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Ch 1 & 2 underwriting management

Underwriting Management Chapter Slides

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Ch 1 & 2 underwriting management

  1. 1. Chapter 1 REGULATIONS
  2. 2. 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
  3. 3. 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.
  4. 4. 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).
  5. 5. 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).
  6. 6. 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.
  7. 7. 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.
  8. 8. 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.
  9. 9. IMPACT ON THE UNDERWRITING FUNCTION • 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.
  10. 10. IMPACT ON THE UNDERWRITING FUNCTION 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.
  11. 11. IMPACT ON THE UNDERWRITING FUNCTION 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
  12. 12. IMPACT ON THE UNDERWRITING FUNCTION 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.
  13. 13. IMPACT ON THE UNDERWRITING FUNCTION 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.
  14. 14. IMPACT ON THE UNDERWRITING FUNCTION 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.
  15. 15. IMPACT ON THE UNDERWRITING FUNCTION 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
  16. 16. 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.
  17. 17. CAPITAL AND SOLVENCY REQUIREMENTS 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.
  18. 18. CAPITAL AND SOLVENCY REQUIREMENTS 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.
  19. 19. CAPITAL AND SOLVENCY REQUIREMENTS 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.
  20. 20. CAPITAL AND SOLVENCY REQUIREMENTS 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)
  21. 21. 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.
  22. 22. 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.
  23. 23. LEGISLATIVE INFLUENCES 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
  24. 24. LEGISLATIVE INFLUENCES 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.
  25. 25. LEGISLATIVE INFLUENCES 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.
  26. 26. LEGISLATIVE INFLUENCES 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.
  27. 27. LEGISLATIVE INFLUENCES 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.
  28. 28. LEGISLATIVE INFLUENCES 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.
  29. 29. LEGISLATIVE INFLUENCES 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
  30. 30. LEGISLATIVE INFLUENCES 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
  31. 31. LEGISLATIVE INFLUENCES 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
  32. 32. LEGISLATIVE INFLUENCES 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
  33. 33. 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
  34. 34. 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
  35. 35. 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.
  36. 36. 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.

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