Underwriting in the insurance world.

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12 Jan 2019, 01:59

The underwriting process is an indispensable part of any insurance business.  Underwriting is the process wherein an individual or an institution undertakes the risk associated with a venture, an investment, or a loan in lieu of a premium. In layman’s term, Underwriting is the process of evaluating whether or not a person or a risk should be insured by a company. Underwriting is the "behind the scenes" work in an insurance company. Insurance companies earn money if they:
  1. Manage an Underwriting Profit,
  2. Control Expenses and
  3. Realize Investment Income.
How Do Insurance Companies Earn Money?
  • Increase underwriting income,
  • Decrease claims and underwriting expenses and
  • Increase investment income.
Underwriting Income (Underwriting Profit) is the profit an insurance company makes from the policies it offers after factoring in the total amount brought in from premiums minus expenses and the cost of resolving claims. If an insurer generates ₹10,00,000 and spends ₹8,50,000 in settling claims and related expenses, then ₹1,50,000  is the underwriting income.

Underwriting profit is the key to success for any insurance company. You can typically judge any insurance operation by their “combined ratio”, which is the standard profitability measure for any insurance company.
Combined Ratio =  (Incurred Losses + Expenses) / Earned Premium

A combined ratio below 100% indicates that the company is making underwriting profit while a ratio over 100% means that a company is paying out more money in claims that it is receiving from premium. However, insurance companies add their investment income and are thus able to arrive at profits at the net level.
A simple example: If a company’s combined ratio is say 113.5%, then that company is paying out ₹113.50 for every ₹100 in premium that it has earned.

Bajaj Allianz General Insurance has emerged as the only non-life company to make underwriting profits among the 22. Bajaj Allianz has substantially improved its combined ratio to 92.3% in FY 17-18 as against 96.8% during the previous year, reaffirming its strong financial health in the Indian insurance industry.

Underwriting cycle or the Insurance cycle is the fluctuation in the insurance business over a period. A typical underwriting cycle spans a number of years, as market conditions for the underwriting business go from boom to bust and back to boom again.

For example, Warren Buffett’s  Berkshire Hathaway’s 14 years run for underwriting profit came to an end in the FY2017 as three big hurricanes hit Texas, Florida and Puerto Rico and wildfires ravaged California. However, the Insurer rebounded in the next 3Q – gaining $1.79 billion of underwriting profit in the first nine months of FY18.

P.S.: How did the word 'Underwriting' come about?
 The term underwriting is believed to have been coined by the famed insurer Lloyd’s of London which, in its early days, would accept some of an event’s risk in exchange for a premium (for example, a sea voyage that features the possibility of a shipwreck and the subsequent loss of cargo and/or even the crewmembers). The individuals paying the premiums would literally write their names under the text describing the possession or event for which Lloyd’s was assuming some risk; hence, the term written under or underwriting.



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