Fiona Andrews explains the underwriting process

' Underwriting is the bedrock of insurance. The skill of the underwriter plays a significant part in determining the competitiveness and overall viability of an insurance company.

Not surprisingly, the role of underwriter demands knowledge, experience and an ability to interpret and weigh a large amount of information. A number of processes, routines, checks and balances exist to ensure underwriting decisions reflect both established market practice and individual company preferences.

Whatever your role, everyone working in the insurance sector needs to have a broad understanding of the science and art of underwriting embracing a number of core elements including: the identification, assessment and acceptance of risk; rating; and relevant financial factors including the crucial element of return on capital.

The technical aspects of underwriting include:

Underwriting and policy wordings

  • Material facts, specifically: why an underwriter needs to be aware of material facts in assessing a risk; the concept of the duty of disclosure; the basic features of peril and hazard and the relationship between them; the significance of moral and physical hazard and how they are manifested; the methods used by underwriters to obtain material facts; the common questions asked of proposers
  • Underwriting procedures, specifically: the legal significance of procedures relatingto quotations; the legal significance of procedures relating to proposals; the different ways in which premiums are calculated; the legal significance of procedures relating to the issue of cover notes, policies and certificates of insurance
  • Premium payment, specifically: the relevance of premium payment for valid cover; the methods used by insurers to collect premiums, including installment facilities; the features of insurance premium tax
  • Policies and the application of terms, conditions and exceptions, specifically: the structure, functions and contents of a policy form, including the policy schedule; the meaning and significance of common policy exceptions and conditions, including terrorism cover; how excesses, deductibles and franchises are used; the distinction between warranties, conditions and representations; the use of exclusions - general and specific, market exclusions
  • Renewals and cancellation, specifically: the legal significance of procedures relating to renewals; the operation of cancellation clauses.
  • Insurance products and associated services
    It is essential to understand the basic features and outline of typical policy cover of insurance products, for example:

  • Motor: private, motorcycle, commercial vehicles
  • Health: personal accident, sickness, medical expenses
  • Personal - household, travel
  • Property - fire and special perils, all-risks, theft, glass, money
  • Pecuniary - legal expenses, business interruption, creditor
  • Liability - employers', public, products, professional indemnity
  • Extended warranties.
  • An understanding is also required of the basic features of additional services such as helplines and advice; authorised repairers; risk control/advice; legal costs services; uninsured recovery services.

    Underwriting considerations
    In addition to understanding the key underwriting criteria for the above-listed policies, it is important to know about the potential for fraudulent claims, their prevention or detection and consequences. An appreciation of the effect on insurance of the: Disability Discrimination Act [1995]; Data Protection Act [1998] is also needed.

    Establishing the price
    With regard to rating, an understanding is required of: the data essential to the underwriting process; the significance of claims information on underwriting terms/premium rates; the nature of risk and significance of the frequency/severity of claims; the significance of the claims loss ratio on premiums/acceptance of risk; the distinction between underwriting, policy, accounting and calendar years.

    With regard to pricing factors, it is important to know: the basis of the risk premium; the reporting factors of expenses, return on capital, investment income, tax and intermediary remuneration.

    Managing exposure
    Knowledge is needed of the basic factors influencing the market cycle; the principles of risk accumulation; the basic reinsurance considerations including the types of reinsurance.

    Along with claims, underwriting is one of the pillars of the insurance business. IT

    ' Fiona Andrews is the manager of the Faculty of Claims and head of CPD at the CII

    Test yourself on the underwriting process
    The market-standard examination subject for those wishing to gain a formal measure of their understanding of the subject is the paper within the CII's Certificate in Insurance qualification: Insurance Underwriting Process (IF3). See how you do with these questions taken from the examination guide:

    Q1: Which part of an insurance policy contains a detailed account of the extent of cover?

    A The heading
    B The operative clause
    C The recital clause
    D The schedule

    Q2: A standard all risks policy covers all perils insurable under a standard fire and special perils policy and

    A Accidental damage
    B Earthquake
    C Malicious damage
    D Riot

    Q3: Which factor is usually the most crucial when an underwriter is determining whether or not to accept professional indemnity business?

    A Age of professionals
    B Claims history
    C Fees charged
    D Size of practice

    Q4: If an insurance policy has a loss ratio of 103%, how much is paid out in claims by insurers for every £100 of premium received?

    A £3
    B £30
    C £97
    D £103

    Q5: XYZ Insurance Company wants to protect its fire insurance account against the impact of large one-off losses. What form of reinsurance should they purchase?

    A Excess of loss
    B Loss ratio coverage
    C Quota share
    D Stop loss

    Answers next week.

    Answers to 20 January CPD
    Q1. Option 1, The Financial Services and Markets Act [2000]

    Q2. Option 3, Firms with a turnover from regulated activities of over £1m

    Q3. Option 3, A Part IV Permission Notice

    Q4. Option 1, The principal of the appointed representative

    Q5. Option 2, Jack Spratt Ltd is an appointed representative of ABC Insurance Brokers, which is authorised and regulated by the FSA

    Q6. Option 1, It sets out fundamental obligations on firms. Other sections of the handbook then expand on some of the principles

    Q7. Option 2, Six years from the date the records are superseded

    Q8. Option 3, An approved person

    Q9. Option 1, Up to the first £2,000 plus 90% of the balance (100% for compulsory classes of insurance)

    Q10. Option 1, Twice a year

    Q11. Option 2, It will feed information into a risk profiling tool and then decide on the nature and extent of any further investigations

    Q12. Option 2, Only staff advising retail customers

    Q13. Option 2, Insurance: conduct of business

    Q14. Option 2, The review of compliance and any action plans should be documented, e.g. in minutes of the management meeting

    Q15. Option 1, That it is adequately resourced by competent staff who are sufficiently independent to monitor the firm's compliance objectively