Reviewed by Stefan Tirschler
un·der·writ·ing | ˈʌndɚˌraɪtɪŋ
Definition: The process of analyzing risk to determine which business an insurance company is willing to accept and at what price.
Sam’s insurance application was referred to underwriting because of her house’s aging roof.
The underwriting department of an insurance company decides which risks the company should take, and how much money they need to charge for those risks to be worthwhile. Insurance companies, after all, are essentially in the business of taking calculated risks.
Each new insurance policy an insurer sells represents a new risk.
Upon issuing a new policy to a customer, the insurance company must pay all claims that customer makes, within the scope of the policy’s coverage. That’s why it’s called a risk: if the insurance company pays one customer more in claim settlements than they collected in premium payments, the company has lost money. That’s normal and unavoidable in many cases; helping customers cover major and unexpected losses is the whole point of insurance, after all.
However, if it happens too often, eventually the company will run out of money (due to a poor loss ratio) and go out of business. That’s why underwriting exists: to help the company take the right kinds of risks, and make sure they’re earning enough money to cover the risks that they do take.
The term “underwriter” can refer to the underwriting department within an insurance company, or to a company as a whole. The underwriting company on an insurance policy is the one accepting the risk and agreeing to pay any claims that arise. For example, The Mutual Fire Insurance Company of British Columbia underwrites policies sold by Square One. Many large insurance companies are their own underwriters.
To analyze risks and help the insurance company stay profitable, underwriters have several jobs.
First, they develop the company’s underwriting guidelines. These are general rules that new customers must follow if the company is to offer them an insurance policy.
In home insurance, for example, the insurance company’s underwriting guidelines would specify which types of homes the company wants to insure. Any home that falls within the guidelines will be no problem to insure. Every insurance provider has their own underwriting guidelines. However, there are a few common factors that almost any home insurance underwriter will feature in their guidelines:
Age, location, and construction of the insured home. Underwriters may determine that homes older than 50-60 years are too risky. Their guidelines may exclude homes located on known floodplains, or condos located in specific buildings with known water issues. Factors like these (and hundreds of others) help underwriters avoid insuring too many homes at high risk of suffering losses.
Home features and systems. Underwriters may exclude homes with outdated systems like knob and tube wiring or Poly-B plumbing. Oil heating tanks and wood stoves increase risk as well, so homes with such systems often fall outside underwriting guidelines.
Liability concerns. Since home insurance policies cover personal and premises liability, the underwriter also looks at things that might lead to a lawsuit against the customer. Front steps without railings, old balconies with rotting floorboards, or aggressive dog breeds are all features of a home that an underwriter might consider too risky.
There are tons of factors in any underwriter’s guidelines, but generally they’re designed to include as many homes as possible. Any well-maintained home with relatively modern systems should fall within the underwriting guidelines of most home insurance companies.
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If a home meets the guidelines, there is no issue insuring it. This is what allows some insurance companies to offer automated online policy sales. If a house meets all their guidelines, they can issue a new policy within minutes.
If a house doesn’t meet all the guidelines, it doesn’t mean they automatically deny the application; it just means that an underwriter will review the application personally before accepting or denying it.
That’s the second task underwriting performs: reviewing policy applications to decide if they’re going to be acceptable for the company.
If a house meets most of the guidelines, the underwriter will often still accept the application and issue a policy. They may, however, include some unique restrictions on the policy to reduce the insurance company’s risk.
Cameron’s house is located on a known floodplain. Homes in the area suffer some degree of flood damage every 10-15 years, give or take. As such, Cameron has had a challenging time finding insurance coverage for their home. Finally, one insurance company agrees to at least look at it.
The company’s underwriter determines that Cameron’s house is perfectly within their underwriting guidelines, except for the flood risk. The underwriter would like Cameron’s business, so she comes up with a compromise: she will issue Cameron a homeowner’s insurance policy, but will add an endorsement that imposes a $10,000 deductible for any flood-related claims. That means Cameron must pay the first $10,000 of any repairs for flood damage, instead of the normal $1,000 standard deductible that applies to other types of loss. Having had no luck getting a policy elsewhere, Cameron is happy to accept this compromise.
In this example, the underwriter weighed the risk of insuring Cameron’s home, and decided that the risk was worthwhile as long as she could address the high risk of flood damage. Her solution was to impose a high deductible for flood damage. The higher deductible leaves a portion of the flood risk with the customer, making the home more reasonable for the insurance company to cover.
One more important task that underwriters perform is creating the insurance company’s policy wordings. Insurance companies don’t write a new-from-scratch policy for every customer. Instead, they have a basic contract that they use for everyone, and modify sections here and there based on each customer’s selections. They may also add endorsements, which are special modifications tacked on to policies on a case-by-case basis that add, remove, or change coverages within the main policy.
Underwriters write the basic contracts and the endorsements. The contracts are based on the underwriting guidelines and describe exactly what the underwriter intends for the insurance company to cover (and not cover).
Underwriting is the function within insurance companies that decides which risks the company is willing to take and which they’d rather not.
Underwriters review insurance applications from customers (where necessary) to decide if that customer is a good match for the insurance company.
“Underwriter” may also refer to the company or entity that’s promising to pay any covered claims from the customer.
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