Risk and Underwriting
Risk fundamentals
Candidates must distinguish pure risk (only loss or no loss) from speculative risk (gain or loss), and fundamental from particular risk. Understand frequency and severity, and how their combination drives pricing and retention decisions. Know the difference between hazard (a condition increasing the chance of loss) and peril (the cause of loss).
Underwriting process
Underwriting is the selection, classification and pricing of risks. It involves gathering information (proposal forms, surveys, loss histories, credit and sanctions checks), evaluating it against underwriting guidelines, and applying terms, conditions, excesses and exclusions to manage the risk. Moral hazard (dishonesty or carelessness) and morale hazard (indifference to loss) must be identified and mitigated.
Rating and pricing
Know the components of a gross premium: risk premium, expenses, commission, profit margin and contingency loading. Understand burning cost, experience rating, schedule rating and exposure rating for high-value risks.
Traps in questions
- Confusing hazard with peril - a peril is what causes the loss, a hazard makes it more likely.
- Assuming a higher excess always reduces premium proportionally; it reduces small claims, not exposure to large losses.
- Forgetting that adverse selection arises when bad risks buy more cover than good ones.
Worked example
A fleet of 200 vans has 30 claims in three years totalling £450,000. Burning cost = £450,000 ÷ £600,000 premium = 75%. If expenses and profit need 25%, the rate is inadequate and the underwriter must re-rate or impose a larger excess.