Page 43 - Insurance Times December 2020

insurers (underwriters) must avoid adverse selection. Understanding risk sharing in insurance:
Adverse selection occurs when the proposed risks present a Understanding the concept of risk sharing or pooling will
higher-than average probability of loss. Underwriting control make it easier for everyone to understand the role of
ensures no adverse selection at operating level and underwriting and risk classification in insurance.
corporate underwriting policy is not giving adverse results.
All risks are not equal. For example, in the field of property
Underwriting is a core insurance function. It is a and casualty insurance, wooden structures are at a greater
methodological approach to ensure that the insurance risk of burning than stone structures. Therefore, a higher
business is conducted on sound lines and that risks offered premium is required to insure a wooden structure. The same
for insurance are evaluated for loss potential on both concept applies to life insurance. An individual with a serious
frequency and severity over a period of time over which the illness such as cancer or diabetes is at a greater risk of
liability may flow to the insurer. In short the underwriter premature death than an individual without the illness.
does a proper exercise to evaluate the insurability of the
risk and if the risk can be assumed, the price, terms and Since all risks are not equal, it would be inequitable to make
conditions at which the risk may be insured.
all insured contribute the same amount. Thus, underwriting
attempts to classify risks based upon their characteristics so
Underwriting is the process of: that each insured in a specific class pays a premium in
1. Determining the level of risk presented by a proposer proportion to the risk involved.
2. Deciding whether to accept the proposal
3. Deciding the terms and price of the accepted proposal The issue of fairness to the other participants is at the core
of this risk classification (underwriting) process. When
Each underwriting decision involves balancing the insurer's viewed from a perspective of fairness, proper risk
desire to earn premium often in competitive conditions with classification becomes a central obligation of insurers to the
margins required to pay claims and expenses and also to policyholders who participate in their risk pools. This applies
ensure compliance with regulatory requirements. for all risks - life, assets or earnings.

Underwriting is essential in all forms of insurance. For We all know that Insurance is a contract by which one party,
example, an automobile insurer may charge higher rates to the policyholder, pays a stipulated consideration, called
old models of vehicles, or may refuse coverage to drivers premium, to the other party called insurer. In return, the
with a history of accidents. The underwriter may offer insurer agrees to pay a defined amount of money or provide
discounts for vehicles fitted with anti-theft devices or having a defined service if the covered event occurs during the
membership of Automobile Association, etc. Fire insurers policy period. So Insurance is a risk transfer-cum-sharing or
may inspect properties, offer reduced premiums for safety pooling of risks. It is created when people pool their
features such as hydrant or sprinkler systems, and so on. contributions to create a common fund that is large enough
to protect themselves from the effects of a loss which may
affect any one or more of them.

The loss could be of any type - life, disability, fire or more. If
the risk of loss can be spread over a large group (the law of
large numbers), the financial loss resulting from the loss to
the members can be paid from the premium collected for
the pool. This is in contrast to one person bearing the full
brunt of economic loss without any financial backing. Thus,
in insurance a large uncertain loss is replaced for a small
certain loss of the premium.

Premium fixation - the essence of

underwriting:
Insurance is a trade that runs on premium collected from

The Insurance Times, December 2020