Underwriting

Study guides: Exam CP-321, Exam GH-101, Exam GH-201C, Exam GH-301, Exam GI-201, Exam ILA-101

Underwriting is an insurer's process of evaluating, selecting and classifying the risks offered to it — deciding whether to accept each one, on what terms and at what premium — so that the business actually written matches the assumptions built into the rates. It is the insurer's defence against adverse selection: pricing assumes an average risk in each class, and underwriting is what keeps the risks in the class average.

$\frac{E[L_i]}{P_i} \leq \text{PLR}$

$P_i^{\text{req}} = \frac{E[L_i]}{\text{PLR}}$

$E[L_i]$ is the underwriter's estimate of expected losses for risk $i$ , $P_i$ the premium it would be written at, and $\text{PLR}$ the permissible loss ratio — one minus the expense and profit provisions. A risk whose expected loss ratio at the offered price exceeds the PLR is declined, re-priced or written on different terms (a higher deductible, a sublimit, required risk control).
The P&C process (DISC-RM, GI-201) runs in six steps: evaluate the submission (physical, moral and morale hazards, COPE for property, loss history), develop alternatives, select one, set the premium, implement, and monitor — see Underwriting Process, and Underwriting Guidelines for the rules each decision applies. Results are measured by underwriting profit; changes in underwriting shift the mix of risks and distort loss development and trend.
By line, in DISC-RM: Workers Compensation Underwriting, General Liability Classification and Personal Auto Underwriting apply the process to particular coverages.
Life underwriting (ILA-101) classifies individual applicants by mortality: full medical, simplified issue, guaranteed issue and data-driven accelerated programs trade underwriting cost and speed against mortality slippage. Underwritten lives show select mortality, lower than ultimate, that wears off with duration.
Group health underwriting (GH-101, CP-321) looks at the group rather than the person: size, industry, participation and contribution rules, prior claims experience and its credibility, large claimants and pooling levels. Where law forbids health-status underwriting — the ACA individual and small group markets — risk adjustment (GH-301) transfers money between insurers for the risks underwriting can no longer price.

Accept, Debit or Decline a Commercial Account A commercial property account rates to a manual premium of $\$80{,}000$ . After reviewing its COPE details and loss history, the underwriter estimates expected losses of $\$58{,}000$ . The permissible loss ratio is $65\%$ and schedule rating allows debits up to $25\%$ . Should the account be written at manual, and if not, at what premium?
Answer
 $\begin{align*} \text{ELR at manual} &= 58{,}000 / 80{,}000 \\ &= 72.5\% \\ P^{\text{req}} &= 58{,}000 / 0.65 \\ &= 89{,}231 \\ \text{Debit} &= 89{,}231 / 80{,}000 - 1 \\ &= 11.5\% \end{align*}$ 
At manual the account would run $7.5$ points above the PLR. A schedule debit of $11.5\%$ — inside the $25\%$ limit — brings it to $\$89{,}231$ . If the market will not bear that price, the alternatives are terms that reduce expected loss (a higher deductible, sprinklers as a condition) or declining it.

Is Full Underwriting Worth Its Cost? A life insurer sells $\$250{,}000$ ten-year term at standard rates assuming $q = 0.002$ a year. Full medical underwriting costs $\$300$ per policy. Without it, $5\%$ of the applicants it now places as standard would be impaired lives with $q = 0.010$ . Ignoring lapses and changes in $q$ over the term, and discounting at $4\%$ with claims at the start of each year, compare the mortality cost of dropping full underwriting with its cost.
Answer
 $\begin{align*} q^{\text{pooled}} &= 0.95(0.002) + 0.05(0.010) \\ &= 0.0024 \\ \text{Extra claims a year} &= (0.0024 - 0.002)(250{,}000) \\ &= 100 \\ \ddot{a}_{\overline{10}|4\%} &= 8.4353 \\ \text{PV of slippage} &= 100 \times 8.4353 \\ &= 843.53 \end{align*}$ 
Dropping full underwriting saves $\$300$ but adds about $\$844$ of expected claims per policy, so at this face amount full underwriting pays for itself. At small face amounts the slippage shrinks in proportion while the cost does not — which is why simplified issue and accelerated programs are offered below a face-amount limit.

How it appears on the exam

GH-101 and CP-321: written recommendations of strategies for pricing, underwriting and funding a case-specific risk — participation requirements, large-claim pooling, credibility on the group's own experience — usually built on a calculation from the case.

GH-301: how risk adjustment substitutes for underwriting where health-status rating is barred, and its use in underwriting and pricing decisions for Medicare, Medicaid and ACA products.

ILA-101: describing and assessing underwriting approaches (full, simplified, accelerated, guaranteed issue) against cost, speed and mortality slippage — written answers.

DISC-RM and GI-201: the steps of the underwriting process, underwriting authority, and line-specific considerations (premises and products liability, auto, workers compensation, umbrella).

Exam traps

Comparing expected losses with premium instead of with the PLR: a $72.5\%$ loss ratio is profitable only if expenses and profit need less than $27.5\%$ .

Computing the debit as $(P^{\text{req}} - P)/P^{\text{req}}$ : that gives $10.3\%$ , not the $11.5\%$ that applied to manual reaches the required premium.

Expecting select mortality to last: an underwriting saving is largest in early durations and wears off, so a level saving over a long term overstates the value.

Describing ACA individual-market underwriting by health status: those products are guaranteed issue; selection is handled by risk adjustment and limited enrollment periods.