Ch 1 & 2 underwriting management

UNDERWRITING
Losses of the few are met by the contribution of many
Each individual risk needs
to bring an equitable
contribution to
the common pool. Few
losses
contribution
Contribution
contribution
contribution
Contribution
contribution

OBJECTIVES
Objectives of a regulatory authority (FSA in UK, SECP in
Pakistan):
• Maintaining confidence in the financial system;
• Financial stability of country’s financial system;
• Securing right degree of protection for the consumers;
• Reduction in financial crime e.g. money laundering, fraud &
dishonesty and criminal market misconduct, such as inside
dealing.

THE CHANGING NATURE OF THE MARKETPLACE
FOR SMALL BUSINESSES
Regulatory changes
ABI & General Insurance Standard Council voluntary codes are followed by the general
insurance till 2005.
Financial Service Authority (FSA - 2005) introduced the statutory regulation for insurers and
intermediaries.
In 2012, Financial Services Act 2012 split the FSA’s responsibility in:
Financial Policy Committee (FPC) within the Bank of England – Responsible for macro-
prudential regulation & watching for emerging risks to the UK financial system;
Prudential Regulation Authority (PRA), a Bank of England subsidiary – Responsible for the
micro-prudential regulation for the systematically important firms (Banks & Insurers) and
seek to prevent all firms failure & ensure that firms failure do not effect entire financial system;
and
Financial Conduct Authority (FCA) – Responsible for conduct of business regulation across
the financial services industry and prudential regulation of small firms (e.g. Insurance brokers
& IFAs).

APPROACH TO REGULATION
Government introduced different rules from time to time for the
development of financial system e.g. in UK FSA adopts Risk-based
approach and Rules-based approaches to regulation.
Risk-based approach (to its monitoring activities) – FSA
identify the key risks to its objectives (discussed in previous slides)
posed by individual firms, markets and market mechanisms, and
new developments and occurrences.
So, greater the risk to financial system, the higher the priority for
regulatory attention.

APPROACH TO REGULATION
Rules –based and Principles-based regulation
FSA impose prescriptive rules upon insurers for achieving
its aims.
Now FSA regulatory approach has moved towards
Principles-based approach i.e. removal of prescriptive
rules and focus on outcome according to statement of
good practices issued by regulators e.g. FSA.

IMPACT ON THE UNDERWRITING FUNCTION
11 Principles for business by FSA:
• A firm must conduct its business with integrity.
• A firm must conduct its business with due skill, care and diligence.
• A firm must take reasonable care to organize and control its affairs
responsibly and effectively with adequate risk management systems.
• A firm must maintain adequate financial resources.
• A firm must observe proper standards of market conduct.
• A firm must pay due regard to the interests of its customers & treat them
fairly.

• A firm must pay due regard to the information needs of its clients & communicate
information to them in a way which is clear, fair and not misleading.
• A firm must manage conflicts of interest fairly, both between itself and its customers
and between a customer and another client.
• A firm must take reasonable care to ensure the suitability of its advice and
discretionary decisions for any customer who is entitled to rely upon its judgement.
• A firm must arrange adequate protection for clients’ assets when it is responsible for
them.
• A firm must deal with its regulators in an open and co-operative way, and must
disclose to the FSA appropriately anything relating to the firm of which the FSA
would reasonably expect notice.

FSA principles apply to underwriting:
TCF: A firm must pay due regard to the interests of its customers & treat
them fairly.
A firm must pay due regard to the information needs of its clients & communicate
information to them in a way which is clear, fair and not misleading.
A firm must manage conflicts of interest fairly, both between itself and its
customers and between a customer and another client.
A firm must take reasonable care to ensure the suitability of its advice and
discretionary decisions for any customer who is entitled to rely upon its judgement.
Monitoring & Audit: A firm must take reasonable care to organize and control its
affairs responsibly and effectively with adequate risk management systems.
A firm must conduct its business with due skill, care and diligence.
Training & competence: A firm must conduct its business with due skill, care and
diligence.

Treating Customer Fairly (TCF)
FSA require senior management to embed effectively TCF into the firm’s values, culture,
and the way in which it conduct business. TCF must be considered and delivered at
every level. TCF in a competitive marketplace, is important for market share.
Principles relating to integrity, communication (need to be clear, fair and not
misleading), the management of conflicts of interest, and suitability of advice,
need to be addressed by firms.
Important factors:
Poor customer understanding
of financial products
Quality and amount of
documentation
Literacy level Complexity of a product
Numeric understanding Customer focus & priorities

FSA States:
• Product development frequently does not take into account risks to the target
customer.
• Incentivisation of sellers favours volume over suitability or quality.
• Firms need to review the impact of TCF over the entire product life cycle.
• Charging is often not transparent or clear.
• Firms appear to place great reliance on customer loyalty to a firm / adviser.
Customer service standards are set by companies & regularly monitored
because it increases client loyalty.
Customer service policy should be communicated to all staff.

Activity:
OBSERVE A COMPLAINT PROCEDURE OF UTILITY BILLS / CREDIT CARDS.
Honest with customer, provide information and support in every situation .
Underwriter usually have to work within over all corporate objectives therefore
have limitations due to higher management decisions about risk acceptance e.g.
premium charged from young & inexperienced drivers (worse claims experience).
So high premium to young & inexperience drivers results in increase in uninsured
driver and this will negatively affect the society.

Monitoring:
• A firm must conduct its business with due skill, care and diligence.
• A firm must take reasonable care to organise & control its affairs responsibly and
effectively with adequate risk management system.
Organisations (at head office) monitoring reports (e.g. budget reports, reports on
flood / earthquake) are observed and any deviation from the budgets will be reported
to higher management / taking more corrective action e.g. Provision of financial or
physical resources.
At local level, manger will observe their area of responsibility.
In insurance claims frequency and severity is observed for comparison with like
period of insurance.
Similarly, sales data of company staff or sales from intermediaries are also
compared to observe any deviation from profitability, sales etc.

Auditing - People will do what is inspected rather than what is expected.
So, auditing is necessary for the success of businesses.
Firms which demonstrate a higher risk are more likely to receive a visit.
Training and competence - A firm must conduct its business with due
skill, care & diligence. Trained & competent underwriters are key to success.
Training & competence (TC) require regulated firm to ensure:
Its employees are competent and remain
competent for the work they do
Level of competence is appropriate to the
nature of the business
Its employees are appropriately supervised Employees competence is regularly reviewed

CAPITAL AND SOLVENCY REQUIREMENTS
All businesses including insurer need assets (shares in companies, bonds, property, machinery,
materials or cash on deposit with a bank) available in order to satisfy liabilities such as debts the
business incurs. Capital is also used to develop the products, sales campaigns, new
projects, and for unexpected trading losses.
Assets can be purchased from Founder’s own savings, from the loans or the issue of
shares in the company.
Capital – Money raised from Founder’s own savings, from the loans or the issue of
shares in the company for the purchase of assets.
Capital:
• Long term investments - Some part of Capital may be set aside in long term
investments as a buffer against poor trading conditions.
• Working capital – Capital used for acquisition of running costs e.g. Raw material,
pay employees, pay for manufacturers, interest payments on loans.

Insurance is a financial business. Insurers accept the transfer of
risk, therefore, insurance co. product is bearing of risk and the
fulfilment of the liabilities under its contracts when called upon.
Fulfilment of liabilities require capital and assets.
An insurance company should:
• Estimate their liabilities and future income as accurately as possible.
• Need to have a cushion of assets over and above those anticipated
liabilities.
Level of certainty and type of risk will influence the amount of reserves.

Statutory requirements for capital:
Minimum capital requirement (MCR) – MCR is the highest of 2 amounts: A Base Capital
Requirement and General Insurance Capital Requirement (GICR) an amount that has to be
calculated from the volume and type of business
Threshold condition for authorisation – A UK insurer must have capital resources that are
adequate having regard to the size and nature of its business.
Capital resource requirement (CRR – Compulsory by FSA) – is the greater of MCR and a
risk based calculation which results in a higher Enhanced Capital Requirement (ECR).
Individual Capital Assessment (ICA) – Insurer regularly asses their own capital
requirement adequacy.
Individual Capital Guidance (ICG) – Guidance provided by FSA if FSA think that ECR & ICA
is not satisfactory.

Capital requirement and underwriting function
Underwriter’s aim – Business underwritten will make a profit.
Riskier business require more capital and so return on the premium needed to write it is
higher.
Underwriter should know liability claims are complex and take more time to settle than
property claims. Therefore, liability needs more capital to support the insurance business.
Underwriter should observe expected claims while setting premium for underwriting profit.
Underwriter should have the knowledge of the account results.

Management of capital
An insurer’s ability to manage & protect its capital (use of capital) is an indicator of
its strength and reliability.
An insurer must have a clear understanding of:
• How much capital it has at any point in time;
• How much capital it needs to support its targeted volumes of business;
• How much capital it needs to meet both current & future regulatory capital
requirements; and
• What it plans to do in the event of having:
 Too much capital for its planned business volumes;
 Too little capital for its plans (not able to write a considerable volume of
business - Purchase reinsurance to increase capacity or use co-insurance)

PREVENTION OF FINANCIAL CRIME
FSA’s handbook specifies:
• There must be allocation to a senior manger of the specific responsibility for the
establishment and maintenance of effective systems and controls for the money
laundering risk.
• The firm must assess, manage and monitor its money laundering risk systematically,
with suitable documentation.
• A Money Laundering Reporting Officer (MLRO) must be the focus of anti-money
laundering activity in a firm and must be given adequate resources to do the job
effectively.
Bribery Act 2010
Enable courts and prosecutors to respond more effectively to bribery either at
home or abroad.

LEGISLATIVE INFLUENCES
Third Parties (Rights Against Insurers) Act 2010 – deal with liabilities to third parties.
Unfair Contract Terms in Consumer Contracts Regulations 1999 – Apply between a
consumer and a seller or supplier.
Unfair term is one which has not been individually negotiated and which, contrary to the requirement
of good faith, causes a significant imbalance in the parties’ rights and obligations under the contract,
to the detriment of the consumer (not commercial customer).
Key points:
• All terms in such contracts must be in plain intelligible language.
• If an insurer wishes to claim that a term has been individually negotiated, it is the
insurer’s responsibility to demonstrate that fact.
• If a term is found to be unfair, the term will be set aside and the contract will continue to
bind the parties if the contract is capable of being interpreted satisfactorily without the
term in question.

The regulation do not apply:
Contracts (Rights of Third Parties) Act 1999 – Change the rule of
Privity of the contract (A person can only enforce the contract if they are party to
it i.e. a contract for the benefit of other can’t be enforced by the beneficiary) and
now Third party has a right to enforce a term of the contract.
Contract must make express provision for the enforcement or the 3rd party must be
expressly identified in the contract by name, class or description e.g. any driver
clause in motor insurance.
Insurer not willing to use this and so exclude the term stating that the terms of this
legislation do not apply to the insurance contract.
Definition of the main subject matter of the contract
The adequacy of price or value of the money

Data Protection Act 1998 – Regulate data transfer and include information
about private individuals.
Rights of individual under ACT:
People may take action & sue.
An underwriter must ensure that data held:
Is disclosed only to those authorised to have Is accurate and relevant
Access to information about the data;
Ability to prevent data processing that may cause damage or distress
Denying the use for direct marketing & Automatic decision taking.

Compulsory insurance
According to law some type of insurance require that insurers should achieve authorisation
from regulatory authority to transact business e.g. Motor insurance, Employers’ liability (EL)
insurance.
Legislation on insurance:
Road Traffic Act (RTA) 1998 – Individual or business using motor vehicles on road.
Dangerous Wild Animal Act 1976 and Dangerous Dogs Act 1969 .
Riding Establishments Act 1970.
Employers’ liability (Compulsory Insurance) Regulations 1998.
Solicitors (Amendments) Act 1974 and Financial Services And Market Act 2000.
Energy Act 2004 – Liability insurance for operators of nuclear reactor.
Marine pollution liability is compulsory due to various international legislations and
conventions.

Motor insurance
RTA 1998 and other legislations impose a no. of obligations for administrative
process, underwriting and pricing.
Legislation imposed following conditions:
Insurer will have to obtain declaration from the court in order to avoid the motor
policy on the basis of mis-representation or non-disclosure.
Age or physical condition of persons
driving the vehicle
Condition of the vehicle and its Engine
capacity or value
Number of persons that it carries Time at which, or the areas in which, it is used.

Employers’ liability (EL) insurance - Require that adequate funds are available to
meet compensation claims in case of injury to employees.
Motor Insurers’ Bureau (MIB) – Formed after agreement between insurers and
government and a central fund is created to compensate the victims of uninsured
motorist. Handle the 3rd party claims and central fund. All insurers in UK must subscribe
to MIB for transacting business.
Article 75 of MIB memorandum entails that insurers are required to accept liability in
circumstances where they would not be liable under the RTA, including:
• Where the insurance has been obtained by fraud, mis-representation or non-
disclosure of material facts;
• Where cover has been back dated;
• Where the use of vehicle is not covered by the policy.

Social legislation
Insurers are generally free to decide which risks to accept. Legislation derive the
demand for insurance and impose constraints how it is underwritten.
Terrorism, flood, and pollution and unlimited statutory liability for motor insurance are
issues of today.
Disability Discrimination Acts 1995 and 2005 – Make it unlawful that to unfairly
discriminate against disabled people in matters such as employment and the provision of
goods, facilities and services including insurance.
Less favourable treatment is not allowed until supported by the information provided
through risk assessment which include actuarial or statistical data, medical research
information and medical reports about the individuals
Documented underwriting philosophy is beneficial for the insurance company and
its practices.

Disability Discrimination Acts 1995 has given following rights to individuals:
Principles of the Act:
Employment and Buying or renting land or property
Access to goods, facilities & services (including insurance)
Disabled person should be treated as the person with no disability
Employers, providers of the services, property landlords, etc. must be able to
justify discrimination against a disabled person, if & when it occurs

Disability – An individual is disabled if they have a physical or mental impairment
which has a substantial and long term adverse effect on his/her ability to carry out
the following normal day-to-day activities:
Conditions excluded from the ACT:
Mobility and Manual dexterity Physical co - ordination
Speech, hearing or eyesight Continence (Voluntary control of urination etc.)
Ability to lift, carry or otherwise move
everyday objects
Memory, or ability to concentrate, learn or
understand
Addiction to, or dependency on, Alcohol,
nicotine or any other substance (unless
medically prescribed)
Seasonal allergic rhinitis, except where it
aggravates the effect of another impairment
Tendency to set fires or steal or physical /
sexual abuse of others
Exhibitionism and Disfigurement due to
tattoos, body piercing etc. and Voyeurism

Sex discrimination Act 1975 – Prohibits unlawful discrimination on the
grounds of gender unless supported by relevant information (actuarial & statistical data)
e.g. life expectancy (female long life) and lower claims costs for vehicles by women allow
insurer to reduce premium than male. Now due to legislation insurance companies are
not allowed to take into account gender when calculating premium.
Equality Act 2010 – Cover nine characteristics (Protected characteristics):
Age and Disability Marriage and civil partnership
Sex, sexual orientation and
pregnancy and maternity
Gender reassignment and Race,
religion or belief

Types of discrimination (Cont.)
Indirect discrimination – Applies to age, race, religion or belief, sex and sexual
orientation, marriage and civil partnership and now extend to cover disability and gender
reassignment. It can occur when there is a condition, rule, policy or even practice in a
company that applies to everyone but particularly disadvantages people who share a
protected characteristic.
Rehabilitation of Offender Act 1974 – Enable the convicted persons to ‘ wipe the slate
clean’ for the purpose of gaining employment, once a prescribed period elapsed since
the date of conviction, without further conviction. Conviction become spent. Insurer must
ignore the spent conviction for non-disclosure of material fact.
Exempt occupations, for which disclosure remains irrespective of time for
obtaining employment, include: Teachers Social workers
Child-minders Sports coaches Health workers

INTERNATIONAL BUSINESS
Insurance is an international business underwriter should keep in mind senior management
guidelines (strategies) when underwriting business outside the country.
Strategic issues - Strategy will have taken into account:
Practical issues – An insurer which has expanded into other territories may have done so by:
Need to diversify risk more widely and
Profit potential
A desire to support native customers who
trade abroad
Competitive pressures and opportunities
Appointing local agents or representative Using a foreign subsidiary within its own
group or by opening a local branch
Entering a joint venture with another insurer Acquiring a local insurer

INTERNATIONAL BUSINESS
Considerations for transacting international underwriting:
• Local legislation may require to purchase certain insurances from locally authorised
insurer
• Some territories insist on state insurers covering all or a %age of certain type of risks
• Local taxes may be payable e.g. fire brigade tax in Germany
• Exchange control and potential of inflation for level of cover and claims
• Documentation requirement to be produced locally
• Cover issue in local market is not desirable to provide abroad e.g. E. quake, flood

DELEGATED AUTHORITY
Delegated authority rely heavily on a trusted relationship between insurer and intermediary and must
have an effective auditing and monitoring regime.
It has the potential of conflict of interest (insured – intermediary - insurer) to arise if any discretion to
accept business is given to the intermediary.
Binders – Delegated authority schemes give a great deal of flexibility to the intermediary within the
defined limits.
Policy wording is specially negotiated to fit a particular category of client e.g. warehouse keepers,
hoteliers etc. More business to flow in. Profit sharing with intermediary if the results are good.
Managing general agents – Independent or owned by insurer or broker.
A type of delegated authority arrangements whereby MGA organization not only ‘ holds the
underwriting pen ‘ of the insurer, it also undertakes all other activities of an insurer such as marketing,
selling & administration but does not provide funding for claims which remains with insurance
company. Created due to specific expertise in a given sector so profitable for insurer.

CONTRACT CERTAINTY
Def. – Contract certainty is achieved by the complete and final agreement of all
terms between the insured and insurer by the time that they enter into the
contract, with contract documentation provided promptly (within 7 working
days for consumer & 30 days for others) thereafter.
All terms and conditions should be clear and understand by each party of the
contract in order to avoid the dispute. This may cause incorrect estimate of
claims reserving, pricing and allocation of capital.
Contract Certainty Code of Practice – Produced by insurance industry for
general insurance contracts.

Ch 1 & 2 underwriting management

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