A proposal form is the mechanism by which the insurer receives information about risks to be insured. It is completed by the proposer and submitted to the insurer for most classes of insurance. However, there are classes of insurance where the proposal form is not necessary. This is particularly so for corporate fire or marine insurance. The details for fire are so complex to be confined to a proposal form. In these cases, insurers use their own risk surveyors to visit the premises to discuss the risk with the proposer. Brokers play an important part, preparing full details for an insurer. For personal insurance, the form carries both general and specific questions. The forms are simple to understand and easy to complete. For business insurances the information required is greater and is supplemented by additional information provided by the proposer or broker. Every proposal has a declaration that the proposer confirms that the information which has been supplied is true to the best of the proposer’s knowledge and belief.
Once a proposer has completed a proposal, submitted it to an insurer and is accepted, then there is a contract of insurance. A contract of insurance is subject to all laws of contract and it exists whether policy is issued or not. The policy is only evidence of the contract. Components of the policy document are:
i) Heading – It includes the name of the insurer, address and logo.
ii) Preamble – This is the wording at the beginning of each of the policies. It covers the following aspects:-
- The proposal is stated as being the basis of the contract and incorporated in it.
- It also states that premium has been paid or agreement that the insured will pay
- It states that the insurer will provide cover detailed in the policy subject to the terms and conditions.
iii) Signature – Under the preamble or close to it is the signature of an authorized official of the insurer.
iv) Operative Clause – It is the part that outlines the actual cover provided. It begins with “The company will…….” And then states what the company promises.
v) Exceptions or Exclusions – This is the inevitable consequence of having a scheduled policy e.g. war and nuclear risks.
vi) Conditions – they include a condition that the insured will comply with all terms of the policy and procedure in the event of a claim etc.
vii) Policy Schedule – This is where the policy is made personal to the insured. The details specified include; name of the insured, address, nature of business, period of insurance, premiums, sum insured and policy number among others.
The premium which an insured pays represents his contribution to the common pool and thus must reflect the value of risk and the degree of hazard brought to the pool. The premium must be sufficient to:-
- Cover expected claims – the law of large numbers does allow the underwriter to make a reasonably accurate assessment of the likely loss costs.
- Create an estimate for outstanding claims – the premium must take into account those claims still to be settled at the end of the year.
- Provide a reserve – contingencies must be taken into account e.g. provisions for IBNR reserve.
- Meet all expenses – including salaries, office costs, advertising, commission etc.
- Provide for profit – underwriter must ensure provision for reasonable profit.
In arriving at the premium figure a number of commercial considerations must be taken into account.
- Inflation – the cost of settling claims may rise due to the fall in the value of money.
- Interest rate – Since insurers are major investors, variability in interest rates should be incorporated in premium calculation
- Exchange rates – Because of movement of money across national borders, there’s a problem of exchange rate risk which must be taken into account in premium computation.
- Competition – Charging too high a premium may result in loss of business but too little could result in a loss, so a balance is needed.
Life assurance premiums are made up of four components namely:-
- Mortality – is the risk of death, mortality tables are used.
- Expenses – salaries, commission etc.
- Investment – Investments earn substantial income & are taken into account
- Contingencies – Unexpected level of loss.
The premium charged will mostly be a level premium though the risk increases each year as person gets older but this is taken into consideration.
Underwriting includes all the activities necessary to select risks offered to the insurer in such a manner that general company objectives are fulfilled.
In life insurance, underwriting is performed by home or regional office personnel, who scrutinize applications for coverage and make decisions as to whether they will be accepted, and by agents, who produce the applications initially in the field.
In property and liability insurance area, agents can make binding decisions in the field, but these decisions may be subject to post underwriting at higher level because the contracts are cancelable on due notice to the insured.
In life insurance, agents seldom have authority to make binding underwriting decisions.
Objectives of Underwriting
The main objective of underwriting is:
- To see that the applicant will not have a loss experience that is very different from that assumed when the rates were formulated.
- To set up the standards of selection relating to physical and moral hazards especially to help when rates are calculated.
- To ensure that the set standards are observed when risks are accepted.
- To accept risk exposures that will not make the insurer to incur losses, and at the same time not to reject exposures just for the sake of it. I.e. ensure profitable business to the insurer.
Services that aid the Underwriter.
In life insurance, the underwriter is assisted by:
- Medical reports from the physician who examined the applicant.
- By information from agents.
- By an independent report (Inspection report) on the applicant prepared by an outside agency created for that purpose.
- Advise from the company’s own medical advisor.
- Applicant’s credit history as an additional rating factor got from credit reference bureaus.
Part of the work of underwriting department may be most concisely described as policy writing. In property-liability insurance, the agent
- frequently issues the policy to the customer,
- Helps fill out forms provided by the company.
The underwriting department then checks the work of the agent to determine the accuracy of the rates charged, whether a prohibited risk has been taken.
In life insurance, the policy usually is written in a special department whose main task is to issue written contracts in accordance with instructions from the underwriting department.
The underwriting department also keeps a register of the policies underwritten.
Claims and Disputes
- Claims notification is the responsibility of the insured- The insurer will want speedy notification of the claim. This enables the insurer for instance to take statements from witnesses immediately after the accident. A claim is normally intimated by completing a claim form. In life assurance, the insurer needs proper proof of death and wills or assignments is taken into consideration.
- Claims handling – Small brokers may have authority to handle claims although limits will be imposed. A majority of claims are handled in the claims department of the insurer. The insured has to prove the amount of loss e.g. purchase receipt, repair account or valuation. In addition to claims staff of insurance companies, experts could be retained like loss adjusters. The adjusters report covers basic facts about the insured and the loss.
- Claims Settlement – The final stage in the claims procedure is the actual settlement. In life assurance, what is payable is a fixed sum. However for general insurance the eventual costs of the claim will depend on the extent of loss or damage and nature of cover afforded by the policy.
- Disputes – when a dispute does a rise it could revolve around a number of factors. The liability of an insurer to pay a claim, amount to be paid or the speed with which claims are handled. Claims where liability has been admitted must first be referred to arbitration, otherwise to court.
Having accepted a risk the insurer is in much the same position as the insured as pertains to uncertainty. Insurers are not immune to the possibility of larger than expected losses or loses that is more than anticipated. Thus insurers also seek insurance; the insurers insure the risk again, which is called reinsurance.
The reasons why insurers buy reinsurance are:-
- Security – the insurer seeks security and peace of mind.
- Stability – to avoid fluctuation in claim costs from year to year.
- Capacity – the insurer can increase capacity to accept business
- Catastrophes – which could cause financial problems are transferred to reinsures
- Macro benefits – the cost of risk is spread at the market place and the world, the impact of risk does not fall solely on one economy.
Forms of reinsurance
There are two main forms of reinsurance namely facultative and treaty. For facultative, each risk is offered to the reinsurer by the direct office and the reinsurer assesses it and decides whether to accept or not to accept. Treaty is where there is an agreement to the effect that all risks within certain parameters will be offered (ceded) to the reinsures. The reinsure cannot decline the risk and the direct office cannot select which risk to offer and which ones to retain.
The methods of provision of treaty reinsurance can either be by proportional treaties or non-proportional treaties. The arrangements under proportional treaties include:
- Quota share treaty where a fixed proportion of every risk defined in the treaty is reinsured e.g. reinsures 80% of each and every risk.
- Surplus treaty – The direct office decides how much to retain on each risk (retention) e.g. Ksh.20, 000. The direct office then arranges reinsurance measured in lines. A line being equal to the retention. Reinsurance will be multiples of this line e.g. a risk of Ksh.500, 000 is placed with an insurer whose retention is Ksh.20, 000. There are two surplus treaties, a ten line first surplus and a ten line second surplus. The reinsurance arrangement would be as follows:-
Retention – 20,000
First surplus treaty (10 x 20,000) – 200,000
Second surplus treaty (10 x 20,000) – 200,000
Facultative reinsurance 80,000
TOTAL RISK VALUE 500,000
The arrangement under non-proportional treaties include; Excess of loss and stop loss reinsurance.
Functions of Reinsurance
(i) Spreading of Risks
Insurance companies are able to avoid catastrophic losses by passing on a portion of any risk too large to handle. Through excess loss reinsurance arrangements, a company may protect itself against a single occurrence of catastrophic scope. Smaller insurance companies are also able to insure expenses they could not otherwise handle within the line of safety.
(ii) Financial Function
When the premium volume of an insurance company is expanding, the net result will be a drain on the surplus of the company. With a continued expanding premium volume, a company faces a dilemma.
Reinsurance provides a solution to the dilemma. When the direct writing company reinsures a portion of the business it has written under a quota share or surplus line treaty, it pays a proportional share of the premium collected to the re-insurer. The re-insurer then establishes the unearned premium reserves or policy reserves required and the direct writer is relieved of the obligation to maintain such reserves.
Since the direct writer has incurred expenses in acquiring the business, the re-insurer pays the direct writing company a commission for having put the business on the books. The payment of the ceding commission by the re-insurer to the direct writer means that the unearned premium reserves is reduced resulting in an increase in surplus.
(iii) Enlarging Financial Capacity
In normal circumstances a primary insurer often assumes liability for loss in excess of the amount that its financial capacity permits. Instead of accepting only a portion of the risk and thus causing inconvenience to and even will on the part of its customer, the company accepts all the risk, knowing that it can pass on the re-insurer the part that it does not care to bear.
The policyholder is thus spared the necessity of negotiating with many companies and can place insurance with little delay. Using a single policy is therefore more uniform, easier to comprehend and there is an added guarantee of the re-insurer, which makes it safer.
Reinsurance allows the ceding company to have a stable level of profits and underwriting losses than it is to have a higher but unstable level in the long run; thus smoothing out fluctuations that may occur. The ceding company may procure new business as it participates in mutual risk sharing.
For new, small companies, the requirement that a company sets aside premiums received as unearned premium reserves for policyholders may hinder growth. Because no allowance is made in these requirements, for expenses incurred, the insurer must pay for producer’s commissions and for other expenses out of surplus. As the premiums earned during the life of the policy, these amounts are restored to surplus. In this case the firm may not be able to finance some of the business it is offered. Through reinsurance the firm can accept all the business it can obtain and then pass on to the re-insurer part of the liability for loss and with it the loss and unearned premium reserve requirement.