UNDERWRITING 1 UNDERWRITING LEARNING OBJECTIVES After studying this chapter, one should be able to Explain the concept of underwriting Explain the processes involved in underwriting Explain the Assessment and Classification of risks Explain the Numerical Rating Method Explain the basis of assessing the risk in Non-life insurance UNDERWRITINGUnderwriting is the process of evaluation of risk involved in an insurance proposal [both life and non-life] or in a primary market issue by a company and determining the terms of acceptance or extent of commitment an underwriter can take in a capital issue.The mechanism of insurance helps in transferring risk to the insurer and the insurance companies use the underwriting process to determine whether the risk is acceptable or not.Underwriting in life insurance presents more problems than the other areas, as the subjective factor is more manifest. The principle of Uberrimae Fides has all the more importance in this area as the insurer has absolutely no opportunity to know the past history and in some cases even the present condition, unless the proposer voluntarily discloses several traits. As such it is important that the proposer presents a totally comprehensive and realistic picture of his / her health status and the other relevant areas so that the risk transferred to and accepted by the insurer is commensurate with the premium that is being charged by the insurer.To evaluate the risk correctly, the proposer should give as many details as are deemed necessary to present a true and correct picture of his / her condition. It would be impossible for an underwriter however perfect one might be, to make a perfect estimate of the risk, unless the proposer positively contributes towards that arduous task. Underwriting can thus be referred to as the process used by the insurance companies to determine the eligibility of an applicant for insurance coverage and if eligible the terms, conditions and price that would be applicable.It is otherwise called Selection and Classification of Risks.Each company sets its own underwriting standards. The life insurance company must establish a range of mortality expectations within which proponents will be regarded as normal and hence insurable at standard rates of premium. Proponents who fall beyond these limits would be considered sub-standard and subject to higher rates or would be rejected (declined).Further a proponents decision regarding insurance may be based more on his / her knowledge or suspicion about his / her condition of health than the insurers knowledge. Naturally the proposer would decide on the most favourable basis open to him / her. This tendency is known as Adverse Selection or Anti-Selection. The underwriting procedures should attempt to screen out such cases and classify them appropriately. The process of underwriting should thus attempt to protect the insurer against such adverse selection. Another very important aspect to be considered is Financial Underwriting, which deals with the quantum of insurance that an individual can obtain. The purpose of insurance is to meet the unexpected eventualities that arise due to the death of the assured, and the death of the life assured should not lead to any sort of financial advantage to the dependents. It is true that the principle of life insurance admits that every individual has unlimited insurable interest on his / her own life. But this dictum can not be put into practice. The proposer might not be agreeable to limit the insurance cover to his current levels of income because this can go up in future. However the insurer is interested to ensure that the premiums on the insurance policy would be paid regularly. As such the need for insurance is related to the current situations of the life to be insured and normally not to the desirable situations.Human Life Value concept which provides scientific ways to arrive at the asset value of the human life is also taken into account while arriving at the maximum insurance coverage that can be given to a particular proposer / life to be insured.This is essential to ensure that there is no financial adverse selection against the insurer.Factors of Insurability Life insurance companies, therefore, carefully consider a number of significant factors when each proposal for insurance is presented. The information obtained by the insurer relating to these factors enables the insurer to determine the extent of risk involved. These factors are called Factors of Insurability. They are the following:AgeGenderPhysical BuildPhysical Condition Physical impairments or handicap, which may be due to accident or certain diseases.Personal health profile of the life to be insuredFamily history of early deaths including the early deaths of siblings; of inheritable diseases and history of insanity and / or suicides in the family.Habits like smoking, taking alcohol etc...OccupationHobbiesMoral HazardAgeAge is an important factor because the rate of premium depends upon the age of life to be insured. The probability of death increases with age. Certain risks increase with age whereas certain risks decrease with age. Some physical factors, for example, a persons weight, have a relationship with age.Age is also an important factor while considering the proposals, as for certain products there is a restriction on the maximum age at entry. If age is not registered at the time of submission of proposal but a proof is subsequently submitted, it is possible that the age may prove to be higher or lower than what was declared at the time of entering into the contract. Based on the actual age, the insurer would have the discretion in such cases to modify the terms of the policy.Insurers accept several types of proof of age- some of which are standard and some are non-standard. Usually the standard proofs of age are: Municipal Birth Certificate, School / College Certificate, Certified extract from Service Record in respect of a life to be insured / proponent who is an employee of Government, Quasi-Government or Public Sector Undertakings, Baptism Certificate.Where such standard proofs are not available, non-standard proofs like Self-declaration, Elders declaration, Copy of the Ration Card, Voters Identity Card, etc, are also accepted.But certain restrictions with regard to the Plan, Term of assurance, Maximum Sum assured, Maximum Maturity Age, etc, are imposed. In some such cases the insurers may charge extra premiums also.GenderFemale lives have to be treated with caution for underwriting purposes because of some additional risks to which they are exposed due to their gender. Mortality of female lives is considered to be more at earlier ages as compared to male lives. Maternity risk is also involved in female lives. Insurable interest is another factor to be considered.BuildThis includes body measurements or physical structure of the life to be insured and this helps the underwriter to study the inter-proportional relationship between height, weight, chest, abdomen measurements vis--vis age. For this purpose, it is necessary to establish charts of standard weights for various heights and ages. Such charts are prepared on the basis of experience of a large number of insured lives over a period of time. Medico-actuarial investigations have brought out the main characteristics of the extra risk associated with overweight and underweight. At younger ages, underweight is a definite impairment. Tuberculosis is frequently associated at younger ages with underweight.At younger ages, overweight of moderate degree is not a serious impairment. The highest mortality rate because of overweight is experienced at the middle and older ages. Overweight can magnify the significance of degenerative diseases of heart, blood vessels and kidneys.To rate the build of an applicant, it is usual to take into account the distribution of weight and nowadays the insurers give importance to the Body Mass Index ( BMI).Physical ConditionImportant systems of the body that may be reflected by blood pressure, pulse rate, urine analysis, etc, as predicted future mortality of the prospect depends upon the abnormalities present in one or more important systems of the body viz. Digestive, Respiratory, Cardio-Vascular, Renal, Genito-Urinary, etc., systems. When there are indications of any abnormalities further examination may be necessary before the proposal can be accepted.Physical ImpairmentsThey reflect the conditions of blindness, deafness, missing limbs, etc. and they could be due to accident or disease.Personal HistoryThe life to be assureds health background would have a bearing on his / her expected mortality. History of chronic diseases is necessary because they do not completely leave the system and have permanent or long after effects. Acute diseases, on the other hand, have generally no after effects except making the system weak for a short period. Apart from these there could be history of surgeries or accidents. Personal insurance history is also equally important. If a proponent who has a large amount of life insurance in force with one or more companies, again comes up with a request for more, the insurer should make sure that it is not speculative, more so if the new proposal is not justified by the present income and finances of the proponent. If the insurance history indicates that a previous insurance proposal / policy had been refused or accepted with special terms then it implies an extra hazard. It may still be present and need investigation. The risk evaluation in insurance is done on a prognostic evaluation basis whereas the family physician takes a diagnostic analysis of his or her patients. The family physician might be of the opinion that nothing is wrong with the person presently, but still an underwriter may impose an extra premium. This is because the underwriter takes a prognostic evaluation of the proponent considering what his / her state of health would be, say, ten years down the line.Family HistoryThis is about the parents, siblings, spouse and children of the prospect. In underwriting this has a great bearing and is considered from three angles-(i) average longevity of the family, ( ii) hereditary susceptibility to disease and (iii) exposure to infection. Normally family histories are better than average when both parents live upto age 70 and they would be considered less than average when both parents had died before attaining age 50 or if the family history discloses two cases of alcoholism, apoplexy, brights disease, diabetes, epilepsy, heart disease, insanity or suicide before age 60.HabitsThe proponents use of habit-forming drugs and intoxicating beverages has a bearing on the underwriting. If the applicant is reported to be consuming alcoholic beverages in large quantities, the proposal may be rejected. So is the case with consumption of drugs.In the light of the various studies which revealed that consumption of tobacco alone in any form, could lead to worse than average mortality standards, insurers universally are taking the habit of tobacco consumption as a serious underwriting factor. However, one practical problem would be the detection of smoking habit in a proponent. But with the use of medical reports and by resorting to declarations by the proponent, reasonably fair information could be elicited.OccupationOccupational hazards may increase the risk in different ways. (i) Risk of accident to professionals as pilots, auto-racers, electrical high-tension line men, boiler operators and those working at great heights.(ii) Risk of health to workers, in chemical factories, who are exposed to toxic gases, fumes, etc., underground drainage workers, workers in mines, workers in textile / cotton mills, who are exposed to cotton dust.(iii) Risk of both accident and health to workers in underground mines (exposed to the hazards of flooding and also health problems due to lack of sufficient oxygen in the mines).(iv) Risk of environmental hazard to workers in entertainment and liquor trades (affecting mode of living).However in view of increased attention to job safety and working conditions due to both external as well as internal compulsions, the underwriters nowadays have either eliminated or reduced the ratings in respect of many occupations. HobbiesWith a high standard of living, some people have found different ways of spending their leisure time. Hence hobbies and avocations have become important factors in underwriting. Such activities as scuba-diving, mountaineering, competitive racing, hand-gliding, sky-diving clearly involve a significant hazard to be considered in underwriting. Usually such hazards are excluded while covering the risks.Moral HazardLife insurance is a long-term contract and a correct appraisal of risk can only be made if the insurer has before it information on all the factors which influence its decision. The proponent may for various reasons deliberately hide or distort some information or do so inadvertently. It may be so to make a gain upon death or it may be an anxiety to obtain insurance at standard rates.The likelihood of hiding or distorting some information affecting risk appraisal is called Moral Hazard.The situations that may lead to suspecting presence of moral hazard can be:(a) Medical examination of the proponent is at a place different from his / her usual place of residence.(b) Old aged proposer asking for large sum assured but not insured earlier.(c) Higher amount of sum assured not justified by the proposers income.(d) Asking for large sum assured on the life of a family member while the earning member of the family is not insured or is insured for relatively small amount.(e) Beneficiary is not a near relative or dependent of the life to be insured.(f) Sudden increase in insurance: when a person who has all along been obtaining insurance policies for small or moderate amounts suddenly applies for a high sum assured policy. This becomes more important when the proponent is old. Moral hazards arise out of the proposers intentions and moral hazard is not measurable. It is a matter of opinion. If Moral hazard is suspected, no amount of extra premium would be appropriate and underwriters would try to avoid such cases.Sources of information for Underwriting The various sources for the underwriter to take decision for grant of insurance are:(a) Statements made by the proposer in the proposal form.(b) Data provided by the proposer about himself / herself and the life to be insured such as habits, hobbies and family history.(c) Report of the medical examiner including additional or special medical reports necessitated by large sum assured or adverse features noticed in the routine medical examination(d) Agents / Advisors Confidential Report- sufficiency of the report may depend upon the professional experience of the agent / advisor.(e) Report of other officials obtained-normally officials are supposed to make enquiries about the life to be insured and the family with special references to education, economic and social background as well as life styles.Classification of LivesThere are two methods of classification in underwriting and they are (i) Judgement or Assessment Method and (ii) Numerical Rating Method.Judgement or Assessment MethodThe underwriter studies all the features of the life to be insured based on the material information placed before him, draws a mental picture and brings into play all his knowledge and experience to determine the terms of acceptance of risk.The Judgement Method functions effectively when there is only one unfavourable factor to consider or where the decision is simply either to accept the proposal at standard rates or reject it entirely. Where multiple factors are involved or a proper sub-standard classification is needed then this method is not found useful. It also requires the use of highly skilled personnel for proper risk appraisal. This method also can not ensure uniformity in the decisions by the same persons at the same or different times.To overcome the shortcomings of this method, life insurance companies evolved the other method viz., Numerical Rating Method.Numerical Rating MethodThis method evolved out of the necessity to bring about more scientific and methodical appraisal of risks. This method takes into account the principles of Hypothesis of Unchanging Extra Mortality and Addition of Specific Rates of Extra Mortality.In the earlier days of life insurance it used to be sufficient for a proponent to appear before the company officials who assessed his / her health by his / her appearance. But as the volume of life insurance business grew, the state of the life to insureds health began to assume more importance in selection and gradually a system of medical examination has evolved. The practice seems to have started in 1809 by the Pennsylvania Company for the Insurance of Lives, but it was not established in U.K until sometime before the middle of the century.In view of the special techniques involved in medical selection, various professional associations and societies were formed by the physicians having special interest in life insurance medicine in order that the Medico-Actuarial aspect of their specialized subjects could be discussed and experiences exchanged.With the establishment of many professional associations, a greater unanimous opinion emerged regarding the important features in the selection of life risks, and a system of tabulating clinical data from the medical examination of proponents. What started out as Judgemental Underwriting became Scientific Underwriting based on sound actuarial figures.In those early years, infectious diseases like tuberculosis, pneumonia, syphilis and the epidemics such as influenza and bubonic plague were of primary concern. However, interest was initially focused on body build as a prognostic indicator, and work was completed on height and weight tables related to age and gender in 1897 and 1906.When the custom of recording blood pressures was established in life insurance practice sometime after World War I, it became evident that the level of blood pressure bore a direct relationship to mortality; the higher the Blood Pressure in a group, higher the mortality. Besides, build and blood pressure covered many other major medical conditions as in the Impairment Studies of 1951 and 1983.Sub-standard insurance was slow to develop but was encouraged by the work of Oscar H Rogers and Arthur Hunter, Medical Director and Actuary respectively of the New York Life insurance Company, who devised a method of risk evaluation called the Numerical Rating System, which was described by them in a paper read before the Association of Life Insurance Medical Directors of America in 1919. This method of measuring risk is now used universally. The Medico-Actuarial Investigation looked into the effect of various factors of insurability on the longevity of individuals. The basic principle is to assign numerical value to each of these factors. The underwriter rates the risk value of the life by assigning credit points for the favourable factors and debit points for adverse factors and impairments. This is called as Extra Mortality Rating.Based on the rating done, the underwriter would classify the risk as belonging to a particular category. Each insurer would have drafted its own rules and guidelines regarding the range of the ratings to be included under Standard classification and range for Sub-standard classification.In applying the Numerical Rating Method, however certain assumptions are made. They are as detailed below:(a) Unchanging Extra MortalityIt is assumed that the Extra Mortality Rate as arrived at for a given impairment would remain the same over the entire duration of a policy term. This assumption is sometimes called the Hypothesis of Unchanging Extra Mortality.(b) Addition of Specific Extra Mortality RatesA large proportion of sub-standard lives present more than one impairment and therefore it is necessary to measure the total effect of such co-existent impairments in terms of expected extra claims. A simple rule viz. Lindquists Rule generally used in such cases, is to ascertain the specific extra mortality for each such separate impairment and then to assume that the total extra mortality of a risk presenting several impairments is equal to the sum of specific extra mortality rates of the separate impairments.Strictly speaking, this rule is valid only when we are concerned with certain distinct impairments independent of each other.In practice, it becomes necessary in certain cases to modify the assumption by taking into account the possible interaction of various co-existent impairments. Such co-existence is often unfavourable and the extra mortality of these co-existent impairments is much higher than the total extra mortality rates taken separately.Advantages of Numerical Rating Method(a) It enables direct usage of the results of various Medico-Actuarial Investigations.(b) The subjective element in underwriting is reduced to the minimum.(c) It facilitates building up of new statistics on the basis of which the basic ratings are continuously reviewed in the light of upto date trends in insurance medicine.(d) It enables the underwriter to look into all the decision influencing factors and helps to ensure that no factor is overlooked.(e) It helps the underwriters in moving towards standardization and makes possible uniform assessment either by several underwriters or the same underwriter at different times. (f) It helps in expeditious underwriting and decision making. LimitationsWhile the numerical rating method has all the above advantages, it is not without limitations. One of the limitations that it suffers from is that it can not be extended to assess the occupational hazard and the extra risk resulting from certain standard impairments such as the following: (a) Defects and deformities such as amputated arms and legs, partial or total blindness and deafness, cleft palate, club foot etc.(b) Standard impairments such as Hydrocele, Bleeding Piles, Caesarean Section, etc.Sub-standard Life Insurance RisksSub-standard risks are categorized into three broad groups according to the incidence and intensity of extra risk.(a) Increasing Extra RiskIn this group, the extra mortality shown by the group of lives with the impairment increases as the life assured grows older (e.g.) Overweight persons and persons with certain afflictions of the heart.(b) Decreasing Extra RiskIn this case, the extra mortality decreases with age and consequently the extra mortality would be experienced more in the early years following the submission of the proposal for insurance. In respect of those who survive a few years the effect of extra mortality tends to decrease until the extra risk completely disappears (e.g.) Young persons with recent history of T.B or an underweight person.(c) Constant Extra RiskHere the extra hazard remains at a certain level throughout the duration of time during which the life assured is exposed to the risk (e.g.) Blindness or loss of a limb or risk of accidents in certain hazardous occupations.Methods of Rating Sub-standard LivesModification of terms to allow for an extra risk can take the following forms:(a) Increase in premium.(b) Decrease in death benefits.(c) Change in the class and / or period of insurance.(d) Any combination of the above mentioned methods. (e) Postponement of consideration of risk ( Of course this can not be called a modification ).(f) Decline or Reject the proposal, in case the risk is very high for the insurer to accept. (a) Increase in premium (i) Rating up of age: Under this method, the life to be assured is assumed to be so many years older (say 5 or 10 years) than the real age and the premium for the higher age is charged. (ii) Flat extra premium: Under this method, a flat annual extra premium is charged. It is normal to charge a flat extra when the extra risk is constant as in the case of hazardous occupations or certain types of physical defects / deformities / impairments. (iii) Extra Percentage Tables: Under this method, a special mortality table is developed for each sub-standard classification, reflecting the experience of each and a set of gross- premium rates is computed for the classification.(b) Decrease in Death Benefits (i) Lien: This is a contingent debt on the policy. Consequently, in respect of a policy where the lien is operative, if the life insured dies at any particular time during the period the lien is in operation, the amount payable under the policy would be reduced by the outstanding lien amount. The most common form of this is the Decreasing Lien, reducing by level annual amounts. For example, a Decreasing Lien of Rs 500 per Thousand Sum Assured for 5 years would mean that the amount payable on death would be reduced by Rs 500 per Thousand Sum Assured if death occurs in the First Year of the policy, by Rs 400 per Thousand Sum Assured if death occurs in the Second Year of the policy and so on. At the end of 5 years the lien would become Nil. Alternatively a Lien may be Constant for the first few years. The method of Lien is most suitable when the extra risk is of a decreasing type i.e. initially very high and is expected to wear off in the course of time during the policy term. An extra premium in such cases would not be advisable because the total extra premium collected might not be sufficient to meet the additional death claims. (ii) Restrictive Clause: Instead of charging an extra premium, a particular proposal involving extra hazard may be accepted with a restrictive clause. Such restriction would limit the death benefits in certain circumstances. In case death occurs due to a specified extra hazard, the policy might provide payment on a reduced basis, say, return of premiums. (e.g.) First Pregnancy Clause, General Pregnancy Clause.(c) Change in the Class and Period of Assurance In case of certain increasing type of extra risks it is possible to recommend a shorter term policy than what was applied for. By reducing the term, that period of the life in which the risk is high would be avoided for the risk cover.(d) Any combination of the above mentioned methods This is sometimes applied for rating a proposal on a sub-standard life. A proposal for Endowment Assurance with a rider of income benefits may be accepted under an Endowment Assurance plan with a lien if the proponent is young and underweight.(e) Postponement This is not a modification of the terms asked for by the proponent. When the initial risk is very high that there is little hope of offering immediate assurance, then this method is followed. Usually consideration of the proposal can be postponed for 6 months, 1 year or 2 years. This also arises sometimes during the period of convalescence after an illness or operation or in cases of heavy over weights. This is because later on, if the immediate danger period is survived, health may improve so that acceptance may be possible perhaps at normal rates.(f) Decline or Reject If the risk is too heavy for the insurer to accept, then the proposal would be declined which means that grant of insurance is refused.As per IRDAs Regulations, decision on a proposal must be conveyed to the proposer within 15 days from the date of receipt of all requirements. Female LivesLife insurance cover is extended only to those who are insurable. Insurability is governed by three factors viz. (i) Need for insurance, (ii) Affordability to pay premiums and (iii) Acceptability based on medical and other relevant data. The main purpose of life insurance is replacement of earning power. The case of female lives therefore needs to be looked at from these points of view.The problems encountered in extending life insurance cover for female lives as far as Indian conditions are concerned, are briefly summarized as:(a) Females are constitutionally more resistant, but more delicate and complex. Underwriting of female lives calls for more care because of inherent risks like additional mortality during the child bearing age and some complexity in their physiological features.(b) Great difficulty in conducting a thorough medical examination. Even with experienced medical examiners, there is a feeling of reluctance to examine as closely and to question as directly in case of females as in the case of males and as such full details of health in respect of female proponents are not easily obtainable.(c) Great difficulty in fixing the identity. Most of the females in our country, especially in rural areas continue to live in comparative protection, seclusion and secrecy. Even the problems arising out of impersonation at the time of medical examination are very serious in such environments.(d) In many cases it can be seen that the females do not take sufficient care of their health and not seeking medical assistance till the disease takes a firm hold is widely prevalent among them.(e) Another aspect is that most women do not have any earned income of their own.Non-Medical Schemes Over a period the insurers have found lot of irritants with regard to arranging medical examination of the life to be insured. Some of such irritants are:(a) Non-availability of qualified doctors at all places, especially in rural areas.(b) Difficulty in bringing proponents to nearby towns for the purpose of comprehensive medical examination which would also be prohibitively costly and the proponents reluctance to go and wait at the doctors clinic as the doctors first priority would be the doctors patients and not the insurance proponents. Further the life insurance companies experience reveals that 90% proposals are being accepted as proposed at standard rates nowadays.The effect of selection by medical examination for life insurance on the rate of mortality is limited to a few years, may be the initial one or two years after acceptance of the risk and the increased outgo due to this extra risk could be compensated by the saving of medical fees.Where the proponents are employees of an institution which insists on standard age proof and a medical examination at the time of entry into service and also maintenance of regular leave records, in such cases medical examination can be dispensed with.In view of the above, the insurers with some safeguards designed and adopted, consider proposals without insisting on medical examination subject to some conditions being fulfilled, nowadays.The proposal form / personal statement to be completed by the proponent may be more exhaustive. Under the Non-Medical portfolio as there is no medical examination the agents or the advisors role becomes very important.Insurance companies both in life and non-life business consider the agents or advisors as primary underwriters. In the context of life insurance the agent or advisor who secures the business is required to satisfy himself/herself about the insurability of the proponent based on the verifiable data like income, standard of living, habits, etc., through personal enquiries about the proponent. The agent or the advisor is required to provide a true and correct evaluation to the best of his/her knowledge in a report called Agents or Advisors Confidential Report which is a must and has to invariably accompany the proposal.There can be certain restrictions regarding age at entry, types of products offered, maximum maturity age, maximum sum assured, maximum period of insurance etc. The underwriting practices vary from one insurer to another and they keep on changing also as various criteria are getting revised due to levels of sugar, cholesterol, systolic and diastolic pressure indicators etc., are all being re-evaluated.The sequencing of genomes throwing open many areas in underwriting, the complex nature of the human body, the far reaching developments in Genetic Engineering and the scientists looking at options of slicing genes to identify the causes of malfunctioning in the human body, the medical fraternity would slowly start looking to Preventive DNA Tests to get an insight into the nature of precautions to be taken and advices to be given in the near future.Such developments would definitely change the very face of life underwriting.After a few years from now, a person may be able to get life cover from a kiosk, like money from a banks ATM. Insert ones PDNA Test report, touch the screen for the required plan and period of cover, press the button to remit the premium by debiting the designated account in the bank and walk away with satisfaction that life risk is covered.Days are not far-off when inanimate software would be evaluating lives in the place of conventional, finicky and fastidious underwriters. Non-Life InsuranceBecause of the varied nature of risk, it is not uncommon that in the non-life insurance business, differential premiums may be quoted for risks that appear similar in nature.The rate of premium to be charged has to be commensurate with the hazards involved in the risk. A thorough knowledge of various hazards to which property and human beings are exposed is most essential for successful underwriting. The hazards can be classified into physical and moral in non-life insurance. Physical Hazard: This can be assessed from the information furnished in a proposal form and can be ascertained by a survey or inspection of the object of insurance. Some examples of physical hazard in different classes of non-life insurance are: Fire Insurance(i) Construction: Construction refers to where and how the building has been constructed. A concrete building is superior to a timber or mud building. (ii) Height: The greater the number of storeys / floors, the hazard is likely to be more due to the risk of collapse of upper floors causing heavy damage and also constraints on the fire extinguishing apparatus/ machinery playing an effective and efficient role. (iii) Nature of flooring: The damage due to wooden floors which can add fuel to fire and also easily collapsible contribute for more loss. (iv) Occupancy: The purpose for which the building is used, is also an important factor e.g. Chemicals, Timber, Paper, Textiles, Electrical appliances etc.(v) Process of manufacture: The process of manufacture involving the use of electricity would increase the risk of fire and in case the work is carried out involving artificial lights then again the risk would be more. (vi) Situation: The location in a congested area, activities carried out in that area and distance from the fire brigade are some examples of locational physical hazard. Marine Insurance(i) The age and condition of vessel(ii) The voyage to be undertaken i.e. the route of the voyage, loading and unloading conditions and warehousing facilities are factors affecting physical hazard. (iii) The nature of the stocks, since glass and brittle items as well as machinery are liable to breakage while in transit.(iv) The method of packing. Accident Insurance(a) Motor(i) Age and condition of the vehicle(ii) Type of vehicle(iii) Use of vehicle(b) Personal Accident(i) Age of the person(ii) Nature of occupation and place of job(iii) Health and physical condition Burglary Insurance(i) Nature of the stocks: Articles of high value in small quantity e.g. jewellery are considered to be bad risks. (ii) Situation: Ground floor viz-a-viz upper floors, private dwellings situated in isolated areas are more hazardous. (iii) Constructional Hazard: Too many doors and windows invite more risks. Fidelity Guarantee Insurance(i) Accounting and control systems(ii) The methods of check and supervisionMoral HazardMoral hazard arises from individual moral weakness or from general social and economic conditions. It is intangible and therefore more difficult to ascertain. Moral hazard could arise in the following ways:(i) Dishonesty: A person may be tempted to stage a loss if he / she happens to be in financial difficulties. (ii) Carelessness: Indifference towards loss is an example. Because of the existence of insurance, the insured may tend to adopt a careless attitude towards the insured property. (iii) Difficult insured: The insured may not deliberately bring about a loss but when a loss occurs he/she might attempt to exaggerate and demand a high amount of compensation. (iv) Industrial relations: Labour unrest may lead to carelessness, malicious damage and even to acts of arson and sabotage. (v) General economic conditions: During times of economic depression insured owners of property would be tempted to cause deliberate losses in order to realize the cash value of their property. Underwriting of Physical HazardMere existence of physical hazard would not render a risk uninsurable as there are various types of physical hazard and they would be dealt with in a variety of ways. Insurers may recommend measures to reduce the possibility of loss or damage occurring or liability arising from the hazard. Insurers may incorporate appropriate warranties to reduce the physical hazard. Insurers may impose some clauses specifying restrictions e.g. marine cargo policies are normally issued with the replacement clause. The clause limits the insurers liability only to the cost of replacing, forwarding and refitting any broken part. In some cases the insurers may insist on prior inspection before accepting the risk. Loading of PremiumNormal rate of premium is charged if the cargo is shipped by liners or other vessels which comply with the prescribed standards. If the cargo is shipped by an over-aged or under-tonnage vessel then extra premium may be charged. In personal accident insurance if the insured is engaged in hazardous pursuits like mountaineering, racing on wheels etc. extra premium is charged. Restriction of coverA proposal for a comprehensive insurance cover on an old motor vehicle may not be accepted and insurers may offer a restricted cover i.e. against third party risks only. Imposition of Excess/ Franchise LimitsWhen the loss amount equals or exceeds the limit, the full amount is paid under Franchise clause whereas the balance amount only is paid under Excess clause loss below the specified limit is not payable in either case. If the physical hazard involved is considerably high, 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 and insurers will not accept risks where the loss potential is predominantly high.Underwriting of Moral HazardMoral hazard cannot be assessed in the same way as physical hazard and normally nothing can be done to improve a bad moral hazard and the risk simply becomes uninsurable. However moral hazard arising out of carelessness can be dealt with by imposing some restrictive clauses, for example Excess Clause in Motor Insurance, Restrictive Warranties in Burglary Insurance etc. The rating that is applied as a standard to a majority of properties is called the Class Premium. Though in principle it has to be assumed that the conditions remain the same, but in reality, this normally doesnt happen and, therefore it becomes difficult for the insurers to cover the risks on a Class Premium basis.There may be many kinds of risks that cannot be charged under the Class Premium for the nature of risk to be covered may vary from unit to unit, and the risk involved may have to be individually rated.The different types of individual ratings are:Judgement Rating: There may be instances where the underwriter is not in a position to find dependable data to verify the probability of risk or due to the divergent nature of the units it is not possible to group them under one class, then the underwriter may have to use his/her judgement to arrive at the premium and this is called the Judgement Rating.Experience Rating: Here the underwriter to some extent is guided by the past loss experience and the premium is arrived at or modified accordingly and this is called the Experience Rating.Retrospective Rating: Under this, a deposit amount is collected at the beginning and at the expiry of the contract period, depending upon the nature of the experience the final premium is arrived at and collected.Schedule Rating: Under this, a rating schedule is taken as a base and to which credits as well as debits are given depending on individual exposure and then the final premium is arrived at.(Similar to No-Claim bonus in Motor insurance)Thus it can be observed that the insurance mechanism constitutes two important characteristics: shifting of risk from an individual to a group and sharing losses on an equitable basis by all the members of the group. Insurers use underwriting to determine whether a risk is to be accepted or not. Underwriting basically involves selection and classification of risks.Underwriters play a significant role in appraising the qualitative and quantitative aspects of risks and strive to ensure safe as well as profitable distribution of risks and also maintenance of equity among the insureds in a pool. To conclude, underwriting has implications of fairness to the insurer and to the policyholders, individually as well as collectively and hence underwriting means analyzing the data, assessing the risk to be covered, avoiding anti- selection, fraud against the insurer and finally accepting or rejecting risk.REVIEW QUESTIONS1. Discuss in detail the factors that affect the risk in life insurance.2. Discuss in detail the Extra Mortality Risk.3. Discuss the advantages as well as disadvantages of the Numerical Rating Method.4. Discuss the options available for the underwriter in respect of sub-standard lives in Life insurance.5. Discuss in detail Moral Hazard and how this would be dealt with by the underwriter in Non-life insurance. ------OOO------