PARA 13.2|IC 57, Fire Insurance|ONE LINER|CHAPTER 6: Underwriting
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Here we are providing One Liner for IC 57, Fire Insurance para 13.2 and III exam . These questions will be very helpful for upcoming promotional exam in 2020.
♦ Underwriting factors
- The term ‘underwriting’ is broadly used to denote the principles and practices concerning:
- The acceptance or rejection of the risks,
- The fixing of rates,
- The total amount of acceptance,
- The amount of retention for insurers own account and
- Treatment of the balance through reinsurance
- The ultimate underwriting objectives are:
- The production of a large volume of premium income sufficient to maintain and progressively enlarge an insurer’s organisation and
- The earning of a reasonable profit on the operations
- Several factors enter into underwriting and these may be broadly classified as follows:
- The production of a well spread and a large volume of business;
- The selection of the business;
- The determination of the limits to be retained; and
- The reinsurance of the surplus
- The production of a large volume of business-This is governed by the need for wide distribution of risks class-wise and geographically.
- Class-wise distribution of risks: According to the law of average, which is the fundamental basis for all insurance operations, it is unlikely that all classes of fire risks would produce adverse results at the same time; again, business obtained in certain classes may not be large enough toproduce average loss experience of the past.
- Geographical distribution of risks: Similarly, in the same class of risks, one territory may produce profits at a time when another is showing losses. The object, therefore, is to spread the business over as wide an area and, to secure business from as large number of classes, as possible. In insurance parlance this is called “Balanced Portfolio”.
- The selection of the business-This involves careful scrutiny of the business acceptances with a view to making a proper assessment of the fire hazards involved. The right decision will depend upon the insurers’ assessment of the probability of
- an outbreak of fire,
- of its spread in relation to the total value at risk and
- of a catastrophic loss
6.The fixing of retentions-The underlying principle of insurance is the spreading of the losses of the
few over many. Too heavy a loss from a single fire event may cause a severe strain on the funds of the insurers, which would affect the security of the rest of the policy holders who have contributed to the “common premium fund”.
- The term “retention” refers to the amount which an insurer is prepared to retain for own account on a risk; the alternative terms used are “limit” and “net holding.
- The financial status of the insurers, as reflected in capital and reserves.
- The premium income of insurers. It is obvious that an insurer with a small premium income may not be able to sustain a loss which may be easily absorbed by an insurer with a larger premium income.
- The experience in the class, which involves:
- The degree of fire hazard present
- The extent of the damage likely to be sustained
- The possibility of fire extinguishment
- The amount of premium income in the particular class of risk.
- Incombustible or burn very slowly: Certain stocks are more or less incombustible or burn very slowly such as metal goods and hardware.
13.Burn moderately: Other stocks which burn moderately, such as flour, tobacco, cotton, jute etc. are regarded as high burning stocks
- Burn with great intensity: Stocks like spirits of all kinds, celluloid burn with great intensity
- Fire protection: The nature and number of fire extinguishing appliances, fire brigade facilities, sprinkler installation etc. are factors which are considered.
- Maximum Probable Loss refers to the insurer’s estimate of potential liability in the worst event.
- Possible means (something) that can happen.
18.Probable means (something) capable of being proved or which may reasonably be expected to happen, wherein reasonable is meant in the sense of having sound judgement or sensible or as is judged appropriate or suitable to the circumstances or purpose.
- PML Concept is one of the main tools used in underwriting, especially in property insurance underwriting.
- The understanding and use of PML concept enables an insurer to
- Maximise his retention capacity and the returns,
- Control the exposure for the own account and
- Use the right combination of reinsurance techniques to manage the risk.
- Net Retention Capacity: The maximum amount of ‘risk ’that can be assumed for the own account of an insurer, in respect of single ‘risk’ is termed the Net Retention Capacity.
- This capacity is determined by the factors such as Net Worth, Premium Volume, Spread of the portfolio, adequacy of premium rates, loss ratio, etc.
- Reinsurance is an arrangement whereby Direct Insurer who has insured a risk insures a part of that risk again with another insurer
- Reinsures a part of the risk in order to reduce his own liability. The difference between the retention and the total amount of acceptance is reinsured.
- Limitation of liability to an amount which is proportionate to their finances is made possible for insurers.
- It makes for stability in underwriting and consistency in underwriting results over a period.
- It provides a safeguard against serious effects of conflagrations.
- A sound system of retentions and reinsurance assists in the steady accumulation of reserves.and Creates an automatic capacity to accept large risks.
- A portfolio or a class of Fire Insurance business operating with adequate premium rates over a long period can balance itself and produce reasonable profits to the insurer.
- PML Assessment Factors: These can be classified into broad categories as under:
- Technical information
- Insurance Information
- Third Party Information
- Causes of Loss Information
- Where explosion is considered as the loss scenario for PML estimate, a quantitative approach is adopted to determine the damage potential of materials of explosion.
- These relate to:
- Unconfined Vapour Cloud explosion
- High pressure equipment rupture and
- Dust cloud explosion
- DOW Chemical’s Manual is used for the purpose of hazard quantification by working out the fire and explosion index.
- ROA had published a set of guidelines approach in respect of Petro chemical risk of which deals with the loss scenarios of Vapour Cloud explosion and Liquid Pool Fires.
- PML Error / PML Burst: The term generally denotes an actual loss being larger in size than PML
- Too low an estimate of PML and resultant higher retention by the cedent may unduly overburden his net account on large losses and may also prove disastrous in the event of a PML BURST.
- Example Fire Policies on simple risks such as dwellings, offices, etc., up to a sum insured Rs. 30 crores are fully retained by the companies for their own account.
- There are two main methods of reinsurance:
- Facultative and
- The main feature of the facultative method is that each risk is reinsured individually.
- The reinsurer to whom the risk is offered has the choice or the faculty of either accepting or rejecting the risk (facultative method)
- facultative method is still used to supplement the treaty facilities.
- There may be risks which are outside the scope of the treaty, because of their size or their nature, or the insurers may not like to include certain types of risks in the treaty to protect that the treaty results not turning unfavourable to the reinsurers. In such cases, facultative method is resorted to.
- There are two types of treaty reinsurance:
- Proportional and
- Proportional Treaties:
- Quota Share Treaty and
- Surplus Treaty
- Under proportional treaties the ceding company decides the part of the original insurance, it wishes to retain for its own account and cedes the balance to the reinsurer.
- Premiums and losses are shared in the proportion that the ceding company’s retention and the reinsurers share bear to the sum insured of the original insurance.
- By using a proportional reinsurance (Quota Share Treaty, Surplus Treaty or Facultative Reinsurance) the risk from large and / or hazardous risks is transferred out, thereby limiting the exposure to the Net Retained account from large single losses.
- Proportional reinsurance can also facilitate insulation from the effect of catastrophe losses
- Excess of Loss (Non-proportional) reinsurance is more effective way of handling catastrophe exposures.
- Quota Share Treaty: the ceding insurer is bound to cede and the reinsurer bound to accept a fixed share of every risk coming within the scope of the treaty.
- Obligatory cessions of certain % of all the business to the GIC may be regarded as Quota Share Cessions
- The Surplus Treaty: this treaty is to reinsure the surplus of a risk beyond the amount of the ceding insurer’s retention.
- The extent to which the surplus can be reinsured is determined by the size of the treaty measured in terms of ‘lines’.
- A ‘line’ is equal to the ceding insurer’s net retention.
- A twenty line treaty reinsurance protection is made available up to an amount equal to
twenty times the retention of the ceding insurer.
- This treaty is called a ‘first surplus treaty’ and may be supplemented by a ‘second surplus treaty’ to absorb the amounts which are beyond the capacity of the ‘first surplus’ treaty.
- the treaty is defined with reference to the
-number of lines,
-the geographical area and
-the class of business
- All settlements, adjustments and compromises of claims including exgratia payments made by the ceding insurer are binding on the reinsurer, provided the cause of loss is within the scope of the cover.
- Whenever loss attaching to the treaty exceeds an “agreed amount” the ceding company has the right to call for immediate payment from reinsurers their share of loss. Such “agreed amount” is known as “cash loss limit” under the treaty.
- The ceding insurer retains an agreed percentage of the annual premium as a premium reserve which is adjusted subsequently in the accounts.
- Accounts are rendered on fixed intervals like quarterly or half yearly basis.
- Provision is made for settlement of disputes through arbitration.
- Surplus Treaty vs Facultative
– The advantage of treaty method is the obligatory nature of reinsurance
acceptances. The reinsurer cannot decline to accept any cession coming within the
scope of the treaty. This facilitates direct underwriting and enables the ceding
insurer to give cover for large amounts immediately.( Surplus Treaty)
-Treaty reinsurance involves much less clerical labour and general costs, because
the acceptances are dealt with in bulk with only periodical submission of limited
information. (Surplus Treaty)
-In facultative reinsurance each case is treated separately involving considerable amount
of documentation.( Facultative)
-The rights and obligations of each party are clearly defined in the treaty agreement. (Surplus Treaty)
-The facultative reinsurance contract is expressed in a reinsurance policy which being
a brief document is open to problems of interpretation.( Facultative)
-From the reinsurer’s point of view, treaty ensures a constant and regular flow of business and gives it a good spread of risks. (Surplus Treaty)
-Reciprocal exchange of business is possible under treaty reinsurance methods either
on the basis of profitability of treaties or premium volume. (Surplus Treaty)
-This facility is not available under facultative method.( Facultative)
- As compared to sum insured underwriting, the PML underwriting can provide a much higher capacity to insurer.
- In case an actual loss is more than the maximum loss expected by an insurer in terms of number of lines; reinsurers impose a “minimum PML condition” to limit the number of lines.
- The condition stipulates that the PML factor (expressed as a percentage of Total Sum Insured) used for any risk shall not be less than a specified percentage.
- This could vary from 20% to 50%.
- Non-proportional treaties do not apply to specific risks but to losses covered under the portfolio.
- The insurer limits the amount of loss for any one claim which is called the deductible (underlying limits)
- The reinsurer agrees to pay that amount of the loss over and above the deductible subject to an upper limit which is called the ‘overlying limit’
- Excess of Loss Treaty: Excess of Loss (XoL) cover protects the insurers Net Retained Account from losses of catastrophe nature e.g. losses caused by weather perils such as STFI ; natural perils such as EQ and resultant tsunami, landslide bush fire etc. and political risks such as Riots, SRCC or even conflagration
- The underwriters keep Risk XoL (individual single large loss) and CAT covers (event losses) separate from each other by “two risk warranty” clause.
- Peril wise monitoring-While monitoring aggregate exposure one should distinguish among perils in terms of their nature of producing loss and area of occurrence. Munich Re’s World Map of Natural Hazards has graphically documented the known natural hazards across the globe into a map.
- As the insurer is interested in knowing PML for the net retained account, the data needs to be segregated into small, medium and large risks information and underwriting break up needs to be applied to arrive at that portion of exposure applicable to Net Retained Account.
- It will be seen that this treaty does not involve any proportionate sharing of risks, as in quota share or surplus treaties.
- The ‘burning cost’ is arrived at by taking a fixed period (say 4 years) and
computing the ratio of the claims paid and outstanding for the share of the excess of loss reinsurers to the gross net premium income of the company for the period.
- Catastrophe Risk Evaluating and Standardising Target Accumulations (CRESTA) Determination-The CRESTA organisation was established by the insurance and reinsurance industry in 1977 as an independent body for the technical management of natural hazard coverage.
77.CRESTA’s main goal is to establish a uniform and global system to transfer, electronically, aggregated exposure data for accumulation risk control and modelling among insurers and reinsurers.
- Promoting a template to exchange exposure data in the industry based on the ACORD standard.
- The Indian Fire Reinsurance programme is reviewed annually and arranged by GIC in consultation with its four subsidiary companies and finally approved by the Government of India.
80.Underwritten on Probable Maximum Loss (PML) basis-Fire reinsurance in India is underwritten on Probable Maximum Loss (PML) basis, which means retention limits are decided based on the PML of a risk and in simple risks on sum insured basis.
- Obligatory Cessions – Quota Share Cessions of all the business, written by any company is ceded to GIC. This is a statutory requirement and such Cessions are called obligatory Cessions. This is retained entirely within the country and protected by Excess of Loss cover.
- Classification of risks – The surplus after obligatory cessions is dealt with depending on sum insured and probable maximum loss. For this purpose, risks are classified into ‘non-risk’ booked, ‘risk-booked’ and ‘listed’ risks.
- Non-booked risks -The surplus after obligatory cessions in non-risk booked portfolio is entirely retained by the companies and protected by excess of loss cover.
- Acquisition Costs-According to the new File & Use guidelines, Margins built into rates shall be consistent with the experience of the insurer in respect of commission, management expenses, contingencies and profit.
- Expenses of management will generally reflect the overall expense ratio of the insurer in recent past.
- Margins built into rates shall be consistent with the experience of the insurer in respect of commission, management expenses, contingencies and profit.
- Internal tariff rated products-These are standard products that can be sold by any of the offices of the insurer with the rates, terms and conditions of cover, including choice of deductible where applicable, as set out in an internal guide tariff.
- Packaged or Customised Products-These are products specially designed for an individual client or class of clients, in terms of scope of cover, basis of insurance, deductibles, rates and terms and conditions of cover.
- Exposure rated products-These are products where the rates, terms and conditions of cover are determined by an evaluation of the exposure to loss in respect of the risk concerned, independent of the actual claims experience of that risk.
- Risk Management-Insurance is a form of risk transfer mechanism for dealing with one aspect of risk, i.e. the transfer of the financial losses caused by the occurrence of uncertain events / risks.
- Prudent underwriting means that the insurer should only offer insurance of risks that are quantifiable and manageable and where the premium can be properly assessed. The cover should be clearly defined and should provide cover that is of value to the person insured.
- Corporate Governance-Underwriting being one of the core functions of the insurers, it is essential that the Board should be involved in deciding the underwriting philosophy of the company in the matter of the underwriting profit expectation.
- The key ingredients of general insurance product pricing are:
- Claims cost;
- Business acquisition cost;
- Management expenses;
- Margin for fluctuation in claims experience and
- Reasonable profit
- Types of Excess of Loss covers include ‘per risk’ cover and ‘per event’ cover.
- AIFT classifies India into four EQ zones with respect to frequency and severity.
- There are two main methods of reinsurance: Facultative and treaty.
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