause) to meet needs of customers
9 Eliminating ambiguity in coverage and exclusions which might have
resulted in claims that had not been anticipated while pricing the policy.
9 Insurers responding to customer needs by offering endorsements to extend
current coverage or new coverage.
9 Service changes
a) Premium payment through Electronic Fund Transfer (EFT) or credit
cards
b) Providing 24 / 7 call centers for customer care and claims assistance
c) Providing cashless facility for claimants with tie ups with auto garages,
hospitals etc.
210
3.6 Preparing product proposals
An effective proposal contains following basic components:
a) Proposal overview giving purpose of the proposal

b) Customer need and identification
c) Proposed new product or change and how it will meet needs of customers
d) Marketing environment and potentiality
e) Post / benefit analysis
f) Expected results and monitoring process
g) Recommended action
3.7 Regulatory compliances
Once the proposals for new product / changes are approved by management of
the company, the new / revised product is filed with the Regulator (IRDA) as per
guidelines and marketed after completing regulatory formality.
At the time of underwriting, exposure measurement is done on the basis of which

of the following parameter/s?
A Frequency
B Severity
C Extent of concentration
D All of the above
Summary
¾ In the underwriting area, challenges for underwriter are considerable due to
continuous flux in the risk fields, new and emerging profile of losses and
unforeseen catastrophes that take place intermittently.
¾ New areas where underwriting challenges are occurring
9 New potential hazards
9 New vulnerabilities with hazards remaining the same
9 Untested insurance
9 Growing need for international insurance coverage
¾ Underwriters and actuaries have begun to construct more complex risk
classes by considering various additional differentiating factors.
211
¾ Recent de-tariffing and competition has made it possible for insurance

providers to offer innovative rate structures geared towards attracting and
rewarding good customers while dealing with bad customers individually on
merits as much as possible.
¾ For setting proper rates, the underwriter requires appropriate data on
policyholder, on risks covered, on cumulative risk behavior and optionally,
on a variety of additional factors that may be relevant.
¾ Pure premium is the premium that would be sufficient to offset all accident
claim costs.
¾ Underwriting activity faces intense pressure in a deregulated market for
various reasons such as:
9 industry competition,
9 overcapacity,
9 customer pressure and
9 other relevant factors
¾ Reasons due to which underwriting errors can occur include:
9 Faulty Information Collection
9 Exposure Measurement
9 Coverage Structuring
9 Wrong Pricing
¾ Product innovation process
9 Identification of customer needs
9 Identifying need for changes in existing products
9 Determining reasons for changes in portfolio
9 Determining cost and benefits of new products and product changes
9 Making corrective changes
9 Preparing product proposals
9 Regulatory compliances

Answer to TY 1
In case of Motor insurance, other things being the same, use of additional anti-
theft devices in a car can lead to a prospect getting lower rates compared to other
prospects.
212
Answer to TY 2
At the time of underwriting, exposure measurement is done on the basis of
following parameters:
9 frequency
9 severity
9 the extent of concentration and
9 similar other considerations
Question 1
Giving insurers the freedom to decide pricing of their products is known as
______.
A De-tariffing
B Re-tariffing
C Free-tariffing
D Market-tariffing
Question 2
The premium level at which an insurance company would not generate a profit,
but ideally would not lose any money either is known as _________.
A Net Premium
B Gross Premium
C Pure Premium
D Breakeven Premium
Question 3
________ the cover is an option that helps to secure a negotiated balance
between need for the widest cover desired by customer and obtaining a fair price
for the cover.
A Constructing
B Structuring
C Configuring
D Organising
213
Answer to SEQ 1
Giving insurers the freedom to decide the pricing of their products is known as
de-tariffing.
Answer to SEQ 2
The premium level at which an insurance company would not generate a profit,
but ideally would not lose any money either is known as pure premium.
Answer to SEQ 3
Structuring the cover is an option that helps to secure a negotiated balance

between need for the widest cover desired by the customer and obtaining a fair
price for the cover.
214
CHAPTER 12
I.T. APPLICATIONS IN UNDERWRITING
This chapter aims to provide you with an introduction to the relationships
between IT (information technology) and Underwriting.
a) Explain how the need for IT applications in insurance underwriting

emerged.
b) Explain the role of IT applications in insurance underwriting.
c) Discuss the role of technology in insurance underwriting process.
215
1. Explain how the need for IT applications in insurance

underwriting emerged.
The insurance industry is undergoing profound changes as a result of:
9 globalisation,
9 deregulation, and
9 technology
In essence, the insurance industry is moving from a product oriented industry

to a customer oriented service provider.
1. Deregulation allowed non-insurance companies, such as banks, even

retailers, to enter insurance market and compete against the established firms.
At the same time, deregulation also allowed insurance companies to enter
different financial markets requiring development and marketing of new
products and identification of potential customer groups.
2. Globalisation emphasized this change, and insurance companies are now

facing competitors from many parts of the world, many of which move
aggressively into new markets trying to attract customers with low rates and
improved services.
3. Challenging market conditions, led by accelerating price competition, are

causing insurers to look more closely at streamlining their underwriting
procedures to defend or improve their profitability. Inevitably, this is creating
a new focus by senior management on data, technology and process
management.
Although underwriting is a basic building block of the insurance process,

traditional methods often are slow, inefficient, inconsistent and inaccurate.
Therefore, to support underwriting optimisation and ensure improved

underwriting profitability, insurers must develop new strategies and deploy
technologies to automate and manage the underwriting process better.
216
These include
9 development of real-time information access;
9 an electronic workspace for sales staff and underwriters to collaborate;
9 streamlined information and data collection with third-party providers;
9 reduced dependence on paper;
9 automation of simple underwriting decisions; and
9 analytical methods to reduce underwriting risk
IT applications are necessary in insurance underwriting because of which of the

following reasons?
A Impact of globalisation
B Challenging market conditions
C Slow and inefficient traditional methods of insurance process
D All of the above
2. Explain the role of IT applications in insurance

underwriting.
Technology further added to the momentum of change, mostly due to different
aspects of computerisations, such as general access to computers, the Internet,
and software to support business operations.
2.1 Advantage of general access to computers
General access to computers allowed:

9 decentralisation of computer resources within a company; and
9 different business units and departments to develop many more business
models, product variants and customer segments than was possible before
As a result, emphasis shifted from the traditional product portfolio to

innovative products targeting selected customer segments.
In the process, different software applications / packages were built and deployed
on different platforms and languages by different business units; each one
catering to specific requirements of respective user departments.
217
Creating a fully automated and efficient underwriting process requires an insurer

to determine and deploy Enterprise wide architecture to integrate different
software / hardware components in use and to be acquired, to gain maximum
mileage from process automation.
Such architecture should meet requirements of both internal and external

customers like:
9 Underwriters,
9 Sales Teams,
9 Agents,
9 Channel partners like Bank assurance, corporate agents, Brokers, Reinsurers,
Co-insurers, T.P.A.s, Dealers, Corporate and individual clients,
9 Surveyors,
9 Advocates,
9 Banks,
9 Regulators and
9 Other stake holders
The following diagram outlines a conceptual I.T. System Architecture of a

medium / large Insurance Enterprise.
Diagram 1: I.T. Enterprise Architecture
218
219
The technology selected for automation of the insurance business process should
be state-of-the-art and next generation.
It should have the following features:

9 Service Oriented Architecture
9 Scalable with growth and needs of the company
9 Capable of Integrating with existing Legacy Systems
9 Minimum Development Time and Risks
9 Capable of delivering high ROI (Return on Investment)
9 Supports both real-time and batch processing.
9 Capable of communicating with different open technologies and external
systems for data transfer
9 Industry data standards such as ACORD’s & XML, enabling a wide range of
strategic applications across multiple channels and systems
The Information Technology Systems (both Hardware and Software) deployed

across the enterprise should support and provide following services with speed,
flexibility and functionality:
9 Underwriting
9 Policy administration
9 Premium collections and Financial Accounting
9 Claims administration
9 Client management - CRM
9 Brokerage & commissions
9 Banks – Bank Assurance & Finance
9 Work Flow management
9 Document and image management
9 Information ordering
9 Brokers, Agents, Loss Assessors Appraisal
9 T.P.A.
9 Business processor
9 Business intelligence
a) Data Mining
b) Risk Management
c) Rate Making
d) Product Development
e) Actuarial Issues
9 Co-insurers and Re-insurers Management
9 Compliance and Regulatory Issues
220
2.2 Advantages of the internet
1. The Internet not only provides customers direct access to the company, but
also now requires the company itself, and not just their agents, to directly
deal with customer regarding individual information requests, and the need to
manage prospects and customers effectively.
2. The Internet also enables competition from a new breed of insurance

organisations through E-business, much leaner, with fewer agents, if any, and
with fewer branch offices, if any, but quite able to compete world-wide for
customers.
3. The result again is an increased focus on the customer, his needs, and
tailoring of insurance policies to fit those needs on a profitable basis for all
concerned.
This trend toward individualisation of services and policies is supported and

implemented by increasingly sophisticated business software.
Relevant areas are:

9 storage and retrieval of customer, policy, and business data in databases and
data warehouses and
9 use of the data in data mining systems
2.3 Advantages of software in supporting business operations
Customer data do not consist any more of the data provided by the customer
when filling in an application form, but is enhanced with any data considered
relevant, limited by ingenuity, availability and legislation.
Common enhancements are data from other business transactions carried out
within the organisation, such as possible investment activities, or other life/non-
life insurance contracts, possibly including other companies, demographic
information, professional and personal information, and where permitted, general
financial, credit information, travel information, and conceivably anything left
behind as electronics trails (e.g. credit card transactions).
221
This potentially vast collection of data on customers and prospects can be

analysed with data mining software for a variety of business concerns, some of
which are:
9 Target marketing
9 Cross-selling
9 Fraud detection
9 Customer Relationship Management
9 Rate making
9 Capital adequacy monitoring
9 Investment strategy
9 Reinsurance strategy
9 Allocation of capital
9 Strategy and business planning
In target marketing, the purpose is to identify group of prospects that are most
likely to be interested in a particular product. A common approach uses so-called
"predictive data mining".
Based on available data of customers who have or have not bought the product in
question, the most important characteristics distinguishing these groups are
determined using one of several modelling tools. These characteristics are then
used to score the likelihood that a prospect will acquire the product.
Often, the data are not already available, but need to be obtained in one or several
test campaigns. Also care needs to be taken, that only those data are used which
will be available for the prospects to be scored in cross-selling; the purpose is
similar, except we are attempting to sell an additional product to already
established customers. In the insurance industry, this turns out to be important for
bonding the customer: a customer is less likely to let a policy lapse if he owns
more than one product from the company.
In addition to predictive data mining, there are other techniques that can be
applied here, for example association analysis. In this type of analysis we could
determine which types of insurance products frequently "go together", e.g. occur
frequently in our customer database.
In addition to frequency, there are also other measures available that assess the
affinity among such products. In any case, we can look for such affinity product
groups that include our product we want to cross-sell. We then focus on all
customers who have all of the affinity products except for our cross-selling
product. These customers will then be the targets of our cross-selling effort.
222
The techniques for fraud detection depend very much on the application
concerned. In areas such as mortgage fraud or health insurance fraud, the
emphasis might be on detecting suspicious relationships between the participants
involved.
For example, it might turn out that many accident victims are diagnosed by a
small set of doctors, or that high-cost producing referrals involve a small set of
doctors, or that a collection of property objects has frequently changed hands
recently, involving the same people, and increasing in price each time.
Customer relationship management focuses on the "life-time-value" of a

customer and addresses various issues such as customer acquisition, retention,
loyalty, cross-selling etc.
It not only involves various data mining business questions and techniques, but
also goes beyond data mining and may involve data management, warehousing
and customer interfacing issues at a minimum, often the entire organisational
structure and business processes as well.
Finally, rate making is the topic of immediate concern in times of increased

competitive pressure. The price of a policy is usually the most direct way that a
competitor can use in order to increase his market share. The same forces that
were discussed above are at work here: a movement away from standard policies
with broadly defined risk classes, moving toward individualised risk assessment,
and almost individualised pricing. The methods used to set policy rates are
undergoing change, and it is data mining again that can contribute innovative
solutions to this task.
In essence, data mining will allow to consider many more factors in the rate
making process than was possible before.
A combination of manual and paper-intensive processes that are time consuming

and inefficient, as well as hard-coded rules embedded in multiple systems that
are difficult to change and maintain, are driving up costs for insurance
companies.
223
For which of the following reasons is the emphasis of insurance companies

shifted from the traditional product portfolio to innovative products, targeting
selected customer segments?
A General access to computers
B Increase in number of customers
C Increase in number of insurers
D None of the above
Which of the following focuses on life time value of customers?

A Target marketing
B Value analysis
C Customer relationship management
D Predictive data mining
3. Discuss the role of technology in insurance underwriting

process.
Technology has started playing a greater role in improving efficiency and
effectiveness of underwriting.
The insurers have started realising that Predictive modelling, risk segmentation
and product management are critical components of underwriting.
The use of analytics and exploitation of internal and external data sources allows
for creation of better risk segmentation and improving underwriting efficiency.
Technology has helped some insurers to achieve a level of sophistication in
underwriting that allows them to review only exception to business rules, which
provides consistency and increased profitability.
With the advent of technology, Rules Engines, Analytical, Business Intelligence

and Audit Tools are now readily available that allow insurers to assess, manage
and execute selection and pricing of risks at a transactional level and at a
portfolio level. Investments in underwriting automation have yielded
consistently lower combined ratios for insurers across the globe.
224
Underwriting is a rational process in which technology can bring consistency

and speed.
3.1 Emerging technologies that can help insurers improve the

underwriting process
Straight-through processing; exception based underwriting; integration of

systems with the sales force and sales force automation tools; incorporating
sophisticated business rules to facilitate underwriting at the point of sale; and
integration of supporting documents, third-party and other internal systems etc.
are strategies that will reduce underwriting costs.
3.2 Role of insurers in making the underwriting process more

efficient to improve profits
Business process automation/management is a key enabler [of efficient

underwriting]. The use of business rules engines, implementing workflow
efficiencies and accessing information to make better decisions all drive
increased bottom-line profit. The closer we get to straight-through processing,
the more efficient companies will become. Sophisticated business rules engines,
exception-based underwriting, improved analytics for rate modelling;
decisioning systems and business process management are critical initiatives.
1. Management of underwriting workflow
An electronic workspace that stores all content and manages the end-to-end
process should be created for distributors and underwriting staff. The use of
middleware, application integration tools and XML will help insurers integrate
the workflow to agency management, point-of-sale and underwriting
workstations to support STP.
2. Rules Engines
Management of business rules and decision support. It is imperative that insurers

reduce the amount of manual underwriting that takes place. Underwriting
business rules should be documented and managed. A rules repository can then
be used to filter incoming cases to automate the decision completely or provide a
decision recommendation.
225
3. Underwriting case management
Additionally, insurers must have a Web-based solution for underwriters to better

manage their cases. This solution must be tightly integrated with the decision
platform and with imaging and workflow systems. It should have enhanced
analytical capability to assess risk, and be able to receive electronic data from
both internal and external sources. Case management information should be real-
time, which will enable the underwriters to quickly make decisions and improve
accuracy of risk assessment.
A new class of integrated and configurable decision-management applications

is now available to insurance companies. The applications consist of robust
analytic modelling or scoring capabilities and actionable rules to immediately
execute underwriting decisions and push these decisions to the point of sale.
Using advanced analytics empowers insurers to more granularly segment

customers based on more accurate predictions of customer behaviour. This
allows them to determine the most appropriate product offerings and pricing
levels.
3.3 How are packaged underwriting systems evolving, in terms of

capabilities and response to market trends?
1. More and more packaged underwriting systems are incorporating the

technologies and capabilities discussed above. Inclusion of rules to
streamline the process, Web services and XML for integration with other
applications makes it easier to gain efficiencies. These also significantly
improve time to market for product and rate changes. Most underwriting
systems available today make it easy to collect and gather data to feed data
warehousing solutions. Availability of current information and improved
analytical tools enable timely and more informed decisions.
2. Web-based technologies make it possible for insurers to improve accuracy

and speed of the underwriting process. They can respond to agents within
minutes and dramatically reduce the turnaround time for policy issuance. To
reduce iterative data collection that delays the underwriting process,
reflexive questioning technologies allow for capture of additional data
depending on the answers to application questions.
226
3.4 How best can insurers adapt their processes to leverage next-
generation underwriting systems?
The implementation and exploitation of the features, processes and information

will be more challenging task for many and a cultural shift for some. The
availability of current information can be used to more accurately evaluate and
price the risk, develop current rating models and quickly adjust rating plans and
products. Information that once had to be looked at long after business was
written can now be immediately obtained and evaluated.
Business rules engines remove people from generic processes and incorporate
their expertise into the system.
Exception-based underwriting, or the process where only high-risk or

exception cases are handled through manual underwriting, can be established and
used to improve decision consistency, speed the decision process, and help
reduce the workload in underwriting department.
It is observed that many insurers in India have started using automated

underwriting for class based products like Motor, Personal lines, packaged
policies and manually underwriting Individually Rated and Exposure Rated
policies.
Which of the following can be established and used to improve decision

consistency, speed the decision process, and help reduce the workload in the
underwriting department?
A Business process automation

B Rules engine
C Exception based underwriting
D Straight through processing
227
The benefits of technology based underwriting discussed above, can be

summarised as follows:
Diagram 2: Benefits of Technology based Underwriting
Benefits can also be achieved in the financial bottom line, as well as throughout
the company.
For example, underwriting analytics and insight can be shared with other
departments, such as product development, claims and marketing, to help with
loss assessment, risk management and opportunity identification.
In-depth underwriting analysis and process documentation can also be used in

compliance and audit procedures, which may help with financial ratings in the
future.
These benefits will provide strategic value to insurers and will drive dramatic
increases in operational efficiency in underwriting.
228
4. Justify that underwriting is both an art and a science.

4.1 Underwriting – a different perspective
Underwriting has traditionally been viewed as both an art and a science. On one
hand, insurance underwriting is very technical with its own specialised
knowledge and mathematical tools, and on the other hand, one needs good
judgement to apply these tools.
However, those organisations that lend more credence to the “science” of

underwriting have used technology differently than organisations that viewed the
underwriting process as an “art,” focusing on higher levels of human review for
transactional risk decisions.
Those companies that trust science have placed a premium on consistency in the
underwriting process, deeming regularity of the automated process to be more
important than human intervention. They recognise that only the most complex
risks or processing exceptions require direct intervention by underwriting staff.
They have been rewarded with higher profits and reduced losses.
4.2 The current model of underwriting

Initially, underwriting automation took place as an extension of policy
management systems, with the business rules and rating engines often hard-
coded in the core application. Processing happened primarily on the “back end.”
In the mid to late 1990s, more robust rules engines and stand-alone components
(like external rating engines) were introduced along with the ability to configure
individual software components and link them to legacy environments. These
improvements allowed for increased flexibility and responsiveness in product
development and deployment. The same improvements also enabled
introduction of better risk evaluation controls during underwriting of new and
existing business.
As seen in Enterprise Architecture Diagram, this strategy provided increased
automation within the core processes:
9 product creation,
9 quoting and rating,
9 risk evaluation, and
9 policy administration
229
Wherever automated controls between the core processes are ad hoc, or at the
most, loosely coupled, these processes still require human intervention and time
for strategy changes and program enhancements. Creating a fully automated and
efficient underwriting process requires an insurer to determine which process can
be eliminated from the manual workflow. Each of the eliminations of a manual
routine underwriting process will lower costs and increase processing speed.
There are no ready-to-use, off-the-shelf software solutions or technologies

available to cater to or suit all requirements of all insurers.
Insurers have to conduct the following exercise before selecting and

implementing a new architecture / software solution for automation of
underwriting and other business process:
Diagram 3: Exercise to be conducted before selecting and

implementing software solution
Successful automation of processes and reaping the rewards of automation

depends upon the vision and quality of I.T. Policy of a company’s top
management and their efforts in implementing the same down the line in the
organisation.
230
Insurers that couple predictive models, underwriting excellence concepts and

modern rules-engine technologies will be able to automate state-of-the-art
underwriting tools and techniques, which can drive optimal risk selection, pricing
and performance management, putting a focus on both quantity and quality.
Summary
¾ The insurance industry is moving from a product oriented industry to a
customer oriented service provider because of globalisation, deregulation and
technology.
¾ Insurers must develop new strategies and deploy technologies to automate
and manage the underwriting process better.
¾ Due to different aspects of computerisations, emphasis shifted from
traditional product portfolio to innovative products targeting selected
customer segments.
¾ The potentially vast collection of data on customers and prospects can be
analysed with data mining software for a variety of business concerns,
some of which are:
9 Target marketing
9 Cross-selling
9 Fraud detection
9 Customer Relationship Management
9 Rate making
9 Capital adequacy monitoring
9 Investment strategy
9 Reinsurance strategy
9 Allocation of capital
9 Strategy and business planning
¾ Predictive modelling, risk segmentation and product management are critical
components of underwriting.
¾ Benefits of technology based underwriting will provide strategic value to
insurers and will drive dramatic increases in operational efficiency in
underwriting.
¾ Underwriting has traditionally been viewed as both an art and a science.
However, it has long been said that life insurance underwriting is more an
art, than a science.
231

Answer to TY 1
All given causes are the reasons for need of IT application in insurance
underwriting.
Answer to TY 2
General access to computers allowed a decentralisation of computer resources

within a company and enabled different business units and departments to
develop many more business models, product variants and customer segments
than was possible before. As a result, emphasis shifted from the traditional
product portfolio to innovative products targeting selected customer segments.
Answer to TY 3
Customer relationship management focuses on the "life-time-value" of a

customer and addresses various issues such as customer acquisition, retention,
loyalty, cross-selling, etc.
Answer to TY 4
Exception based underwriting can be established and used to improve decision

consistency, speed the decision process, and help reduce the workload in the
underwriting department.
232

Question 1
Insurers must develop new strategies and deploy technologies:
(i) To support underwriting optimisation

(ii) To ensure improved underwriting profitability
(iii) To support traditional methods of insurance process
A (i) and (ii)

B (ii) and (iii)
C (i) and (iii)
D (i), (ii) and (iii)
Question 2
Which of the following has not been automated within the underwriting system?
A Rating individual insurance proposals

B Client renewal visit
C Recommending acceptance/rejection of the risk
D Issuing the documentation
Question 3
Ratemaking involves providing sufficient income to pay for certain aspects –

which of the following is NOT one of these?
A Projected claims
B Selling and administration expenses
C Investment income
D Margin for a reasonable return on the capital employed
Question 4
Exception based underwriting enables which of the following?
A Manual underwriting of complex cases

B Rating of simple cases
C Client management in the SME area
D Identification of problematic young drivers
233
Question 5
C.R.M. stands for ___________.
A Customer Relationship Management

B Commercial Rating Mechanism
C Critical Response Management
D Catastrophe Research Mission

Answer to SEQ 1
Traditional methods of insurance process often are slow, inefficient, inconsistent

and inaccurate.
Therefore, to support underwriting optimisation and ensure improved

underwriting profitability, insurers must develop new strategies and deploy
technologies to automate and manage the underwriting process better.
Answer to SEQ 2
It is not usual to automate the client visit (although it could very occasionally be
done by video conferencing).
Answer to SEQ 3
Investment income is not part of rate making – income is a bonus, but globally
tends to be too volatile to be an effective part of rating – most insurers look to
ensure they make an underwriting profit excluding investment.
234
Answer to SEQ 4
Exception underwriting relates to the identification of complex cases leaving the

system to handle simpler risks.
Answer to SEQ 5
Customer Relationship Management is the correct title.
235
GLOSSARY
Data Mining: has been defined as "the nontrivial extraction of implicit,

previously unknown, and potentially useful information from data" and "the
science of extracting useful information from large data sets or databases". A
class of database applications that look for hidden patterns in a group of data that
can be used to predict future behavior. For example, data mining software can
help retail companies find customers with common interests. The term is
commonly misused to describe software that presents data in new ways. True
data mining software doesn't just change the presentation, but actually discovers
previously unknown relationships among the data.
Data Warehouse: Abbreviated DW, a collection of data designed to support

management decision making. Data warehouses contain a wide variety of data
that present a coherent picture of business conditions at a single point in time.
The term data warehousing generally refers to the combination of many different
databases across an entire enterprise.
Document & Image Management: The computerized management of electronic

as well as paper-based documents. Document management systems generally
include the following components:
9 An optical scanner and OCR system to convert paper documents into an
electronic form
9 A database system to organized stored documents
9 A search mechanism to quickly find specific documents
Document management systems are becoming more important as it becomes
increasingly obvious that the paperless office is an ideal that may never be
achieved. Instead, document management systems strive to create systems that
can handle paper and electronic documents together.
Enterprise wide Architecture: In the computer industry, the term is often used
to describe any large organization that utilizes computers. An intranet, for
example, is a good example of an enterprise computing system. The term
architecture can refer to either hardware or software, or to a combination of
hardware and software.
Legacy Systems: Typically, legacy applications are database management

systems (DBMSs) running on mainframes or minicomputers. An important
feature of new software products is the ability to work with a company's legacy
applications, or at least be able to import data from them.
236
Open Technologies: An open architecture allows the system to be connected

easily to devices and programs made by other manufacturers. Open architectures
use off-the-shelf components and conform to approved standards. A system with
a closed architecture, on the other hand, is one whose design is proprietary,
making it difficult to connect the system to other systems
Portal: a Web site or service that offers a broad array of resources and services,
such as e-mail, forums, search engines, and on-line shopping malls.
Rating Engine: A software application used for rating the products / proposals.
The rating engine analysing the existing data and application data and generates
the competitive rates.
Service Oriented Architecture: Abbreviated SOA, an application architecture

in which all functions, or services, are defined using a description language and
have invokable interfaces that are called to perform business processes. Each
interaction is independent of each and every other interaction and the
interconnect protocols of the communicating devices (i.e., the infrastructure
components that determine the communication system do not affect the
interfaces). Because interfaces are platform-independent, a client from any
device using any operating system in any language can use the service.
System Architecture: A design. The term architecture can refer to either

hardware or software, or to a combination of hardware and software. The
architecture of a system always defines its broad outlines, and may define precise
mechanisms as well.
Work Flow: Workflow at its simplest is the movement of projects and/or tasks
through a work process. More specifically, workflow is the operational aspect of
a work procedure: how tasks are structured, who performs them, what their
relative order is, how they are synchronized, how information flows to support
the tasks (workflow) and how tasks are being tracked. As the dimension of time
is considered in workflow, workflow considers "throughput" as a distinct
measure. A Workflow Application is where various applications, components
and people must be involved in the processing of data to complete an instance of
a process. For example, consider a purchase order that moves through various
departments for authorization and eventual purchase. The orders may be treated
as messages, which are put into various queues for processing. A workflow
process involves constant change and update. You can introduce new
components into the operation without changing any code.
237

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IC-45

GENERAL INSURANCE UNDERWRITING

We also acknowledge Get Through Guides, Pune for their contribution in

INSURANCE INSTITUTE OF INDIA

First Edition: 2010

All Rights Reserved

Published by Sharad Shrivastva, Secretary-General, Insurance Institute of India,

This course is designed for the use of candidates of the Associateship

Specifically, the course explains the meaning, objectives and process of

Chapter No. Title Page No.

a) Understand the concept of underwriting.

1. Understand the concept of underwriting.

Insurance is a contract between the insurer and a policyholder/insured, where the

Let us first understand the various terms used in this definition:

Insurance refers to the risk transfer cum-sharing mechanism, where risk of an

1.2 Introduction to General Insurance

Underwriting refers to the process by which insurability of the ‘risk’ is

a) To determine the level of risk presented by the proposer

Underwriting is the process of determining the level of risk presented by a

b) To classifty risk based upon the risk characteristics

Underwriting attempts to classify risks based upon their characteristics so that

Understanding the concept of risk sharing or pooling makes it easier to

In the field of property insurance, wooden structures are at a greater risk of

c) To ensure that the insurance business is conducted on sound lines

In case of vehicle insurance, an insurance company might charge higher premium

In case of property insurance, an insurance company may inspect propertieswith

1.4 Purpose and Objectives of underwriting

By purchasing an insurance policy, a policyholder transfers his risk to the

9 If premium is kept low: If a company charges too little, it could become

1.5 Profile of an underwriter

The profile of an underwriter may be understood by what he does in the

9 Analyse proposal forms and do background check on proposer.

b) Underwriters use computer applications to manage the risks they

9 analyse and rate insurance proposals,

1.6 Importance of underwriting

Underwriting is important to different entities from different perspectives.

For Insurance companies underwriting is a core activity. The underwriting

Underwriting is a key differentiator enabling the insurer to stay competitive, and

c) Agents and brokers

Underwriting is important to Brokers and Agents as it will match the needs of

The underlying principle of _____________ is that in a group, only few

A Law of large numbers

2. Learn about the process of underwriting.

2.1 Important factors in the process of underwriting

As discussed earlier, underwriting is the process of determining whether a risk

Some important factors that need to be considered by an insurer in the

a) To maintain equity and sustainability

An insurer has a responsibility to its current policyholders to ensure that it will be

b) To protect consumer’s long term interest

Regulation is another important factor in the underwriting process. In order to

2.2 Process of underwriting

The process of underwriting involves four basic functions:

The first three underwriting functions—risk selection, classification and rating,

The underwriter also performs a fourth, separate function before underwriting is

Diagram 1: Process of underwriting

The first three processes are interdependent.

Underwriting involves examining material disclosures in proposal forms, and

b) Classification and rating

The purpose of using classifications is to separate risks into homogeneous groups

From the point of view of the insurer,

After determining the acceptability of a risk and assigning proper classification

d) Retention and reinsurance

Reinsurance in simple terms is insurance of insurance. It is a mechanism used by