Page 45 - Insurance Times December 2020

by people/ organizations with average or lower than average Actually the item no. 5 influences the consumer demand for
expected losses. That is, insurance is of greater use to insurance and looks at what is economically feasible & viable
insured whose losses are expected to be high. from the perspective of potential insured. Other
requirements (i.e. item nos. 1 to 4) influence the willingness
So it is desired in underwriting that insurers may simply of insurers to supply desired insurance cover.
charge higher premiums to the insured with higher expected
losses. Here comes the problem of intense competition in Issue of fair pricing in insurance market:
this free market underwriting. Often, however, the insurer
simply does not have enough information to be able to In a free market society, an entity offering a product for sale
distinguish completely among insured. Furthermore, the should try to set a price at which the entity is willing to sell
insurer wants to aggregate in order to use the law of large the product and the consumer is willing to purchase it.
numbers. Thus, some tension exists between limiting Determining the supplier-side price to charge for any given
adverse selection and employing the law of large numbers. product is conceptually straightforward. The simplest model
focuses on the idea that the price should reflect the costs
Adverse selection, then, can result in greater losses than associated with the product as well as incorporate an
expected. Insurers try to prevent this by learning enough acceptable margin for profit. The following formula depicts
about applicants for insurance to identify such people so they this simple relationship between price, cost, and profit: Price
can either be rejected or put in the appropriate rating class = Cost + Profit.
of similar insured with similar loss probability. In this fierce
competition in this Indian General Insurance market, This is however, true in case of a tangible product. It is also
underwriters have practically very limited scope in this to be noted that for many non-insurance goods and services,
direction where the demand now-a-days is to match the the production cost is known before the product is sold.
market or to quote for becoming L1 to book the client's Therefore, the initial price can be set so that the desired
insurance business. profit per unit of product will be achieved. However,
Insurance is different from most products as it is a promise
Some insurance policy provisions are designed to reduce to do something in the future if certain events take place
adverse selection. The pre-existing condition provision in during a specified time period. For example, insurance may
health insurance policies is designed to avoid paying benefits be a promise to pay for the rebuilding of a home if it burns
to people who buy insurance because they are aware, or to the ground or to pay for medical treatment for a worker
should be aware, of an ailment that will require medical injured on the job. Unlike a can of soup, a pair of shoes, or
attention or disable them in the near future. It is, therefore, a car, the ultimate cost of an insurance policy is not known
desired by the underwriters that the insurance device should at the time of the sale. This places the classic equation in a
be suitable to all pure risks but ironically as a practical somewhat different context and introduces additional
matter, many risks that are insured meet these complexity into the process of price setting for an insurance
requirements for insurability only partially or, with reference company.
to a particular requirement, or not at all.
The price the insurance consumer pays is referred to as
Thus, in a sense, these requirements to be listed & be premium, and the premium is generally calculated based on
described the ideal requisites for insurability which would
be met by the ideal risk. No insurer can safely disregard
them completely. Any risk that is perfectly suited for
insurance coverage in Indian market would basically need
to meet the following requirements:
1. The number of similar exposure units would be large.
2. Losses that occurred would be accidental.
3. A catastrophe needs to be a remote possibility.

4. Losses would be definite and the probability distribution
of losses would be determinable.
5. Insurance coverage cost would be economically
feasible.
The Insurance Times, December 2020