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Underwriting in the changing world April 2013 BLOG POST

Introduction Insurance and reinsurance industries differ from the other industries in two important ways. First, in most industries, companies and individuals attempt to shed risk, but the insurance industry is in the business of attracting risk. Second, the insurance industry is unique in that it sells a product for which the ultimate cost is not known at the time of sale. Hence, identifying, understanding and underwriting risks and exposures are critical to the insurance business.

Today, the world of insurance is changing at an exponential rate as volumes of available data rapidly expand and sources of data proliferate. With time, Life as well as Commercial insurance will become more efficient by creating more automation in decision making and customer assessment. Right technology and data are needed to take the advantage of the changing environment.

Historically, insurance and reinsurance pricing has been based largely on past experience using tools known as the burning cost ratio or experience rating. It is an insurance industry calculation of excess losses divided by total subject premium. The burning cost ratio is an experience-based insurance-rating method commonly used in determining rates for excess of loss reinsurance, or the insurance that insurance companies buy to protect themselves against total claims that exceed their total premiums collected. This kind of prior loss analysis is important but it often bears little relationship to the future period losses because it is not representative of the underlying future exposures. In today’s business scenario, investment income can no longer be relied upon to improve operating ratios. To ensure a more predictable return on equity, risk selection and work management processes must be advanced. For long-term sustainable success, insurers need precision and granularity in their business rules, processes, and in the information they collect. Insurance underwriters, however, face significant challenges in selecting and classifying risk exposures, and then in appropriately matching price to exposure. While identifying and classifying risk exposure is the first key step in the underwriting process, the real difficulties arise in evaluating risk. Pricing is not simply assessing whether future losses will be greater or lesser than past losses, but also assessing the probability of losses for the exposures being covered during the prospective coverage period. Risks must be assessed against the insurer’s own risk appetite, and then the appropriate coverage must be identified. Automated underwriting systems, which promise better information and greater efficiency, offer solutions to many of these problems. Insurers considering such systems, however, should prepare a checklist to make sure that the systems address underwriters’ concerns.

Underwriting in the changing world

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Things to Consider while Developing a New Automated System Implementing and supporting new automated systems presents various challenges for insurers. One of the critical steps in the process is to think through and identify objectives. It is imperative for the insurer to think whether it wants to improve efficiencies, reduce cost or improve time to a final underwriting decision. There are a lot of components that can help the insurer achieve these objectives, but they need to be thought through. It makes a difference if it wants to go to the point of sale, to try to do things immediately, or if it wants to do later approvals, where data is collected. The key here is to start off by thinking what a company is trying to accomplish with an automated underwriting system. It can be a strategic or tactical decision. By strategic, it means making the system part of a multi-faceted plan to enhance the company's performance. By tactical, it means looking at specific issues and specific problems that the company is trying to address. The second most important thing is to think what product will suit its objectives. A lot of times, companies take their current product and develop and wrap the technology around it to make that work. Sometimes, it works okay, but often it does not. The insurer really has to think about what that product is, what its pricing objectives are, whether it is going to do simplified underwriting or full underwriting and what its sales estimates are. The type of technology that it brings to the forefront will depend upon what the insurer’s expectations are with respect to the product. Despite all the benefits of automated underwriting, it is critical for insurers to be aware of the fact that implementation and maintenance of automated underwriting is not easy. A large number of insurers depend on the vendor for support for implementation and maintenance process. Automated underwriting applications, though, have currently not reached the ultimate stage of maturity in the insurance sector, have made several promises to the industry, which they seem to be fulfilling.

Underwriting in the changing world

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Underwriting in the changing world