Underwriting and claim management, Study notes of Insurance Economics

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ENGINEERING

UNDERWRITING & CLAIM

MANAGEMENT

Subject: UNDERWRITING & CLAIM MANAGEMENT Credit: 4

SYLLABUS

Underwriting Management- Meaning & Fundamentals of underwriting, underwriting policy, Sources of underwriting information, Classes of Business, Product design, Underwriting of Life Insurance, Underwriting of General Insurance.

Underwriting & pricing of product, Assessment & Management of Exposure, Perils & Clause of Insurance Policies, Operational Control.

Claim Management – Concept & Classification of Claim, Essential elements of Claim, Claim procedure, Role of insured & insurer in claim management, Claim settlement & its significance, Nature of claim for various classes of insurance, Dispute, Litigation & Arbitration.

Trends in claim, Role of IT in claim settlement, Customer service, Quality aspect, Insurance business & claim management in other countries.

Suggested Reading:

1. Principles of Risk Management & Insurance – George E. Rejda.
2. Risk Management & Insurance- Scott Harington.
3. Risk Management & Insurance- C. Arthur Willams

and assets will have to pay more in premiums to receive the same level of protection as a (perceived) lower-risk person or asset. There are multiple purposes of underwriting. The main predominant purpose is to develop and maintain profitable book of businesses for the insurer. Underwriting is crucial for insurer‘s success. Underwriting goal follow directly from insurer‘s corporate strategies and objectives. Underwriting is common in all forms of insurance, not just health insurance. For example, an automobile insurer will charge higher rates to young, unmarried males, or it may refuse coverage to drivers with a history of accidents. Fire insurers may inspect properties, offer reduced premiums for safety features such as sprinkler systems, and so on.

Two key considerations govern an insurer‘s behavior:

■ People are more likely to buy insurance if they have reason to believe they will incur high costs in the near future. This phenomenon is known as ―adverse selection.‖ Non group health insurers must be aware that people may wait until they are sick before they start shopping for coverage. ■ a small proportion of the insured population accounts for a very large share of total claims costs.

Basically, underwriting consists of two components; risk assessment and pricing. Successful underwriting requires a system of risk selection to obtain a group in which loss results will be reasonably predictable by means of the law of averages. To accomplish this goal there must be a balance between obtaining volume and obtaining homogeneous risks. If an insurance company issuing individual life policies, for instance, adopted such strict standards that it would only accept individuals who were practically perfect physically, ideal from a moral standpoint, and in risk-free occupations, there would be only a very small group from which to choose. Such a group would be very homogeneous, with all the risk units--in this case the individual lives--subject to about the same chance of loss. But the mass or volume of risk units would be very small, and thus the predictability of loss might be adversely affected. Another element entering in to make selection of such a group impractical would be that selection procedures necessary to obtain this near-perfect set of individuals. The expense involved would more than offset the savings from the mortality rate of the group. In

underwriting, selection expense is a factor to be considered. There has to be a balance between the strictness of selection standards and the necessity of having a large volume of risk units to be insured.

To achieve profitability, the underwriting function serves additional purposes: Guarding against adverse selection Ensuring adequate policy holder Enforcing underwriting guidelines. The objective of underwriting is to produce a pool of insured‘s, by categories, whose actual loss experience will closely approximate the expected loss experience of a given hypothetical pool of insured‘s. That is, if an underwriter is told that a pool of exposures with specified characteristics (e.g., a pool of brick buildings located no more than 5 miles from a fire station) will produce a specified loss rate of, say, 1% of the value of the insured property, then the underwriter should try to place in this pool all the exposures whose characteristics match the specifications.

Underwriting Policy

When evaluating applicants, underwriters determine whether insurance on the applicant will be: · rejected; · issued on a substandard basis; · issued on a standard basis; or · issued on a preferred basis.

Rejecting Applicants

Insurers reject applications for insurance when they find that the applicant represents a risk that falls outside of the underwriting standards established by the insurance company. These underwriting standards take into consideration many items, such as regulations that require the insurer to establish adequate rates, laws that mandate that certain factors cannot be used to reject an application, insurance principles such as insurability and indemnity, the marketplace in which the insurer sells its products and the profit the insurer hopes to make on its business.

applicant. Dealing with substandard applicants by limiting policy benefits is most common in commercial coverage‘s. Excluding Certain Provisions from Coverage

Another option an insurer may have is to offer an substandard applicant a policy that excludes coverage for certain property, insured‘s or operations that are deemed too high a risk for the insurer to cover. As with the other options discussed, such exclusions must be allowable under state regulations. This type of exclusion is most common in commercial property and liability coverage‘s. For example, an insurer may cover all the property owned by a business, except that within a building whose operations have been discontinued. Or, an insurer may offer to provide liability coverage for all business operations except for that portion that has potential pollution liability that is too high for the insurer to cover.

Issuing Policies on a Standard Basis

Underwriters base their determination that a policy should be issued on a standard basis on an analysis of the characteristics of the risk represented by the applicant. Applicants who are issued policies with standard rates fall within the normal boundaries of underwriting standards for that type of policy.

Issuing Policies on a Preferred Basis

If an application falls within the lowest risk boundaries of the underwriting standards, the policy is issued on a preferred basis. Preferred rates represent the lowest rates offered by an insurer for its coverage. Rates offered on a preferred basis must adhere to the insurance regulations applicable to them, just as rates offered on a substandard and standard basis must. Insurance regulators do not want insurers to offer rates that are so low that the insurer cannot meet its contractual obligations to pay covered claims.

Formulating Underwriting Policy

Staff underwriters try to formulate an underwriting policy that effectively translates the goals of an insurer's owners and management into rules and procedures that guide individual and aggregate underwriting decisions. Underwriting policy determines the

composition of the insurer's book of business. Goals for an insurer's book of business might be established by types of insurance and classes of business to be written; territories to be developed; or forms, insurance rates, and rating plans to be used. An insurer's underwriting policy is influenced by management's desired position in the insurance marketplace. Most insurers see their role as standard insurers-that is, they seek better-than-average accounts. Some insurers, however, see an opportunity to offer coverage in areas that are underserved by the standard market. These nonstandard or specialty insurers might use loss control, more restrictive coverage forms, or higher prices to make a profit insuring accounts considered marginal or unacceptable in the standard market. Underwriting policy is always being reviewed and it is subject to these limitations:

1. Financial capacity
2. Regulation
3. Personnel and physical resources
4. Reinsurance

Terms at Policy Issue

Besides setting specified rates, the applicant may be required to meet underwriting requirements in order for insurance to be issued or remain in force. For example, a business may be required to install a sprinkler system, a homeowner may be required to add railing to a deck, and an individual with a valuable coin collection may be required to place it in a safety deposit box in order for the insurance to apply.

SOURCES OF UNDERWRITING INFORMATION

Many resources are used during the underwriting process. The most important of these resources is the application. In this section, we will review the basic components of applications for various lines of insurance, along with the other resources used in underwriting, including reports, site inspections, insurance maps, insurance company files and industry statistical reports and data.

· Alzheimer‘s disease; · Liver disorder; · Organ transplant; · Alcohol or drug use treatments; · AIDS or HIV; · Irregular heart beat; · High blood pressure; · fainting spells; · Emphysema or other chronic lung or respiratory disorder; · Inability to work for more than a week in the past six months or year; and · Other similar questions.

If there is a ―yes‖ response to the medical questions asked, the application will generally ask for more details. Once the application reaches the home office, medical reports or an attending physician statement may also be requested. Or, the insurer may have issued underwriting guidelines to the agent, who requests such reports through his or her agency office. These reports will be discussed later in this chapter.

Replacement

Each application also asks whether this proposed insurance will replace or change any existing or pending insurance. If the applicant answers ―yes‖ to this question, the agent may be required by state regulations to complete state replacement forms with the applicant. State replacement forms generally include comparative information for the applicant to read regarding the proposed insurance and the policy to be replaced. They may also include disclosure statements for the applicant to sign indicating that the applicant understands that there may be surrender charges involved in canceling the existing policy, that the new policy generally includes commission loads and that a new surrender charge period may apply to the new policy. An insurance company required ―1035 Exchange‖ or ―Absolute Assignment‖ form must also be completed in a replacement situation.

CLASSES OF BUSINESS

Refers to an industry classification according to the perils insured and the exposure the purpose is to group homogeneous risk for the purposes of rate development Insurance coverage is available for every conceivable risk your business might face. Cost and amount of coverage of policies vary among insurers. You should discuss your specific business risks and the types of insurance available with your insurance agent or broker. Your agency can advise you on the exact types of insurance you should consider purchasing.

General Liability Insurance

A standard insurance policy issued to business organizations to protect them against liability claims for bodily injury (BI) and property damage (PD) arising out of premises, operations, products, and completed operations; and advertising and personal injury (PI) liability. The CGL policy was introduced in 1986 and replaced the "comprehensive" general liability policy.

General liability insurance (GL) is coverage that can protect you from a variety of claims including bodily injury, property damage, personal injury and others that can arise from your business operations. General liability insurance is often combined with property insurance in a Business Owners Policy (BOP), but general liability insurance also is available to many contractors as standalone coverage through the Progressive Commercial Advantage SM program.

Business owners purchase general liability insurance to cover legal hassles due to accident, injuries and claims of negligence. These policies protect against payments as the result of bodily injury, property damage, medical expenses, libel, slander, the cost of defending lawsuits, and settlement bonds or judgments required during an appeal procedure.

As a contractor or small business owner, one need some form of general liability insurance to safeguard your livelihood.

If you have a joint venture or partnership, all of your partners, members, and their spouses are protected if they are sued for something they do in an official capacity related to your business

If your business is a corporation, your policy covers all of your business‘s executive officers, stockholders and directors while they are acting in their official capacities

If you have subsidiaries, your policy‘s liability coverage extends to any subsidiary where you own at least 50 percent of the stock

Your policy protects your employees from claims that result from actions they take in their capacity as employees

If you have a written agreement to indemnify a person or organization, such as a vendor, that person or organization would be protected against liability claims for property damage or bodily injury as a result of selling or distributing your products

During the first 90 days after you acquire a new business, it is automatically covered by this policy. After that time frame, you would need to update your policy to continue this protection for the new part of your business

People legally associated with your business, including volunteers working under your direction, are covered for liabilities that result from the work they do for you, and for the use or maintenance of your property that is in their care

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Specific Coverage Offered by General Liability Insurance

Bodily Injury

It may be difficult to imagine how your business could cause another person serious harm or even death. But it‘s good to know that if you are ever held responsible for someone else‘s sickness, injury, or disease, your general liability insurance policy would pay for: Medical care costs

Loss of services Court-awarded compensation for deaths that result from an injury Property Damage

Even if you‘re careful and take precautions, it‘s still possible that something your business does – or something it doesn't do – could damage another person‘s property. It‘s also possible that your actions might prevent the property‘s owner from being able to use it. In such cases, your business liability insurance coverage compensates for: Physical damage to the property, or Loss of use of the property It is important to note that property damage liability coverage often does not cover damage caused to client property you are working on or have in your possession.

Products-Completed Operations

Commercial general liability insurance policies generally include liability protection for services or products completed by your company. So if something your company manufactures or a service your company provides causes an injury, your policy would pay for any resulting legal expenses, as well as damages up to your policy's limit.

Contractual Liability

Your commercial liability insurance coverage would cover liability you might take on when you enter into various contracts, such as: Easement-of-license agreements Building leases Elevator maintenance agreements Agreements to indemnify a municipality, if required by ordinance

Liquor Liability

If you do not manufacture, distribute, sell, serve, or furnish alcoholic beverages as a business, your general liability insurance policy will cover you if are held liable for a liquor-related accident. If you distribute alcoholic beverages occasionally, such as at a

Legal Defense Expenses

Even if your company is not found liable for a claim, the process of mounting a defense is expensive without insurance. A business liability insurance policy will generally pay for: The cost to defend or investigate a suit or claim against you, including court costs, witness fees, attorney's fees, and police report costs If the insurance company asks you to assist in your defense against a claim, it will pay your reasonable expenses, such as the loss of your income for a day in court It will pay the judgments or settlements resulting from covered suits, including interest required on the judgment and the injured party‘s medical expenses, if your defense is unsuccessful When a court requires you to post a bond to ensure you can pay a potential judgment in a liability suit, this insurance will pay the premium for the bond

Medical Payments

If a person should be injured, either directly by you or at your place of business, your commercial liability insurance coverage would pay for funeral and medical expenses incurred within a year of the accident. For example, if one of your clients slips and falls at your office and requires medical treatment, your policy would cover the cost of that treatment. Of course, policy limits apply.

Personal Injury

Personal injury is the part of the commercial general liability policy that protects you should someone claim that your business caused damage that isn‘t physical. In the following examples, most liability policies would protect you against any lawsuits related to: Publishing, in writing or verbally, false information that libels or slanders an organization or person Publishing material that violates someone‘s privacy rights

Falsely detaining, arresting or imprisoning someone Maliciously prosecuting someone Evicting someone wrongfully

Advertising Injury

Should you ever be sued over something that happens while advertising your company's products or services, your business liability insurance protection will cover the claim. Advertising injuries can arise from: Publishing, verbally or in writing, false information that libels or slanders a person or organization Publishing material that violates an individual‘s privacy rights Copying another company's style of doing business, or advertising concepts Infringing on another business‘s title, copyright or slogan

General Liability Insurance & the Business Owner‟s Policy (BOP)

For some business owners, general liability insurance can be simplified through an insurance package known as a business owner‘s policy, or BOP. In order to qualify for a BOP, which offers the kinds of insurance business owners most commonly need in one pre-packaged policy, a business must meet certain criteria.

Product Liability Insurance

Companies that manufacture, wholesale, distribute, and retail a product may be liable for its safety. Product liability insurance protects against financial loss as a result of a defect product that causes injury or bodily harm. The amount of insurance you should purchase depends on the products you sell or manufacture. A clothing store would have far less risk than a small appliance store, for example.

Product liability insurance protects the business from claims related to the manufacture or sale of products, food, medicines or other goods to the public. It covers the manufacturer's or seller's liability for losses or injuries to a buyer, user or bystander caused by a defect or malfunction of the product, and, in some instances, a defective

this coverage will be present in the standard commercial general liability or business owners' policy. You will need to confirm this with your insurance professional. You will want to have a clear understanding of what is covered (for example, some policies will cover economic damages, but not punitive or statutory damages). Finally, the premiums on such policies are based upon the type of product, volume of sales, and the role of the insured in the process. Thus, underreporting the volume of sales may seem like a good way to lower premiums or the idea may be to insure only a part of the sales. Don't under report or try to insure less than the actual amount of sales. This is because there are usually substantial underinsurance penalties applied when the insured underinsures. On the other hand, you will want to make absolutely sure that your products are properly identified. For example, if you supply step stools, you do not want them categorized as ladders. Ladders will have a much higher premium because of the risk potential. Professional Liability Insurance Business owners providing services should consider having professional liability insurance (also known as errors and omissions insurance ). This type of liability coverage protects your business against malpractice, errors, and negligence in provision of services to your customers. Depending on your profession, you may be required by your state government to carry such a policy. For example, physicians are required to purchase malpractice insurance as a condition of practicing in certain states. Professional liability insurance protects your business assets from claims that may result from advice, expertise or professional services you provide. If your business engages in these activities, you could be at risk for being sued by a customer, client or other party who claims he or she lost money or was harmed in some way due to a negligent act, error or omission. Professional liability insurance may take on different forms and names depending on the profession. For example, in reference to medical professions it is called malpractice insurance , while errors and omissions (E&O) insurance is used by consultants, brokers and lawyers.[1]^ Other professions that commonly purchase professional liability insurance include accounting and financial services, construction and maintenance (general contractors, plumbers, etc., many of

whom are also surety bonded), and transport. Some charities and other nonprofits/NGOs are also professional-liability insured. Any individual in a profession that provides advice, expertise, recommendations or a professional service to customers, clients or another party would benefit from professional liability insurance. Professionals are expected to have extensive knowledge or training in their area of expertise. Additionally, they are expected to perform the services for which they were hired, according to the standards of conduct in their profession. If they fail to use the degree of skill expected, they can be held legally responsible for any harm or financial loss that they cause to another person or business. Professional liability insurance protects you in cases of faulty service (errors) or failure to provide a service altogether (omission). This type of insurance coverage pays the cost of your defense and any damages awarded (up to policy limits). Insurance companies have developed many specialized policy forms that respond to the individual risks of particular professions and services. Professional liability insurance coverage is specialty coverage and is generally not included under homeowners insurance, in-home business policies or business owners policies. The primary reason for professional liability coverage is that a typical general liability insurance policy will only respond to a bodily injury, property damage, personal injury or advertising injury claim. Other forms of insurance cover are employers, public and product liability. But various professional services and products can give rise to legal claims without causing any of the specific types of harm covered by such policies. Common claims that professional liability insurance covers are negligence, misrepresentation, violation of good faith and fair dealing, and inaccurate advice. Examples: If a software product fails to perform properly, it may not cause physical, personal, or advertising damages, therefore the general liability policy would not be triggered; it may, however, directly cause financial losses which could potentially be attributed to the software developer's misrepresentation of the product capabilities. If a custom-designed product fails without causing damage to person or property other than to the subject product itself, a product liability policy may cover consequential damages such as losses from business interruption, but will generally