Assignment-Group 7

Underwriting in
Underwriting inaadetariffed
detariffed
environment
environment
The role of TAC-pre and post
The role of TAC-pre and post
detariffing
detariffing

SUDHANSHU PANDEY FK-1963

PAWAN KUMAR FK-1959

KUMAR BISHWAJEET FN-86

FACULTY
BHUPATI RANJAN DWARI FN-61
MS.JOBY JOY
PUSHPENDRA SINGH FN-71

PRASAD T P FN-105

NAVEEN V PILLAI FN-87

DIPANKAR MALLICK FN-64

 UNDERWRITING IN INSURANCE

In the insurance industry, the practice of underwriting refers to the process of accepting or
rejecting risks. It is the very heart of insurance and is the first step taken by an insurance
company to generate premiums. Originally, insurance and underwriting were synonymous.
That is, underwriting referred to the operation of the insurance business. As the insurance
industry developed, underwriting took on a more specialized meaning.

The word "underwriter" is said to have come from the practice of having each risk-taker
write his or her name under the total amount of risk that he or she was willing to accept at a
specified premium. In a way, this is still true today, as new issues are usually brought to
market by an underwriting syndicate in which each firm takes the responsibility (and risk)
of selling its specific allotment.
Underwriting is the process of choosing who and what the insurance company decides to
insure. This is based on a risk assessment. It is pretty much the "behind the scenes" work in
an insurance company where they determine who is insured and how much in insurance
premiums they will charge the insured person.

UNDERWRITING'S FOUR BASIC FUNCTIONS :-

The process of underwriting involves four basic functions: 1) selection of risks, 2)

classification and rating, 3) policy forms, and 4) retention and reinsurance. By performing
these four functions the underwriter increases the possibility of securing a safe and
profitable distribution of risks.

RISK SELECTION :-

In this step the underwriter decides whether or not to accept a particular risk. It involves
securing factual information from the applicant, evaluating that information, and deciding
on a course of action. The underwriter is typically aided by a list of acceptable and
prohibited risks.
CLASSIFICATION AND RATING :-

Once the risk has been accepted, the underwriter then classifies and rates the policy. Several
tentative classifications are usually assigned before a final decision on classifying the risk is
reached. The purpose of using classifications is to separate risks into homogeneous groups
to which rates can be assigned. Insurers may have their own classification and rating
system, or they may obtain a system from a rating bureau.

POLICY FORMS :-

After determining the acceptability of an applicant and assigning the proper classification
and rating, the underwriter is ready to issue an insurance policy. The underwriter must be
familiar with the different types of policies available as well as be able to modify the form
to fit the needs of the applicant.

The first three underwriting functions—risk selection, classification and rating, and policy
selection—are interdependent. That is, the underwriter determines that a certain risk is
acceptable when specified rates and forms are used. The underwriter also performs a fourth
separate function on every risk before the underwriting is complete: reinsurance.

RETENTION AND REINSURANCE :-

Reinsurance involves protecting the insurance company against a certain portion of

potential losses. Every risk presents the possibility of loss that will equal or exceed the
policy limits. It is up to the underwriter to protect his or her company from undue financial
strain. The underwriter does this by retaining only a certain portion of the risk and securing
reinsurance for the remainder of the risk.
UNDERWRITTING IN DETARIFFED ENVIRONMENT

Underwriting refers to the process that a large financial service provider (bank, insurer,
investment house) uses to assess the eligibility of a customer to receive their products. The
act of removing the pricing regulations of an industry, set forth by tariffs created by a
regulatory body. Detariffing allows an industry to price its goods or services at market
value, as regulation is discontinued to promote market equilibrium. Detariffing removes the
obligation to file these forms, and allows companies to choose what to charge for their
goods. Underwriting involves measuring risk exposure and determining the premium that
needs to be charged to insure that risk. The detariff processes already in place has impacted
the market. However, it should be noted that in removing the pricing cap, the IRDA has
asked insurers to obtain their boards’ approvals on underwriting policies and to ensure that
appropriate pricing mechanisms are in place. The IRDA expects pricing will become more
rational as insurers adopt a “risk-based” pricing approach to determine premiums. Basically,
the rates charged to insured’s should be set at a level that will produce an underwriting
profit. Aside from immediate benefits from this detariff process, clients should understand,
the detariff will most likely lead to an environment where technical underwriting standards
will become more important, an approach supported by the IRDA.

ADVANTAGE OF TARIFFING:-

 Disallows indulgence in unhealthy competition amongst the insurance Cos. Avoid

price war. In the excitement of competition of business procurement, pricing
component is always the first victim. Tariff strictly disallows this.
 While the insured is protected against the risks insured (risks as stipulated by Tariff
only) the risk patterns, perils covered, conditions are all uniformly adopted by all the
Companies and no reckless indulgence by the underwriters can take place. Highly
regulated market conceptually makes it safer for the Insurance companies as well as
for the insuring public.
  However, in view of the uniformity in the rates and the product itself, customer is not
able to dominate the market forces

THE REGULATOR IN A DETARIFF SCENARIO: ROLE OF IRDA

In the context of a predominantly tariffed market keeping in mind the core objectives as
stated, the regulator would need to examine whether moving from tariff to non-tariff rates
and terms are in customer interest, and whether the players in the market are able to roll
over from one to the other in a smooth and effective manner. Detariffed markets can address
issues in innovation, flexibility and tailoring that make insurance more relevant, effective
and capable of meeting customer expectations. The regulatory approaches look to
ascertaining that necessary steps are taken to maintain the safety and soundness of
operations. The new policies and practices adopted for a non-tariff environment must see
that the potential turbulence and volatility that may arise from the roll over, is smoothed.
The other aspect of regulatory intervention is in managing the consumer anxiety that may
arise from the switch to risk based underwriting. This anxiety may arise from perceptions
that insurers may reject proposals on some pretext or other, or due to the fact that
consumers may find a bewildering variety of offerings with the widely differing premium
rates and terms from competing insurers, and that as insurers move away from standard
products, when it comes to claims, insurers may not pay claims fairly.

UNDERWRITING POST 31ST DECEMBER 2006:-

The function of underwriting and rating of insurance business should be independent of

business development function. For operating convenience every insurer requires to have
internal guide tariff for the smaller valued and simple risk. Staff will be trained to guide
them to underwrite and rate risk as per guide tariff. Risk not covered by guide tariff must be
referred to nominated underwriter stated at higher office of the insurer. These underwriters
will be specially trained in evaluating risk, securing write inspection report or risk
evaluation report and underwriting and rating of the risk and determining the terms and
condition of the cover.

The nominated underwriter with the authority to accept or decline risk and to quote rates
and terms will not report to any officer with business development responsibilities but will
report to only senior level officer whose work and performance will be assessed on the basis
of the results of underwriting. There will be a core team of well qualified underwriters who
will do the internal audit of the underwriting efficiency of the nominated underwriters.
Where a nominated underwriter is found wanting in skills he will be further trained. Where
he is found careless or lacking diligence, his authority will be withdrawn. The insurers will
have a risk inspection team within the organization or may use the services of the outside
experts for risk evaluation. These persons will be totally independent of business
development staff and will report to the head of the underwriting function. Good
underwriting has to be freed to enable it to seize the opportunities thrown up by the
economy, so that the risks in the economy are readily addressed for reduction and
protection, the revenues of the insurer are thereby enhanced, in a way that leads to capital
enrichment and expected or superior returns to shareholders. Risk based underwriting
would need supervision that looks at how well the management of the insurer identifies,
measures, controls and monitors risks.

The role of TAC: Pre Detariffing

The era of tariffs

1. The price of an insurance product is linked to the scope of the cover. The tariff
mechanism provides floor rates for various insurance products based on estimates of
average of all losses across insurance companies, average administrative costs including
commissions and average expected profit.

2. In India, the Tariff Advisory Committee (TAC) established under the Insurance
Act 1938 is vested with the functions of administering the rates, terms, advantages and
conditions in the general insurance business which are under tariff.

3. Upto 1972, some data was being received at TAC from the insurers. After nationalization
in 1972, the data flow reduced. Further, there was no system of
dissemination of data to the public. Even the four public sector insurers were not
able to publish consolidated data on each class of insurance. Thus scientific rating became a
casualty. As a result pricing of different classification of risks was done in an ad-hoc
manner. This resulted in cross subsidization among different class of risks and also within a
class the better risks subsidizing the loss making risks.

4. Apart from this, the insurer in a regulated market did not have flexibility in pricing or
innovation of products as they had to adhere to the terms and conditions of the tariff in letter
and spirit. With the standardization of covers, freezing of rates, terms and conditions, there
was little choice available to the insuring public in terms of products and prices. Thus, while
the parameters or risk factors fixed in the tariff were adhered to for rating purposes, new
and emerging risk factors could not be dove-tailed into the tariff for want of data on those
factors. On the customers. side, there was a perception that the better risks were being
charged as much premium if not more than those for the high risk ones. In short there was
no distinction between good risks and bad risks as the same rate applied to all.

Post IRDA Act 1999

5. IRDA Act was enacted with the objective to protect the interests of insurance policy
holders and to regulate, promote and ensure orderly growth of the insurance industry.
Though the benefits of liberalization can be seen with increase in volumes of premium,
there was little innovation in the tariff driven General Insurance business. Even after the
opening up of the insurance sector, the general insurance business was predominantly
governed by the tariffs prescribed by TAC.
6. Considering prevalence of such tariffs against the principles of competition, there was a
constant demand from insurers and other industry experts to abolish the tariffs. However,
sudden removal of tariffs can result in unhealthy price-wars
thereby affecting the solvency of the company itself. It means that there is need for
sustainable growth on scientific lines and enhanced customer satisfaction.

Motor Insurance. The Loss making portfolio in a regulated set up

7. Generally the countries with a tariff regime and with a controlled market tend to have
higher premium than those of the free market. In India, however the situation has been
different. The motor premium rates are among the lowest in the world. The average motor
premium ranges from 2 to 3 per cent of the value of the vehicle as compared to 8 per cent in
western countries. This is due to the absence of data in the Indian market to support a
justifiable pricing mechanism.

8. However, the older insurers, who had a market share of more than 80% were unable to
generate adequate database to enable scientific calculations for risk assessment and rating of
different groups of vehicles. Therefore, underwriting in the transport sector was perceived
to be a losing proposition, with claims well over 120 per cent of the gross premium income.
The net result was that the administered pricing became flawed in the absence of data. For
the same reason, the commercial vehicle operators, users, lobbyists, Government or the
Courts could not be convinced to approve increase in rates even in the wake of deterioration
of claims experience of the insurers.

Evolution of De-tariffing Concept:-

1. In a competitive market, the products need to be priced equitably based on their

individual risk experience which was not practiced due to tariff restrictions. It was alleged
that tariffs were rigid based on out-dated statistical data, and that premium rates were not
revised in response to the market dynamics. It resulted in heavy cross subsidy of premium
for those lines of business which had persistent high claims ratio, for e.g. Motor Third
Party.

2. In other profitable portfolios, tariff rates were higher than rates for similar risks in other
parts of the world. Hence, General insurance companies and other stakeholders in the
insurance market had been voicing the demand for the removal of tariff as the existence of
tariff was considered contrary to free market principles and insurance products need to be
priced based on free market forces.

Reasons for transition to detariff regime

3. Pursuant to liberalization and the entry of private insurers, the motor underwriting
scenario changed drastically. On one hand the private players refrained from underwriting
the loss making areas such as stand alone liability policy and on the other, they clamoured
for detariffing of motor portfolio. They also had in place sophisticated IT set ups and
systems capable of statistical analysis of various risk factors over and above the ones
prescribed by the motor tariff.

4. The awareness among customers in the wake of liberalization also resulted in a

movement towards risk based rating rather than a rigid tariff structure. Representations have
been received by the IRDA that insurers were not willing to offer Mandatory Third Party
Liability cover and that there were loading the own damage policies. The response of the
insurance companies was that the third party liability insurance was not a viable business
without cross subsidizing with the premia from own damage portfolio.

5. The Authority has accordingly considered moving to a tariff free regime in a phased
manner. To begin with, by notification dated 31.10.2002, it constituted a Committee under
the Chairmanship of Justice T.N.C. Rangarajan to examine the various aspects of motor
underwriting including de-tariffing and pooling arrangements.
Road map for a tariff free regime

1. With the intention to ensure that there is an orderly movement from tariff regime to the
future set up, on 23rd September, 2005, IRDA circulated a detailed note to all general
insurers outlining the various steps to be taken by insurers for movement to a tariff-free
market. Considering the existence of tariffs contrary to free-market forces, the road map has
emphasized the need for strengthening internal capabilities of insurers.

2. It has enunciated the various steps to be taken by insurers in the following areas :

i) Underwriting:

The function of underwriting and rating of insurance business should be independent of

business development function and not be made subservient to the business development
function. The underwriters should be specially trained in evaluating risks, securing required
inspection reports or risk evaluation reports, underwriting and rating of the risks and
determining the terms and conditions of cover.

ii) Rating of risks:

Absence of statistical data for rating support is a widespread malady in the general
insurance industry. It is hoped that with the active involvement of the Appointed Actuary in
the process of product design and rating, this deficiency will be minimized. The appointed
actuary in association with senior underwriters of the insurer, will be responsible to list out
the rating factors to be looked at for every sub-class of business and every type of risk. He
will not only be responsible for drawing of internal guide tariffs, but also work with IT
Department to design the system for collection and compilation and analysis of data on
premium and claims by the several risk factors. Such analysis will serve as the technical
input to nominated underwriters.
iii) Policy terms and conditions:

All insurers will continue with the policy terms and conditions as per the existing tariffs for
some more time and thereafter, IRDA will look at the changes from the point of view of the
simplification of the language of the cover, underwriting prudence and technical soundness
of the changes.
However, where the risks are rated based on international market terms, the terms and
conditions that are acceptable to reinsurance market of repute will continue.

iv) Corporate governance:

Every report of the CEO to the Board of Directors on the business development must also
comment on the emerging claims experience of the business and adequacy of the current
underwriting and rating levels. Such reporting needs to be done atleast one every half year.
It has also stressed on the indispensable need towards development of quality database that
is essential for rating of risks based on sophisticated actuarial/statistical analysis and set a
time schedule for implementation of the milestones indicated therein.

3. With the abolition of tariffs, the role of Tariff Advisory Committee will undergo a change
and it will act as a Data Repository for insurance industry.

4. After notifying the road map, the Exposure draft on File & Use guidelines prepared by
IRDA was placed on the website of IRDA seeking comments of insurers and industry for
filing of products, to be filed once de-tariffing takes place. The guidelines were discussed at
length and the responses were consolidated for finalizing of the guidelines.

Final take off

5. Thereafter, vide IRDA Circular Ref. No. 034/IRDA/De-tariff/Dec-06, dated December 4,

2006, the Authority has confirmed withdrawal of tariffs effective from 1st January 2007. It
was reiterated that the tariff general regulations, other than those relating to rating viz.
terms, conditions, clauses, warranties, policy wordings etc. shall continue to be followed
until further orders.

6. In case of the mandatory motor TP, where the insurers have been expressing difficulty to
underwrite unless they are permitted to charge the premium that they consider appropriate
(which means heavy premium in commensuration with high claim ratios of motor
portfolios) rates are prescribed by regulator. The Authority has issued an Order directing
insurers that they shall not refuse cover for third party risks. The underlying reason for
existence of price regulation is consumer pressure to avoid enhancement of premium and to
ensure that insurers shall provide motor third party liability insurance cover to all vehicles.

Formation of Motor Third Party Insurance Pool

7. A direction under Sec. 34 of the Insurance Act was issued by IRDA stating that all
general insurers registered to carry on general insurance business including motor insurance
business or general reinsurance business shall collectively participate in a pooling
arrangement with the following provisions to share in all motor third party business written
by any of the registered general insurers:

a). Participation in pooling arrangement: Every insurer registered to carry on general

insurance business (including motor insurance business) or general reinsurance business
shall automatically participate in the pooling arrangement to the extent set out herein.

b). Underwriting insurers: Every underwriting office of every insurer that is authorized to
underwrite motor insurance business for the insurer shall also be authorized to underwrite
motor third party insurance business that will be shared among all insurers through the
pooling arrangement.
c). Pooling mechanism: The pooling of business among all insurers will be achieved
through a multi-lateral reinsurance arrangement between the underwriting insurer and all
the other registered insurers carrying on general insurance business (including motor
insurance business) and general insurance reinsurers.

d). Participation in motor third party insurance pooled business: The participation of
General Insurance Corporation of India (GIC) in the Pooled business shall be such
percentage of the motor business that is ceded to it by all insurers as statutory reinsurance
cessions under Sec 101A of the Insurance Act. The business remaining after such cession to
GIC shall be shared among all the registered general insurers writing motor insurance
business in proportion to the gross direct general insurance premium in all classes of
general insurance underwritten by them in that financial year.

e). Underwriting of business: Underwriting offices of insurers shall follow the

underwriting instructions of the General Insurance Council in the matter of procedures for
underwriting and documentation and accounting and settlement of balances. The business
shall be underwritten at rates and terms and conditions of cover as notified by the Authority
from time to time. No vehicle owner shall be denied third party insurance cover in respect
of his vehicle which is holding a valid permit for use on public roads except on grounds of
attempted fraud.

f). Claims processing and settlement: All claims in respect of third party death or injury or
physical damage shall be processed for settlement in a speedy and efficient manner in
accordance with the instructions of the General Insurance Council. For this purpose, the
Council shall adopt a pro-active claims settlement policy adopting the most efficient claims
processing practices possible.

g). Administration of the Pooling arrangement: The GIC shall act as the administrator of
the pooling arrangement. It will act under the guidance of the General Insurance Council.
For this purpose, the Council may establish such Committees of insurers as are necessary to
operate the Pooling arrangement and process and settle claims in the most efficient manner.

h). Remuneration: There will be no agency commission or brokerage payable in respect of

motor third party insurance business. The underwriting insurer will be paid a reinsurance
commission of 10% on the premium ceded by it to all the other insurers and reinsurers. The
GIC as administrator shall be paid a fee of 2.5% of the total premium on motor third party
insurance business in respect of the business underwritten for the pooled account. Each
insurer shall bear the cost of hardware required to operate the pooling arrangement within
its offices. The GIC will bear the cost of hardware necessary to administer the pooling
arrangement in its offices. The cost of the operating software for the pooling arrangement
shall be shared by all the insurers and reinsurers in the manner decided by the General
Insurance Council. Each insurer shall bear the cost of travel of its executives to attend to the
work relating to the pooling arrangement. However, any travel specifically to service a
claim shall be recoverable as claims related expenses.

i). Agreement: The insurers and GIC shall enter into a multi-lateral reinsurance
arrangement to give effect to this pooling scheme.

j). Review: The Authority will review the operation of the pooling arrangement and the
need for regulation of the premium rates and terms of cover and will issue such directions
from time to time as may be considered necessary.

It is the responsibility of the CEO or any other senior officer designated for the purpose of
the compliance of the File & Use guidelines. However, the insurer shall also appoint a
senior as Compliance officer to ensure compliance with the requirements of the File & Use
guidelines.
Role of TAC

With the abolition of tariffs, the role of Tariff Advisory Committee will undergo a change.
It is expected that TAC may perform the following functions in the changed scenario:-
- Collection of data on premiums and claims, analysis of such data and dissemination of the
results to the insurers.
- Report to IRDA on the underwriting health of the market and any aberrations in market
behaviour.
- Constitution of Expert Groups at the request of the General Insurance Council, to look into
underwriting issues and recommend necessary action.
- Organize training to underwriters at the market level
- Attend to public grievances on non-availability of insurance and try to resolve the issues
by discussion with insurers.

TAC May Become Data Provider After De-tariffing:-

The Tariff Advisory Committee (TAC), a body primarily meant for monitoring the tariff
and premium of various products in the general insurance sector, may be turned into a
central data organization after de-tariffing takes place in 2005.

IRDA has said that monitoring the tariff in a liberalized market has no meaning and
justification.

The general insurance sector has already seen a 12 per cent growth in the current financial
year as against 20 per cent in 2002-03. The total market of the segment is estimated at Rs
14,000 cr. at present.

De-tariffing is important to bring in a level-playing field among the various players in the
general insurance market. Meanwhile, the government has initiated the voluntary retirement
scheme (VRS) for the four general insurance PSUs namely New India Assurance, National
Insurance, Oriental Insurance and United India Insurance.
Attention of insurers is invited to Section 64 UC of the Insurance Act, 1938, which
authorizes TAC to control and regulate “any risk” or “class or category of risks”... “Which,
in its opinion, it is proper to control and regulate”. Attention is also invited to Section 14 (2)
of the IRDA Act, 1999 which authorizes the IRDA to control and regulate general insurance
business “not so controlled and regulated by the Tariff Advisory Committee”.

In the context of the proposed detariffing of the general insurance products, the need for
data for both the insurer and the Regulator has become more pronounced than ever.
Authentic and error free data has to flow consistently to a national data repository. The
varied requirements of data by the Regulator, the insurers and industry and the consumers
have to emanate from this repository with due aggregations. The confidentiality of the data
has to be protected and the sensitivities associated with a competitive market are to be
respected.

In this context, insurers attention is also invited to Section 64 UE of the Insurance Act,
1938, which inter-alia, authorizes Tariff Advisory Committee to require and collect
information, etc. The data repository work has already commenced at TAC focusing
initially on the motor and health insurance segments and the results so far are encouraging.

The Authority, therefore, reiterates that TAC will continue to collect data from all insurers
in respect of all branches of business in the tariff-free regime. The Authority also wishes to
clarify that in the tariff-free scenario also, the TAC continues to be empowered to collect
data from the insurers and take such actions including imposition of penalties in consonance
with the Act provisions to ensure timely and error free submission of data. It would be
imperative for all insurers / reinsurers to provide to TAC the requisitioned data in the mode,
manner and periodicity prescribed by TAC. All directives and correspondence in this regard
will emanate from TAC, which will be the custodian and manager of the data of the
insurance industry.