Adverse Selection is a situation that occurs because people with greatest possibility of losses are the ones most likely to purchase insurance. Adverse Selection normally occurs if the premium is low related to the loss exposure.
Capacity Considerations
Capacity refers to the amount of business an insurer is able to write usually based on the comparison of the insurer’s written premium to the size of the policyholder’s surplus. An insurer must have adequate policyholder surplus to be able to increase in the volume of insurance it writes.
Insurers attempt to protect their available capacity in three primary ways: -
· Maintaining a spread of risk
· Optimizing the use of available resources
· Arranging Re-insurance
Maintaining a spread of risk
Since every insurer has limited capacity insurance companies must allocate their available capacity. By spreading their risk among various type of insurance and different geographical areas, insurance companies reduce the chances that overall underwriting results will be adversely affected by large number of losses in one type of insurance or one territory.
Insurance companies allocate capacity by setting limitations on the amount of insurance they write for any one insured.
Optimizing use of available resources
Various resources of an insurance company shall include financial resources, physical resources such as building, office equipment and human resources which include underwriters, claim representatives, producers and service personnel.
Optimizing use of available resources means that an insurance company shall use all its resources to make a profit from the line of business which it specializes. For instance, an insurance company will not generally write farm business from applicants who have little or nil experience in the same because of non availability of expertise towards intricacies of the business.
Arranging Reinsurance
Reinsurance is a contractual agreement whereby one insurer, the primary insurer, transfers some or all of the loss exposures from policies written for its insureds to another insurer, the reinsurer.
If the reinsurance is readily available, insurance company can increase the number of new policies they write by transferring some of the premiums and loss exposures to the reinsurers. Thus the availability of reinsurance can affect an insurance company’s to write business.
Pricing Coverage
The Underwriting pricing objective is to charge a premium that is commensurate with the exposure. Commensurate means showing an appropriate relationship. A premium is commensurate with the exposure when the appropriate relationship exist between the size of the premium and exposure assumed by the insurer.
Premium Determination
Rate is a price of insurance charged per exposure unit, and an exposure unit is a measure of loss potential used in rating insurance. The premium is determined by multiplying the rate by number of exposure units.
CHAPTER 5 : UNDERWRITING
