What Is Underwriting In Insurance And How Does It Work?

In the last two decades, India has seen a major emergence of the insurance sector in various segments like health, life, personal accident cover, travel and a host of other types of insurance policies where the demand of clients to safeguard themselves has gone up. Since the coming of private players, the insurance sector has witnessed an unprecedented boom, and this is just the tip of the iceberg with the Indian market presenting huge potential for exponential growth.

While this rapid growth is great news for the industry as a whole, insurance companies also have the responsibility to maintain sound work practices, avoidmis-selling and most importantly, to fix a fair price for their products. In other words, calculating the right premium for different policies.

The premium amount for any insurance policy is entirely dependent on the quantum of risk likely to be incurred. The process by which this risk is assessed and a premium calculated is called underwriting. This process would be applied to all types of insurance, be it life, personal accident, health, or a physical asset like a car or a house.

Since this is a complex process, insurance companies hire specialized underwriters for this function. So here is what underwriters do. They use actuarial data and special computer programs to calculate the probability and the extent of a claim taking place during the term of the policy.

Let us understand this in the light of health insurance. At the time of taking a policy, the policy holder is asked to furnish results of certain health tests and also furnish personal details like age, height, weight, medical history, lifestyle and habits. The underwriter will use this information to assess the extent of risk. For instance, if the policy holder is a male above the age of 50, is overweight, is a heavy smoker and has a family history of high blood pressure, he faces a high risk of heart and other related disease. Which means that there is a high possibility that he will make claim on his health insurance, perhaps multiple times. Since in this case, the risk assessment is high, the insurance company will charge a commensurately high premium for the policy. On the other hand, for a young man in his 20s who runs 12 kms a day, the risk will be far lower and therefore his health insurance will come at a much lower premium.

In the insurance sector, well thought and executed underwriting process can make a huge difference. Any prospective policy buyer judges an insurance policy on three parameters. The first and foremost parameter is whether it meets the needs of the buyer, is the coverage comprehensive and affordable. Lastly, whether the premium of the policy is at competitive pricing. These factors can truly make or break any policy.

But in the insurance sector, it’s not just the prospective policy buyer that is at risk but also the insurance company itself. On an average, every insurer has to tackle many major uncertainties like how many people will make claims and how much the insurer will have to pay to settle them. These subsequently, have a major impact on how much an insurance company will charge for the protection it provides and how much reserve has to be present to deal with any claims that may arise in the future. This is why, as a rule, all insurers include the clause of ‘Utmost Good faith’ or (Uberimma fides) where it is a client’s duty “to voluntarily disclose, accurately and fully all material facts pertaining to risk proposed, whether requested or not”.