Underwriting: The Gambling Of The Insurance World

Underwriting in the insurance sector is the process of evaluating the level of risk and exposure of any potential clients, to work out if insuring that client could be profitable for the insurer.

Factors such as coverage, cost and eligibility for the insurance are all taken into consideration. It is a bit like placing a bet for insurance firms but is it more of a calculated risk than an outright gamble?

Let’s find out.

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Why Does Underwriting Exist?

The act of underwriting is crucial for insurance firms. It can help them work out which clients they wish to aim their services towards.

If you have ever wondered why your car insurance premiums suddenly increase one year, there is a reason for it. Your provider simply wishes to target a different demographic.

The demographic for car insurance premiums

It could be that you’re a twentysomething single man. When you took out your policy it was your demographic that your insurer wanted on board. Twelve months on and they now realize that twentysomething single men are not as profitable as they anticipated. Now, they want to target women over 50 years old.

Every time an insurance firm carries out the process of underwriting it is taking a risk. It is assessing what is the best approach to offering its services. The end target is for the insurance firm to find the approach to coverage, cost, and target audience that will bring in the most profit.

Failing to find the right approach could result in the firm taking a financial hit.

BBC World Service journalist Tim Harford wisely states, “Legally and culturally, there is a clear distinction between gambling and insurance. Economically the difference is less visible. Both gambler and insurer agree that money will change hands depending on what transpires in some unknowable future.”

The Stats

The logo for the Organization for Economic Co-Operation and Development
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The figures show that underwriting is not so much of a wild gamble as a problem there to be solved.

Members of the OECD (Organization for Economic Co-Operation and Development) reported varying trends in 2016 for their domestic insurance statistics. Proof that as hard as they try to get it right, insurance firms are still not mastering the art of underwriting.

On the positive end of the scale, Lithuania confirmed that it experienced a 21.5% increase in real growth rate. Insurance firms within the country saw premiums hit $600 million.

Other countries such as Spain, Mexico, Chile, and Costa Rica all also reported healthy real growth rates over the year.

The other end of the scale showed how insurance companies in some countries are not fairing quite as well. Finland saw a decrease in its real growth rate of 16.8%. The premiums of insurance firms based within the country recorded figures of $9.9 billion.

Other countries that saw their real growth rate drop included Portugal, Italy, Ecuador, and Australia.

It is interesting to note that generally it was the less-developed countries that saw their real growth rate increase and it was the developed countries that experienced their insurance firms seeing their real growth rate plummet.

Insurance statistics being analysed

The statistics for claims paid in 2016 offer similar results. If an insurance firm has correctly calculated the right approach when underwriting, then the money being paid out on claims should be lower. Unless they are targeting a demographic that is happy to pay a higher premium.

Iceland, Canada, Mexico, Chile, and Estonia saw the percentage of claims paid out increase. Interestingly, Portugal and Ecuador also saw their pay outs on claims rise. Not good news considering their premiums had suffered a sharp fall.

Things That Are Underwritten

An image of the different insurance company logos
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If something can be insured then the underwriter will go through the facts meticulously to work out if it is in the best interests of the insurer to offer a premium and at what cost.

It could be home insurance, car insurance, medical insurance, pet insurance, life insurance, loan insurance, business insurance, or travel insurance.

Every little aspect will be looked into. If you are taking out home insurance then the age of the house, its structure, its location, and utilities will all be analyzed.

Car insurance will cover the model, age, where it is parked, how many miles you drive, and what security it has. Medical and life insurance will look into your health and lifestyle. The same goes for pet insurance, except this will concern your pet instead of you.

Loan insurance will dig through your financial transactions over a period of time with a fine tooth comb.

Whatever you’re insuring, no stone is left unturned.

Can It End in Disaster?

Ransomware attacks on Insurance firms
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Essentially, if an insurance firm gets the underwriting all wrong, they could lose huge profits. One recent factor that has had a huge impact on underwriting is claims being made to insurers due to online hacking.

The recent Ransomware attack in the UK on a number of front line services including the NHS saw a lot of companies and individuals have their data compromised.

Online hacking is something that had never been addressed with underwriting until now. Hacking eventually led to the birth of cyber insurance but it took a big financial hit before insurers realized how badly it was needed.

Is It Really a Gamble?

Underwriting is technically a gamble because nobody can see into the future. However, insurers use underwriting to best position themselves to make profit from clients. The attention to detail is borderline obsessive compulsive.

An image showing the similarity between gambling and insurance
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The insurers will never be able to tell if a client will claim or not but they can do their research to get a better idea of the odds of a claim happening and how much they would need to pay out if such a claim was made. In the same way a betting tipster becomes professional. It is gambling to a degree but they do the leg work to ensure the odds often work in their favour.