Chapter Introduction
In this chapter you will learn the basics of underwriting and rate making. You will learn about the different methods of dealing with hazards in the process of rating of risks. You will learn how to decide the “Sum Insured” for various types of insurance policies.
Learning Outcomes
A. Underwriting basics
B. Ratemaking basics
C. Rating factors
D. Sum insured
After studying this chapter, you should be able to:
1. Define the basics of underwriting
2. Explain the basics of ratemaking
3. Determine „Sum Insured‟ under various policies
A. Underwriting basics
In the previous chapters we have seen that the concept of insurance involves managing risk through pooling. Insurers create a pool consisting of premiums that are made by several individuals / commercial / industrial firms / organizations.
The amount of premium to be paid by each depends on a rate, which is determined by two factors;
• The probability of loss due to a loss event (caused by an insured peril) and
• The estimated amount of loss that may arise due to the loss event
Example
Assume the average amount of loss as a result of a fire was Rs 100000 [which we denote as L]
The average or mean probability of the loss [denoted by P] was 1 out of 100 [or 0.01].
The mean or average expected loss would then be given by: L x P = 0.01 x 100000 = 1000
How can the insurer ensure that the pool is sufficient to compensate for the losses that are actually incurred?
As we have seen earlier, the whole mechanism of insurance involves pooling of a large numbers of statistically similar risks so that the law of large numbers would operate and the probability of number of losses (frequency) as well as the extent of loss (severity) becomes predictable.
The problem is that all exposures are not alike. A pool of exactly similar [or „identical‟] risks may be quite small.
For instance, how many houses would you find that are exactly similar and located in exactly the same external environment? Not many.
As the pool size increases, it is likely to include non similar risks, which are exposed to same or similar perils. The insurer faces a dilemma here.
How to create a pool which is large enough so that the risk becomes more predictable while at the same time ensuring that the pool is sufficiently homogenous and contains similar risks?.
Insurers have found a solution to the problem.
Example
In the field of property insurance, the chances of a wooden structure catching fire are more than stone structures; hence, a higher premium is required to insure the wooden structure.
The same concept applies to health insurance also. An individual suffering from high blood pressure or Diabetes has higher chances of suffering a heart attack
Consider the risk of high medical costs of treatment for a disease. The risk would be different for a person who suffers from high BP and Diabetes compared to a person who is in good health.
This process of classifying risks and deciding into which category they fall is important for rate making.
1. Basics of Underwriting
Definition
Underwriting is the process of determining whether a risk offered for insurance is acceptable, and if so, at what rate, terms and conditions the insurance cover will be accepted.
Underwriting, in a technical sense, comprises the following steps:
i. Assessment and evaluation of hazard and risk in terms of frequency and severity of loss
ii. Formulation of policy coverage and terms and conditions
iii. Fixing of rates of premium
The underwriter firstly decides on whether or not to accept the risk.
The next step would be to decide the rates, terms and conditions under which the risk is to be accepted.
Underwriting skills are acquired through a continuous learning process involving adequate training, field exposure and deep insights. To be a fire insurance underwriter one needs to have a good knowledge of the likely causes of fire, impact of fire on various physical goods and property, the process involved in an industry, geography, climatic conditions etc.
Similarly a marine insurance underwriter must be aware about port/road conditions, problems encountered by cargo/goods in transit or storage, ships and their seaworthiness and so on.
A health underwriter needs to understand the risk profile of the insured, age, medical aspects, fitness levels and family history and measure the effect of each factor affecting the risk
a) Underwriting, equity and business sustainability
The need for careful underwriting and risk classification in insurance arises from the simple fact that not all risks are equal. Each risk thus needs to be appropriately assessed and priced in accordance with the likelihood of loss occurrence and severity
Since all risks are not equal, it would not be equitable to ask all those who are to be insured, to pay equal premium. The purpose of underwriting is to classify risks so that, depending on their characteristics and degree of risk posed, an appropriate rate of premium may be levied.
Every insurer has a responsibility to its current policyholders to make sure that it is able to meet all the contractual obligations of existing policies. If the insurance company issues policies on risks that are uninsurable or charges premiums much lower than is required to cover the risk, it would result in jeopardising the insurer‟s ability to meet its contractual obligations.
On the other hand, an insurer who wants to charge very high rates for risks that do not warrant such high rates may find that its business is non-competitive and unsustainable. Therefore in the interest of equity and sustainability, the underwriting process needs to be meticulously followed
The main features of underwriting are as follows
i. To identify risk based upon the characteristics
ii. To determine the level of risk presented by the proposer
iii. To ensure that the insurance business is conducted on sound lines
The objectives of underwriting are achieved, in short, by deciding the level of acceptability, adequacy of premium and other terms.
Test Yourself 1
Identify the two factors that affect insurance ratemaking.
I. Probability and severity of risk
II. Source and nature of risk
III. Source and timing of risk
IV. Nature and impact of risk
B. Ratemaking basics
Insurance is based on transfer of risk to the insurer. By purchasing an insurance policy, the insured is able to reduce the impact of financial losses arising from the peril against which the property is insured.
Example
If one drives a car, there is a risk that it may be damaged in an accident. If the owner has motor insurance, in the event the car gets damaged, the insurance company will pay for the repairs.
The company needs to adopt a process of calculating a price to cover the future cost of insurance claims and expenses, including a margin for profit. This is known as ratemaking.
A rate is the price of a given unit of insurance.
For example, a rate may be expressed as Rs.1.00 per mille for earthquake coverage
Rates vary according to the likelihood and potential size of loss. Each rate is established after looking at past trends and changes in the current environment that may affect potential losses in the future.
Example
Consider the above example of earthquake insurance, the rates charged would be higher near a fault line and for a brick house, which is more susceptible to damage, than for a concrete structure.
Taking an example of health insurance, numerical or percentage assessments are made on each component of the risk. Factors like age, race, occupation, habits etc. are examined and scored numerically based on predetermined criteria.
Note that rates are not the same as premiums.
Premium = (Sum Insured) x (rate)
1. Objectives of rating
The basic objective of rate making is to ensure that price of insurance should be adequate and reasonable, both from the point of view of the insurer and the insured.
From the point of view of the insurer, this means that the rates in the aggregate must be sufficient to provide for the payment of claims, expenses and taxation and leave an adequate margin for catastrophes and for profit.
From the point of view of the insured, reasonable rates imply that one should not be required to pay more than a sufficient sum to cover the hazards involved, together with a reasonable charge for expenses, catastrophes and profits.
Fire premium rates can be considered reasonable if they take into account all major factors, which affect the risk but ignore minor factors, which in aggregate may cause only a small variation in the estimated rate.
2. Determining the rate of premium
The pure rate of premium is arrived at on the basis of past loss experience. Therefore, statistical data regarding past losses is most essential for purposes of calculating rates.
To fix the rates, it is necessary to give a „mathematical value‟ to the risks.
Example
If loss experience of a large number of motor cycles is collected for a period of say 10 years, we will get the sum total of the losses resulting from damage to the vehicles. By expressing this amount of loss as percentage of the total value of motor cycles we can fix the „mathematical value‟ of the risk. This may be expressed in the formula given below:
M = L/V X 100
L refers to the sum total of the losses and V to the total values of all the motor cycles
Let us suppose that:
• Value of a motor cycle Rs. 50,000/-
• Loss experience: out of 1000 motor cycles in 10 years, 50 cycles are stolen
• On an average, five motor cycles become total losses due to theft every year
Applying the formula, the result will be:
Losses (Rs. 50,000 X 5) = Rs. 2,50,000
Values (Rs. 50,000 X 1000) = Rs. 5,00,00,000
This means that (L / V) x 100 = [2,50,000 / 5,00,00,000] x 100 = 0.5%
Therefore the rate of premium that a motor cycle owner pays is half a percent of Rs. 50,000/- i.e. Rs. 250/- per year. This is called the „Pure‟ premium.
At the rate of Rs. 250 per cycle, Rs. 2.5 lakhs is collected which is paid out in claims on total losses of 5 vehicles.
If the pure premium, which is arrived above, is collected it would constitute a fund which will be sufficient only to pay for losses.
In the example above we can see that there is no surplus. But insurance operations also involve costs of administration (expenses of management) and costs of procurement of business (agency commission). It is also necessary to provide a margin for unexpected heavy losses.
Finally, since insurance is transacted on a commercial basis, like any other business, it is necessary to provide for a margin of profit which is a return on the capital invested in the business.
Therefore, the „pure premium‟ is suitably loaded or increased by adding percentages to provide for expenses, reserves and profits.
The final rate of premium will consist of the following components:
• Loss payments
• Loss expenses (e.g. survey fees)
• Agency commission
• Expenses of management
• Margin for reserves for unexpected heavy losses e.g. 7 total losses against 5 assumed
• Margin for profits
It is necessary to have a careful selection of the experience period. The most recent loss experience period must be used. The selected period must contain sufficient loss experience data so that the results have necessary statistical significance or credibility. Finally where the business is subject to catastrophic losses, the experience period must be representative of the average catastrophic incident.
By taking all the relevant rating factors into consideration, one can ensure the rates are not inadequate, excessive or unfairly discriminatory as between risks of similar type and quality.
Test Yourself 2
What is pure premium?
I. Premium sufficiently big enough to pay for losses only
II. Premium applicable to marginal members of the society
III. Premium after loading for administrative costs
IV. Premium derived from the most recent loss experience period
C. Rating factors
The relevant elements that are used to add up the rates and make the rating plan are referred to as rating factors. Insurers use „rating factors‟ to determine the risk and to decide the price they will charge.
• The insurer uses his assessments to firstly establish a base rate
• Insurer then adjusts this rate with discounts applied for positive features such as superior fire protection on property risk and loadings applied for adverse features such as drivers with poor conviction records on motor risks
Important
Sources of information for underwriting
The first stage in any numerical (or statistical) analysis is the collection of data. When pricing a risk, an underwriter should gather as much information as possible to aid accurate assessment.
Sources of information are:
i. Proposal form or underwriting presentation
ii. Risk surveys
iii. Historic claims experience data: For some classes of business, such as personal and motor lines, underwriters often utilise historic claims experience data to provide an indication of the likely future claims experience, and to arrive at a suitable premium.
Accurate interpretation and effective use of claims experience is vital to the pricing process. Catastrophic losses are unpredictable and infrequent in nature. Hence, statistical information is not always available or meaningful as a basis for calculation. (With the advent of modern computers various simulation models are used nowadays to measure the likely impact of natural catastrophic events)
1. Hazard
The term hazard in insurance language refers to those conditions or features or characteristics which create or increase the chance of loss arising from a given peril. A thorough knowledge of various hazards to which property and persons are exposed is most essential for underwriting.
Hazards can be classified into physical and moral. Physical hazard refers to the risk arising from material features of the subject matter of insurance, whereas moral hazard may arise from human weakness (e.g. dishonesty, carelessness, etc.) or from general economic and social conditions. At the operating level, ratemaking process involves assessment of physical and moral hazards.
2. Physical hazards
Physical hazard can be ascertained from the information given in a proposal form. It can be better ascertained by a survey or inspection of the risk. The following are some examples of physical hazard in various classes of insurance.
a) Fire
i. Construction
Construction refers to the building materials used in walls and roof. A
concrete building is superior to a timber building.
ii. The height
Greater the number of storey‟s, the greater the hazard because of difficulties of extinguishing fire. Besides, a greater number of floors involve risk of collapse of the upper floors causing heavy impact damage.
iii. Nature of flooring
Wooden floors add fuel to fire. Besides, wooden floors collapse easily in the event of fire, causing damage to property on lower floors through falling machinery or goods from upper floors.
iv. Occupancy
The occupancy of a building, and the purpose for which it is used. Various types of hazards arise from occupancy.
v. Ignition hazard
Buildings in which chemicals are produced or used in large quantity involve a considerable ignition hazard. A timber yard presents a high combustibility hazard because once a fire starts, timber burns quickly. The contents may be highly susceptible to damage in the event of fire.
For example, paper, clothing etc. are susceptible not only to fire damage but also to damage by water, heat etc.
vi. The process of manufacture
If work is carried during the night, the hazard is increased due to the use of artificial lights, continuous use of machinery leading to friction and the likely carelessness of workers due to fatigue.
vii. Situation
Location in a congested area, exposure to hazardous adjacent premises and distance from the fire brigade is an example of physical hazard.
b) Marine
i. The age and condition of vessel
Older vessels are inferior risks.
ii. The voyage to be undertaken
The route of the voyage, loading and unloading conditions and warehousing facilities at the ports are factors.
iii. The nature of the stocks
Articles of high value are exposed to theft; machinery is liable to breakage in transit.
iv. The method of packing
Cargo packed in bales is considered to be better than cargo in bags. Again, double bags are safer than single bags.
Liquid cargo in second-hand drums constitute bad physical hazard.
c) Motor
i. The age and condition of the vehicle Older vehicles are more prone to accidents. ii. The type of vehicle
Sports cars involve greater physical hazard etc.
i. The nature of the stocks
Articles of high value in small bulk (e.g. Jewellery) and easily disposable are considered to be bad risks.
ii. Situation
Ground floor risks are inferior to upper floor risks: private dwellings situated in isolated areas are hazardous.
iii. Constructional hazard
Too many doors and windows constitute bad physical hazard.
e) Personal accident
i. The age of the person
Very old persons are accident prone; besides they will take longer to recover in the event of an accident.
ii. Nature of occupation
Jockeys, mining engineers, manual workers are examples of bad physical hazard.
iii. Health and physical condition
A person suffering from Diabetes may not respond to surgical treatment in the event of accidental bodily injury.
f) Health insurance i. Age of the person
Younger age bracket are less prone to falling ill frequently.
ii. Health status of the person i.e. if presently suffering from any illness
iii. Consumption of alcohol or tobacco iv. Nature of occupation
Working in factories where there is an excessive exposure to smoke or dust.
3. Addressing physical hazards in rating
Underwriters use the following methods to deal with physical hazards:
• Loading of premium
• Applying warranties on the policy
• Applying certain clauses
• Imposition of excess/ deductibles
• Restricting the cover granted
• Declinature of cover
a) Loading of premium
There may be some adverse features in a risk exposure for which the underwriters may decide to charge an extra premium before acceptance of the same.
By loading the premium the higher probability of claims or occurrence of large claims is taken into consideration.
Example
i. Normal rate of premium is charged for cargo shipped by liners or other vessels, which comply with the prescribed standards. However, if an over- aged or under-tonnage vessel ships the cargo then extra premium is charged.
ii. In personal accident insurance if the insured is engaged in hazardous pursuits like mountaineering, racing on wheels, big game hunting etc. extra premium is charged.
iii. In health insurance if there are adverse features at the time of underwriting, it can also lead to loading of premium.
Sometimes loading of premium is also done for adverse claims ratio, as in case of motor insurance or health insurance policies.
As per the recent regulation of IRDA Individual claim based loading cannot be applied. Loading can only be applied to the overall portfolio, based on objective criteria.
b) Imposition of warranties
Insurers incorporate appropriate warranties to reduce the physical hazard. Some examples are provided below.
i. Marine cargo
A warranty is inserted to the effect that goods (e.g. Tea) are packed in tin lined cases.
ii. Burglary
It is warranted that the property is guarded by a watchman for twenty four hours.
iii. Fire
In fire insurance, it is warranted the premises would not be used beyond normal working hours.
iv. Motor
It is warranted that the vehicle will not be used for speed testing or racing.
c) Application of some clauses that will reduce the claim/loss amounts
Example
Marine cargo: Small damage to parts may cause costly machinery to be a constructive total loss. Such machinery are subject to the Replacement Clause, which limits underwriter‟s liability only to the cost of replacing, forwarding and refitting any broken part.
Cast pipes, hard board sometimes get damaged only at the edges. Marine policies on cast pipes, hardboard etc, are subject to the cutting clause warranting that the damaged portion should be cut off and the balance utilised.
Many a time marine insurance for inland transit is demanded on goods imported from abroad. It‟s quite possible that loss or damage on such goods may have already occurred during the ocean voyage but may not be apparent on external examination.
Such risks are accepted subject to an inspection of the goods on landing in port. Policy is subject to survey before acceptance.
d) Imposition of Excess / Deductibles
When the loss amount exceeds the deductible/excess mentioned the balance is paid under 'excess' clause. Loss below the limit is not payable.
The object of these clauses is to eliminate small claims. As the insured is made to pay part of a loss, he is encouraged to exercise more care and to practice loss prevention.
e) Restriction of cover
Example
i. Motor: A proposal for an old motor vehicle will not be accepted on comprehensive terms but insurers will offer a restricted cover i.e. against third party risks only.
ii. Personal accident: A personal accident proposer who has crossed the maximum acceptance age limit may be covered for death risk only instead of on comprehensive terms i.e. including disablement benefits.
iii. Health: At times the insurer may impose a restriction of cover for certain surgical procedures or conditions and the cover would be to a limited extent only. E.g. cataract or eye lens procedures.
f) Discounts
Lower rates are charged or a discount is given in the normal premium if the risk is favourable.
The following features are considered to contribute to improvement of risk in fire insurance.
i. Installation of sprinkler system within the premises
ii. Installation of hydrant system in the compound
iii. Installation of hand appliances consisting of buckets, portable extinguishers and manual fire pumps
iv. Installation of automatic fire alarm
Example
Under motor insurance a discount in the premium is provided if the motor cycle is always used with a side-car attached, as this feature contributes to improved risk because of the greater stability of the vehicle.
In marine insurance, the insurer may consider giving discounts on premium for “Full Load” container as this reduces the incidence of theft and shortage.
Under a group personal accident cover, discounts would be given for coverage of a large group, which reduces the administrative work and expenses of the insurer.
g) No claim bonus (NCB)
A certain percentage is given as bonus for every claim free renewal year with a limit to the maximum bonus that can be availed. It is allowed by way of deduction on the total premium at renewal only, depending upon the incurred claim ratio for the entire group.
No claim bonus is a powerful strategy to improve underwriting experience and forms an integral part of rating systems. This bonus recognises the factor of moral hazard in the insured. It rewards the insured for not lodging claims either by adopting better driving skills as in motor insurance or taking better care of his health as in mediclaim policies.
h) Declinature
If the physical hazard involved is considerably bad, the risk becomes uninsurable and is declined. Based on their past loss experience, knowledge of hazards and overall underwriting policy, insurers have formulated a list of risks to be declined in each class of insurance.
4. Moral hazard
Moral hazard could arise in the following ways:
a) Dishonesty
An extreme example of bad moral hazard is that an insured taking insurance with deliberate intention of creating or making a loss to collect a claim. Even, an honest insured may be tempted to stage a loss, if he happens to be in financial difficulties.
b) Carelessness
Indifference towards loss is an example of carelessness. Because of the existence of insurance, the insured may tend to adopt a careless attitude towards the insured property.
If the insured does not take the same care of the property as a prudent and reasonable man would if he were uninsured the moral hazard is unsatisfactory.
c) Industrial relations
Employer-employee relationship may involve an element of bad moral hazard.
d) Wrong claims
This kind of moral hazard arises when claims occur. An insured may not deliberately bring about a loss but once a loss occurs, he would attempt to demand unreasonably high amount of compensation, in total disregard of the principle of indemnity.
Example
Examples of such moral hazard arise in personal accident insurance, where the claimant would tend to prolong his period of disablement in order to obtain more benefits of insurance than is justified by the nature of injury.
In motor claims such a hazard would arise when the insured unreasonably insists on replacement of new parts whereas the damage could be satisfactorily repaired or attempts to carry out certain repairs or replacements which are not related to accidental damage.
Moral hazard can be reduced using the mechanisms of co-payment, deductible, sub-limits and offering incentives like no-claim bonus in health insurance.
Information
i. Co-payment
When an insured event occurs, many health policies require the insured to share a part of the insured loss. E.g. If the insured loss is INR 20000 and the co-pay amount is 10% in the policy, then insured pays INR 2000.
ii. Sub-limits
The insurer may impose a limit on the total payout separately each for room expenses, surgical procedures or doctor fees to check the inflated bills.
iii. Deductible
Also called as excess, it is the fixed amount of money the insured is required to pay initially before the claim is paid by insurer, for e.g. if the deductible in a policy is INR 10000,the insured pays first INR 1000 in each insured loss claimed for.
Where the moral hazard of the insured is suspected, the agent should not entertain or bring such proposals to the insurance company. She should also bring such issues before the insurance company officials.
5. Short period scales
Normally, premium rates are quoted for a period of twelve months. If a policy is taken for a shorter period, the premium is charged according to a special scale, known as short period scale.
It may be observed that according to the scale, the premium chargeable for short period insurance is not on proportionate basis.
Need for short period scales
a) These rates are applied because the expenses involved in the issue of the policy whether for a 12 months period or a shorter period, are almost the same.
b) Further, an annual policy requires renewal procedure only once during a year whereas short period insurances involve more frequent renewals. If a proportionate premium is allowed, there would be a tendency on the part of the insured to go on taking short period policies and thereby, in effect, pay premiums in instalments.
c) Besides, some insurance are seasonal in character and the risk is greater during that season. Insurances are sometimes taken during such period when the risk is greatest and thereby selection takes place against the insurers. Short period scales are evolved to prevent such selection against the insurers. They are also applicable when annual insurance is cancelled by the insured.
6. Minimum premium
It is the practice to charge minimum premium under each policy so that administrative expenses of issuing the policy are covered.
Test Yourself 3
What is expected of an agent when she detects a moral hazard?
I. Continue with the insurance as before
II. Report the same to the insurer
III. Ask for a share in the claims
IV. Turn a blind eye
D. Sum Insured
It‟s the maximum amount that an insurance company will indemnify as per policy condition. An insured has to be very careful in choosing the limit of indemnity, for that is the maximum amount that would be reimbursed at the time of claim.
The sum insured is always fixed by the insured and is the limit of liability under the policy. It is an amount on which rate is applied to arrive at the premium under the policy.
It should be representative of the actual value of the property. If there is over insurance, no benefit accrues to the insured and in case of under insurance, the claim gets proportionately reduced.
1. Deciding the sum insured
Under each class of business the insured should be advised of the following points which have to be borne in mind while deciding the sum insured:
a) Personal accident insurance: The sum insured offered by a company can be a fixed amount or it can also be based on the insured‟s income. Some insurance companies may give a benefit equal to 60 times or 100 times of the insured‟s monthly income for a particular disability. There could be an upper limit or „cap‟ on the maximum amount. Compensations can vary from company to company. In group personal accident policies the sum insured may be fixed separately for each insured person or may be linked to emoluments payable to the insured person.
b) Health insurance: The sum insured is available within a certain range. It depends on the age bracket too. Let us say for age group of 25 -40 years the insurer may offer a sum insured of 10 lakhs or higher and for age group of 3 months to 5 years it could be 2 lakhs or so.
c) Motor insurance: In case of motor insurance the sum insured is the insured's declared value [IDV]. It is the value of the vehicle, which is arrived at by adjusting the current manufacture's listed selling price of the vehicle with depreciation percentage as prescribed in the IRDA regulations. Manufacturer's listed selling price will include local duties / taxes excluding registration and insurance.
IDV = (Manufacturer‟s listed selling price – depreciation) + (Accessories that are not included in listed selling price-depreciation) and excludes registration and insurance costs.
The IDV of vehicles that are obsolete or aged over 5 years is calculated by mutual agreement between insurer and the insured. Instead of depreciation, IDV of old cars is arrived at by assessment of vehicle‟s condition done by surveyors, car dealers etc.
d) Fire insurance
In fire insurance the sum insured may be fixed on the basis of market value or reinstatement value for buildings / plant and machinery and fixtures. Contents are covered on the basis of their market value which is cost of the item less depreciation.
e) Stocks insurance
In case of stocks, sum insured is their market value. The insured will be reimbursed at the cost at which these stocks can be purchased in the market to replace the damaged raw material, after the loss.
f) Marine cargo insurance
It is an agreed valued policy and the sum insured is as per the agreement between insurer and insured at the time of contract. Normally it would consist of the sum of cost of the commodity plus Insurance + freight i.e. CIF value.
g) Marine hull insurance
In marine hull insurance, the sum insured is the value, agreed between the insured and the insurer at the beginning of the contract. This value would be arrived at by a certified valuer after an inspection of the hull/ship.
h) Liability insurance
In case of liability policies, the sum insured is the liability exposure of the industrial units based on the degree of exposure, geographical spread. Additional legal costs and expenses may also form part of claim compensation. The sum insured is decided by the insured based on the above parameters.
Test Yourself 4
Suggest an insurance scheme for a doctor to protect him from any claims of negligence against him.
I. Personal accident insurance
II. Liability insurance
III. Marine hull insurance
IV. Health insurance
Summary
a) Process of classifying risks and deciding into which category they fall is important for rate making.
b) Underwriting is the process of determining whether a risk offered for insurance is acceptable, and if so, at what rate, terms and conditions the insurance cover will be accepted.
c) A rate is the price of a given unit of insurance.
d) The basic objective of rate making is to ensure that price of insurance should be adequate and reasonable.
e) „Pure premium‟ is suitably loaded or increased by adding percentages to provide for expenses, reserves and profits.
f) The term hazard in insurance language refers to those conditions or features or characteristics which create or increase the chance of loss arising from a given peril.
g) The objective of imposing deductible / excess clauses is to eliminate small claims.
h) No claim bonus is a powerful strategy to improve underwriting experience and forms an integral part of rating systems.
i) Sum insured is the maximum amount that an insurance company will indemnify as per policy condition.
Key terms
a) Underwriting
b) Rate making
c) Physical hazards
d) Moral hazards
e) Indemnity
f) Benefit
g) Loading of premium
h) Warranties
i) Deductibles
j) Excess
Answer 1
The correct option is I.
Probability and severity of risk affect insurance ratemaking.
Answer 2
The correct option is I.
Pure premium is sufficient enough to pay for losses, however it does not account for administrative expenses or profit.
Answer 3
The correct option is II.
An insurance agent should report to the insurer any detection of moral hazard.
Answer 4
The correct option is II.
Liability insurance can insure the doctor against claims of negligence.
Self-Examination Questions
Question 1
____________
decides whether to accept or not to accept the risk.
I. Assured
II. Underwriter
III. Agent
IV. Surveyor
Question 2
____________ is the price of a given unit of insurance.
I. Rate
II. Premium
III. Sum Assured
IV. Bonus
Question 3
____________ is the maximum amount that an insurance company will indemnify to someone who files a claim.
I. Sum insured
II. Premium
III. Rider
IV. Benefits
Question 4
____________ is not a source of information for underwriter.
I. Annual accounts of a proposer
II. Pre-acceptance risk survey of the asset
III. Proposal form
IV. Registration certificate of insurer
Question 5
Hazards are:
I. Factors that increase the impact of losses
II. Factors that increases the frequency of loss
III. Factors that increase the impact and severity of losses
IV. Factors that decrease the impact and severity of losses
Question 6
Which of the following is true?
Physical Hazards:
I. Are not important for rate making
II. Cannot be ascertained
III. Can be calculated from the balance sheet
IV. Can be ascertained from information given in a proposal form
Question 7
In motor insurance one of the warranties is:
I. The vehicle should be washed daily
II. The vehicle should not be used for speed testing
III. The vehicle should not be used for carrying luggage for personal use
IV. The vehicle should not be run more than 200 km per day.
Question 9
Installation of sprinkler system in the premises:
I. Increases risk
II. Decreases the risk
III. Neither increases nor decreases risk
IV. Increases risk of hooding
Question 10
Insured‟s declared value in motor insurance includes:
I. Registration
II. Manufacturer‟s cost price
III. Manufacturer‟s selling price
IV. Arbitrary price component
Answers to Self-Examination Questions
Answer 1
The correct option is II.
Underwriter decides whether to accept or not to accept the risk.
Answer 2
The correct option is I.
Rate is the price of a given unit of insurance.
Answer 3
The correct option is I.
Sum insured is the maximum amount that an insurance company will indemnify to someone who files a claim.
Answer 4
The correct option is IV.
Registration certificate of insurer is not a source of information for underwriter.
Answer 5
The correct option is III.
Hazards are factors that increase the impact and severity of losses.
Answer 6
The correct option is IV.
Physical hazards can be ascertained from information given in a proposal form.
Answer 7
The correct option is II.
In motor insurance one of the warranties is that vehicle should not be used for speed testing.
Answer 8
The correct option is II.
The purpose of deductible clause is to eliminate small claims.
Answer 9
The correct option is II.
Installation of sprinkler system in the premises decreases the risk of fire.
Answer 10
The correct option is III.
Insured‟s declared value in motor insurance includes manufacturer‟s selling price.