General Insurance Underwriting Considerations and Procedures: Practice Questions and Solutions

This section of the study guide is intended to provide practice problems and solutions to accompany the pages of Insurance Operations, Regulation, and Statutory Accounting, cited below. Students are encouraged to read these pages before attempting the problems. This study guide is entirely an independent effort by Mr. Stolyarov and is not affiliated with any organization(s) to whose textbooks it refers, nor does it represent such organization(s).

Some of the questions here ask for short written answers based on the reading. This is meant to give the student practice in answering questions of the format that will appear on Exam 5. Students are encouraged to type their own answers first and then to compare these answers with the solutions given here. Please note that the solutions provided here are not necessarily the only possible ones.

Source:

Myhr, A.E.; and Markham, J.J. Insurance Operations, Regulation, and Statutory Accounting (Second Edition). American Institute for Chartered Property Casualty Underwriters. 2004. Chapter 4, pp. 4.10-4.18.

Original Problems and Solutions from The Actuary's Free Study Guide

Problem S5-51-1. Myhr and Markham, p. 4.10, state that the three alternatives open to an underwriter are as follows:
1. Accept the submission as is.

2. Reject the submission.

3. Make a counteroffer to accept the submission, subject to certain modification.

If the underwriter selects alternative 3 above, what are the four major types of modifications that the underwriter could require?

Solution S5-51-1. According to Myhr and Markham, p. 4.10, the underwriter could do the following:

"1. Require loss control measures;

"2. Change insurance rates, rating plans, or policy limits;

"3. Amend policy terms and conditions;

"4. Use facultative reinsurance."

Problem S5-51-2. What are the differences among experience rating, schedule rating, and retrospective rating? Define each term and state the elements that are unique to each rating approach.

Solution S5-51-2. This question is based on the discussion in Myhr and Markham, pp. 4.11-4.12. Here are the definitions of each term, as given by these authors:

Experience rating is "a ratemaking technique that adjusts the insured's premium for the upcoming policy period, based on the insured's experience for the current period."

Schedule rating is "a rating plan that awards debits and credits based on specific categories, such as the care and condition of the premises or the training and selection of employees."

Retrospective rating is "a ratemaking technique that adjusts the insured's premium for the current policy period, based on the insured's loss experience during the current period; paid losses or incurred losses may be used to determine loss experience."

The differences can be encapsulated as follows:

Experience rating develops the premium for time period X on the basis of the experience from time period (X-1). Also, an experience rating plan "uses three years of past loss experience, when available, and a credibility factor based on the size of the policyholder's premium to determine the modification. In comparison to other rating plans, experience rating has a formal methodology that must be applied without discrimination to all submissions that must meet experience-rating eligibility requirements" (Myhr and Markham, p. 4.11).

Retrospective rating develops the premium for time period X on the basis of the experience from time period X. Premiums are adjusted at the end of time period X; the insured incurs an additional premium charge or receives a refund on the basis of experience from period X. Retrospective rating "is an individual experience modification program" (Myhr and Markham, p. 4.12), and only current-year experience, as opposed to experience from past years, is used.

Schedule rating is not dependent on actual loss experience per se, but rather on conditions deemed by the underwriter to contribute to more or less favorable loss experience. The underwriter uses a combination of judgment and the insurance company's stated policies to decide what credits or debits to apply to the insured's premium based on the underwriter's evaluation of the insured's physical premises and practices.

Problem S5-51-3. Myhr and Markham, p. 4.13, discuss factors that need to be considered in making an underwriting decision. List five of these factors.

Solution S5-51-3. The following factors are explicitly mentioned by Myhr and Markham, p. 4.13:

1. Loss exposures contemplated in the insurance rate;

2. Loss control measures;

3. The insured's commitment to loss prevention;

4. Amount of underwriting authority required;

5. Presence of supporting business;

6. Mix of business;

7. Producer relationships;

8. Regulatory restrictions.

Other valid answers may be possible, depending on the loss exposure being underwritten.

Problem S5-51-4. Myhr and Markham, p. 4.16, discuss three steps that are involved in implementing an underwriting decision. What are these three steps? For each step, name one more specific course of action that might be required.

Solution S5-51-4. The three steps, in general, are as follows:

1. Communicating the decision;

2. Putting coverage into effect;

3. Recording information for accounting, statistical, and monitoring purposes.

For step 1, the following courses of action are possible:
i. If the underwriter decides to accept the submission with modification, he or she needs to communicate the reasons clearly to the producer and the applicant; "the applicant must agree to accept or implement the modifications" (Myhr and Markham, p. 4.16).

ii. "If the underwriter decides to reject the application, he or she must communicate the rejection to the producer in a positive way to preserve their long-term relationship. Underwriters must provide clear and logical reasons why the particular applicant does not meet the insurer's underwriting requirements" (Myhr and Markham, p. 4.16).

For step 2, the following courses of action are possible:

i. Issuing a binder;

ii. Sending a policy worksheet to the policywriting department;

iii. Preparing certificates of insurance.

For step 3, the following courses of action are possible:

i. Entering data about the policyholder's "location, limits, coverages, price modifications, and class of business" (Myhr and Markham, p. 4.16).

ii. Coding data so as to make it available for purposes of ratemaking, statutory reporting, financial accounting, and book-of-business evaluations.

iii. Using the data to "monitor the account, to trigger renewals, and to flag situations requiring special attention" (Myhr and Markham, p. 4.16).

Other answers are possible, depending on the situation in question.

Problem S5-51-5. Which of the following statements about monitoring loss exposures are true? More than one statement may be correct.

(a) An underwriter should distribute his resources properly so as to enable a thorough and constant monitoring of all existing individual policies, while he continues to underwrite new business.
(b) Changes in policies or the occurrence of losses on policies provide a good opportunity for an underwriter to monitor loss exposures.
(c) Premium audits, when they occur, usually accompany a renewal policy and occur simultaneously with it.
(d) Underwriters should try to obtain first-hand knowledge from insurer personnel who were involved in any premium audits of the insured.
(e) Monitoring primarily pertains to individual policies, and not to the insurer's entire book of business. Monitoring the entire book of business would be a prohibitively costly task.
(f) A poor loss ratio for a particular class of business indicates overly restrictive underwriting guidelines for that class of business.
(g) It is possible for one large loss to distort a loss ratio.

(h) Good underwriting decisions will always lead to good underwriting results.

Solution S5-51-5. This question is based on the discussion in Myhr and Markham, pp. 4.17-4.18. The following statements are correct:
(b) Changes in policies or the occurrence of losses on policies provide a good opportunity for an underwriter to monitor loss exposures.

(d) Underwriters should try to obtain first-hand knowledge from insurer personnel who were involved in any premium audits of the insured.

(g) It is possible for one large loss to distort a loss ratio.

Choice (a) is not correct; it is too large a task for most underwriters to continually monitor all existing policies; rather, most monitoring is done when there are policy changes, losses, premium audits, or other circumstances that bring attention to the policies in question.

Choice (c) is not correct; premium audits typically lag behind renewal policies by a few months.

Choice (e) is not correct; monitoring can be usefully done both for individual policies and at an aggregate level, for a book of business.

Choice (f) is not correct; overly restrictive underwriting is unlikely to lead to a poor loss ratio; overly permissive underwriting or inadequate rates, however, might.

Choice (h) is not correct; a major loss might not be anticipated even by the best underwriting practices. Over the long run, however, more competent underwriters will tend to develop a book of business that performs more favorably.

See other sections of The Actuary's Free Study Guide for Exam 5.