UPDATED: Mar 13, 2020
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In simple terms, underwriting is the process by which an insurer decides to accept a risk and issue an insurance policy or to reject that risk and decline to offer coverage. It’s an important task for insurers to manage their approach to risk carefully – if they take on too much risk for too little return then they may find themselves unable to pay on claims made under the policies they have issued and this will result in insolvency, that’s not in the interest of the insured party or the insurance company.
How are insurance policies underwritten in the United States?
Insurance policies are underwritten by an insurance underwriter. An insurance underwriter’s job is to assess all the information regarding an application for an insurance policy or group of policies and determine the exact level of risk exposure that the insurer would face by issuing those policies.
They’ll collect as much data as possible from credit history to information about the age or sex of policyholders, to any other important information that may increase the risk under a policy. They will then compare this data to data that the insurance company already holds on policies it has previously issued and possibly to actuarial tables of risk that display general trends across a wider group of insured parties in similar circumstances.
The underwriter will then be able to determine what precise risk the insured party presents for an insurer and be able to determine the appropriate premium at which to provide coverage or in the event that a claim is deemed to be too likely for the levels of available premium they will instruct the insurer to decline coverage to the individual who was being assessed.
Underwriting is a standard part of an insurance company’s day to day activities. It is an essential part of the financial management of an insurer, determining whether a risk is worth taking or not means that an insurance company can properly balance their risk exposure against the premiums they collect. The purpose of an insurance company is to make money, as it is with all businesses, and it’s important that an insurance company manages risk in order to make money and to prevent insolvency. In the case of insolvency, policyholders may face increased levels of individual liability if the insurer cannot make payment in the event of a claim.