Page 18 - Risk Management in current scenario

Now consider the game of roulette where fairness is ensured through
the random nature of each spin and the instrument is not in an undue
advantage position. The randomness is the lack of pattern or predictability
in events. If the events are not random, some players may have more
chances of winning as compared to others. This is unfair defying the
objective of entertainment. Fairness is important for every player having
equal chance of winning

How is fairness ensured in Insurance Business?

Fairness in Insurance Business
As the insurance business is based on utmost good faith, the risk to
the Insurance Company is that the actual claims could be higher
than expected. There could be two reasons for this scenario, one is
there could be changes in the demographic situation, external
events impact, proliferation of new disease etc.

The second reason where the actual claims could be higher than expected
is when policyholders are not declaring all the information about their
age, health, family history etc leading to the unfair advantage of these
people where they can make claims earlier or higher in number than
expected. Based on the fair price charged by the Insurance Company, in
the second case, it's a deliberate attempt to win the game which is
referred as "Fraud". Fraud is impossible to price, so insurance companies
manage the risks using following tools.

Underwriting
Underwriting is a process whereby insurance company filters the standard
lives and substandard lives so that those who are standard lives from
whom a fair price to be charged likely to have similar claim experience
as assumed at the time of pricing.

From the substandard lives, special conditions are given in terms of extra
premium or changing the terms and conditions which represents their
risk against the fair price. It is at this point in time, the underwriter finds

16 | Risk Management in Current Scenario