Explain underwriting in detail.

Underwriting is defined as a process of analysing risks of insurance applicants, and deciding whether the insurance company should accept or reject the application. Underwriting is a challenging task where the underwriter has to consider the applicant’s side and also the risks that the company will have to face if it accepts the new policy. Though the task of choosing polices is the responsibility of underwriters, the power to accept or reject the policy lies with the insurer.

For example, if an applicant asks for a health insurance, the provider has to thoroughly scrutinise the present and past health of the applicant, within applicable terms. Sometimes the underwriter may have some reservation due to past medical records, but decide to insure the applicant, with some conditions not included in the coverage for a period of time. At some other times, the medical records may indicate a level of risk that the company cannot accept, and the provider will decide to not underwrite the health coverage. If the underwriter discards the applications where the applicant is expected to take long time medial coverages then the insurance company can maintain a steady monetary base and serve other clients.

Underwriting differs for life and property insurances. For life insurance, either a numerical method or a judgmental method is used. In judgmental method, an underwriter judges the application, by studying the applicant’s medical history records and present health conditions. In numerical method, the underwriter (insurer) numerically rates every type physical disability. These rates are added up and used to find the risks involved in the particular policy. In some cases, the underwriters do not consider policy proposals wherein the applicant has very bad health conditions.
Underwriting is carried out in accordance with an underwriting policy and principles.

Statement of underwriting policy
The underwriting policy is the first step in underwriting. This policy clearly obeys the company’s policies and is written to ensure that the company gains more profit and business. This policy establishes certain rules and conditions which the underwriters follow thoroughly. This policy defines the statements of insurance policies that will be written, prohibited exposures, the coverage to be given for each exposure and similar terms and limitations.
The underwriting officers write the underwriting policy and the desk underwriter applies these terms and conditions to the applications and chooses the best policies. 

Basic underwriting principles
The basic principles of underwriting, which the underwriter has to follow, to achieve profit in insurance business, are: 

• To select the applicants according to the company’s underwriting principles - The underwriters should consider only those applicants whose actual loss rating is less than the expected loss rating. For example, a company may consider insuring buildings which are highly protected against fire hazards as the actual loss rate will be less than the expected loss rate. Assume that the loss percentage is expected as 20%. Then the underwriters should make sure that the applicants meet the underwriting requirements strictly so that the actual loss percentage does not exceed 20%. 

• To balance the rate classification effectively - The underwriters should ensure that there is a balance in rates between the belowaverage applicants and above average applicants. The applicants are grouped according to the percentage of expected loss rate. Then the underwriters have to use their skills wisely and choose the applications to keep the rate balanced. 

• To charge equitable rates to the policy owners - Apart from the rate balancing, the underwriter should make sure that one set of policy holders should not subsidise some other set. For example, a 25-year old person and an 84-year old person should not be charged the same premium for a life insurance policy. Here the rate is inequitable, as the 25-year old person will be charged more premium compare to the 84- year old. This equity balance should be maintained while underwriting.

Other underwriting factors
The underwriter should consider some more factors while underwriting. They are rate adequacy, reinsurance, renewal underwriting. The underwriter should ensure that the business has adequate profit rate available. They have to check if reinsurance is available for the application, if so the underwriting can be made liberal. Insurance policies cannot be renewed if the loss due to an insured-insurer partnership is not favorable.