Definition

Underwriting in insurance is the process by which an insurance company evaluates the risks associated with insuring a person, property, or organisation.

Description

Before accepting the insurance proposal, the insurer assesses various factors, such as the applicant's health, lifestyle, occupation, or the value and condition of the property, to determine whether to accept the insurance application and, if so, at what premium and coverage terms. 

Underwriting helps ensure that the insurer maintains a balance between the risk they take on and the premiums they collect.

Advantages of Underwriting
 

Knowing why underwriting is important. Here are the reasons why:

1. Risk Management: Underwriting, a comprehensive process that involves evaluating an applicant's risk factors, allows insurance companies to assess and manage risk effectively. By scrutinising potential risks before issuing a policy, insurers can determine appropriate premiums, ensuring they are adequately compensated for the risks they cover.
2. Fair Premium Pricing: Through underwriting, insurers can set fair and accurate premium rates based on the level of risk. This ensures that low-risk policyholders are not subsidising higher-risk individuals, fostering a sense of justice and equity in the insurance market.
3. Protection Against Fraud: The underwriting process, with its thorough review of the applicant’s information, is a robust defence against fraudulent claims. This reduces the likelihood of the insurance company paying out on fraudulent policies, ensuring the integrity of the insurer and the trust of honest policyholders.
4. Customised Coverage: Underwriting allows insurers to tailor policies to meet individual customers' specific needs and risk profiles. This customization ensures that policyholders receive the right level of coverage for their unique situations, preventing them from overpaying for unnecessary protection.
5. Financial Stability for Insurers: Through careful evaluation of risks and setting appropriate premiums, underwriting is a cornerstone of the financial stability of insurance companies. This stability ensures they have sufficient reserves to pay out claims, bolstering their long-term viability and ability to serve their customers.

How to do underwriting in insurance?
 

Underwriting is assessing risk and determining whether to insure someone or something. Here's a simplified overview:

1. Application Review: The underwriter examines the insurance application for completeness and accuracy.
2. Risk Assessment: They evaluate the applicant's risk profile based on factors like age, health, occupation, and lifestyle for life insurance; property condition, location, and history for property insurance; or driving record, age, and vehicle type for auto insurance.
3. Information Gathering: Additional information might be required, such as medical exams, property inspections, or driving records.
4. Rate Calculation: The underwriter determines the appropriate premium based on the assessed risk.
5. Decision Making: The underwriter decides whether to accept the application, decline it, or offer coverage with modifications (like higher deductibles or exclusions).
6. Policy Issuance: If approved, the policy is issued with the agreed-upon terms and conditions.

Trends that can affect Underwriting process
 

Here are three trends that can affect the underwriting process:

1. Advancements in Technology and Data Analytics:

The use of big data, AI, and machine learning is revolutionising underwriting. This allows insurers to analyse vast amounts of data from various sources, such as social media, wearable devices, and online behaviour, to gain deeper insights into risk profiles and enables more precise risk assessments, faster decision-making, and personalised insurance products. 

Despite concerns about data privacy and accuracy, the potential benefits of this trend are significant and promising, offering a brighter future for the underwriting process.

2. Changing Regulatory Environment: 

Evolving regulations and compliance requirements can significantly impact the underwriting process. Stricter data protection laws, anti-discrimination policies, and transparency mandates require insurers to adapt their underwriting practices to ensure compliance. 

These changes can lead to more rigorous documentation, additional checks, and adjustments in how risk factors are evaluated. It's crucial for insurers to stay abreast of these changes and ensure their underwriting practices are in line with the evolving regulatory landscape.

3. Shift in Consumer Behavior and Expectations:

Modern consumers increasingly expect convenience, speed, and transparency in their interactions with insurers. The demand for instant quotes, simplified applications, and digital interactions is pushing insurers to adapt and innovate. 

This shift not only requires underwriters to adapt to new tools and platforms, but also presents an opportunity for the industry to evolve and meet the changing needs of consumers. It's a call to action for underwriters to embrace change and innovate to stay ahead in the industry.

Example

Mumbai native Amit, 45, submits an application for a health insurance policy with a ₹10 lakh maximum benefit.

Amit provides information about his age, work, and health history, mentioning any prior illnesses like hypertension or diabetes.

In the course of their extensive underwriting procedure, the insurance provider asks Amit to submit to certain medical examinations, including electrocardiograms and blood tests. These tests are essential for evaluating his present state of health and setting the parameters of the policy.

Amit's medical reports and lifestyle characteristics are taken into consideration by the underwriter while determining the insurance risk. The underwriter may accept the insurance, perhaps with a higher premium or particular exclusions for pre-existing conditions, based on his age and medical history.

FAQ
 

Types of underwriting

The primary forms of underwriting are as follows:

• Loan Underwriting: Assess a borrower's creditworthiness for personal or business loans, including mortgages, through loan underwriting.
• Insurance underwriting: Determines coverage and premium rates for life, health, property, and car insurance policies by evaluating risk.
• Securities Underwriting: Investment banks are involved in securities underwriting, which consists of evaluating the risk of issuing new stocks or bonds and setting the price and parameters for initial public offerings.
• Real Estate Underwriting: Before financing or buying a property, underwriting evaluates the worth, risks, and possible returns on real estate investments.

Underwriting of shares.

Underwriting shares involves a financial institution or investment bank guaranteeing to buy a specific number of shares in a new public offering in the event that the public does not acquire them. This ensures that the issuing business raises the desired capital even with low investor demand.