Underwriting
Underwriting is the analysis of the characteristics of a risk to decide if the risk is acceptable, unacceptable, or acceptable if certain requested conditions (changes) are met. The underwriter reviews applications that are submitted and decides if the characteristics presented meet company guidelines that are in place for that particular type of business (such as homeowner, auto or business owner policies).
By its very nature, underwriting is discriminatory. Underwriters apply a set of criteria, and many times are also allowed personal leeway (known as “underwriting judgment”) when making decisions on specific accounts.
The underwriter typically has the power to make exceptions to the insurance company’s guidelines and to issue a policy based on a submission
—even though that submission does not technically qualify. If an exception is made, it is typically documented, and is frequently reviewed by management. Underwriters also possess pricing authority. This is true in both personal lines and commercial lines, though much more evident on large commercial accounts. The most frequent pricing structure used in personal lines (auto and homeowner policies) is application of preferred credits, or use of a tiered approach. Whichever method of pricing is used, the idea is that the best risks (those that the company underwriter feels will have no future claims) get the best pricing. This is not always the case, however, as favors are frequently done on the underwriting level based on things such as an underwriter’s
relationship with an agent.
One of the craziest things about the underwriting process is the archaic rating methodology that is used to price commercial lines (business insurance) policies. There is no good (quick and easy-to-use) rating system
that is widely available in the insurance industry.
Some insurance companies have developed proprietary rating systems and do provide their field underwriters with the capability to price insurance products outside of the office. However, once the insurance products are quoted in the field, arcane rating systems are used back at the home office in order to get insurance policies issued.
A tremendous amount of effort and time is required to rate coverages that the insurance company provides. All the customer and agent want is a bottom line price. They don’t care how difficult it is to massage the insurance company’s computer software to come up with a price. Much of the problem has to do with the history of commercial lines ratemaking and the fact that “it has always been done this way.” What is needed is a major overhaul of the commercial lines products rating methodologies in order to simplify the way that accounts are priced. The result will be a welcome reduction in the amount of time it takes to issue a commercial insurance policy, as well as a better understanding by consumers of how prices are determined (greater transparency).
Policy Services
Policy Services provides the internal assistance necessary for the insurance company to get their policies issued. This includes rating entry, secretarial- related work, and other jobs that move a policy through the organization and out their doors.
Many insurance companies also include some type of quality control as part of their Policy Services Department. Quality control entails the review of issued policies to ascertain whether they contain the policy forms, endorsements, exclusions and other items that match the insurance coverage requested by the consumer.
Amazingly enough, some insurance companies have completely done away with the quality control function. For example, during a recent deposition I discovered that a large, national insurance company relies completely upon their insurance agents to review issued policies for accuracy. The attorney for the insurance carrier stated that the insurance company feels it is the responsibility of their insurance agent representatives to review policies as part of the services the agency provides to earn the commissions paid by the insurance company. I find this stance utterly
amazing. This position is similar to the automobile manufacturer producing a new vehicle and expecting the dealership that sells the car to perform a product safety check of the car. To me, common sense dictates that the party that has the most knowledge about the product being produced should implement quality control procedures.
Audit Department
The main purpose of the Audit Department is to find out if there have been changes in a commercial policy since the last anniversary date. Many commercial insurance policies are issued on an ‘’audit-able” basis. This means that the initial insurance premium is based upon an estimate — a best- guess as to what the business exposure will be at the end of the policy term. Auditable insurance policies include General Liability, Worker’s Compensation, Business Automobile, and may include certain other policies such as Commercial Inland Marine and some Non-Standard insurance policies. Auditable policies are rated based upon estimated “exposures.” For example, General Liability rating may be based upon things such as square footage (area), gross sales receipts, units, payroll, admissions, or “A-Rates” where underwriting judgment is used to determine a rate to charge for the exposure. For Worker’s Compensation, rates are based upon worker job duties (classifications); and payrolls are assigned to each classification on the current policy.
Here is an example of an auditable policy situation: Acme Widgets has an insurance policy that is effective January 1, 2014, and expires on January 1, 2015. Acme plans sales of $1,000,000 during the 2014 policy year. Therefore, the insurance policy is issued using a specific rate (i.e., 1.57 per
$1,000 of sales), which is chosen by the underwriter. This rate is then applied to the estimated sales value. The policy is issued with a General Liability premium of $1,570, which reflects the 1.57 rate x 1,000 exposure units ($1,000,000 dollars of sales). The policy is audited six months after the end of the policy term (June 30, 2015) and it is discovered that Acme actually sold $2,000,000 worth of widgets during the policy period.
In this case, an additional premium is developed taking the 1.57 specific rate and multiplying it by 1,000 additional sales exposure units (representing the additional $1,000,000 of sales that took place during 2011). Another
$1,570 of premium is owed to the insurance company as a result of the actual
sales that took place at Acme Widgets. This is fair to all parties because additional sales represent additional exposure to risk for the insurance company and they are entitled to additional premium to offset the additional risks present. Alternately, if only $500,000 in sales were generated by Acme during 2014, they would be entitled to a credit of $785 for the reduced exposure basis. If a credit is due to the policyholder, a check is issued by the insurance company and sent to the policyholder.
Note that there are some insurance policies that are issued on a non- auditable basis. Generally, this is a positive situation for the insurance customer because it allows businesses to better budget their annual insurance costs, and it can result in cost-savings for businesses that are growing. However, for those businesses with declining sales, an auditable policy is best since they will get money refunded when an audit takes place after the policy period ends.
Loss Control
Loss Control (also known as Loss Control Engineering or Safety Engineering) is a service offered by insurance companies to clients who meet certain criteria. These criteria include the class of business (a manufacturing business certainly warrants loss control while a small ice cream store generally does not); premiums generated by the account (many insurance companies do not feel it is cost effective to offer these types of services to an account that generates less than $25,000, or so, of annual insurance premium); and on a case-by-case basis (usually as a result of customer or agent request).
Loss control is a valuable service if the individual performing the inspection is well-trained and experienced in looking at the particular type of business you own. Where this potential benefit fails is when the loss control inspector is not knowledgeable, or when business owners do not follow through on specific key recommendations generated during the personal inspection of their business.
Loss control can work miracles in bringing down both the frequency and severity of Worker’s Compensation injuries. Loss control engineers can help implement safety programs, and they work with Human Resources, as well as supervisors and foremen, to ensure the success of safety programs. They also address things such as potential products liability claims and whether or not
the business is complying with current work-related laws and regulations (i.e., OSHA). However, the most important thing that loss control engineers can do is to get owners or top-level managers involved in key loss control issues. If top management is not 100% behind recommended changes, necessary loss control changes—and resulting business improvements—will simply not occur.
Never underestimate the importance of good company management. I have worked with companies that have had a mentality of “good enough” or that were unwilling to instill sound operating practices because of the “hassle factors” involved with making changes. Insurance companies seldom desire to insure this type of company. On the other hand, I have seen a change of management come with a corresponding change of operational mentality. New management enacted new policies, procedures and safety requirements and the difference was amazing. Where old management was content with no changes, new management abhorred claims and became much more profitable as a result. The increased profitability resulted in part from reduced insurance premiums due to improved claims results. Same company name but a completely different management mindset.
For effective loss control, the insurance company representative should visit the business a minimum of twice per year. Four times to twelve times per year may be necessary initially. This would depend on the type of business, the focus of the loss control initiatives (i.e., Worker’s Compensation vs. premises liability related) and/or the severity of problems that are discovered. But more than likely, the insurance company will not offer this frequency of visits, so it is up to the customer to demand it.
Alternative sources of information are available if your business does not meet the minimum qualifications for insurance company loss control services. These include hiring private loss control engineering firms, requesting an OSHA inspection, or using other state or local government agencies.
A business can request a free OSHA inspection to see if they are in compliance with federal laws. The OSHA inspector will point out areas of non-compliance (if any) and will not levy a fine for any deficient areas discovered during this process.
Other resources may be available, depending on the state in which your business is located. For example, in the State of Wisconsin, a Worker’s Compensation classification code audit can be provided by an entity known
as the Worker’s Compensation Rating Bureau (WCRB). In the course of their inspection, they will also point out safety concerns that they might observe.
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