The first step of ensuring the solvency and claims-paying ability of the insurance carriers and MGAs in the insurance space is in the process for determining the who, what, when, and, in some ways most importantly, the how much of insurance – the space of underwriters and actuaries.
These two positions are critical to the success of carriers and, overall, the industry, in determining risks, providing the basis of all policies and contracts, and ensuring carrier solvency at a bare minimum. Of course, carrier solvency is supported by many more safeguards and underlying regulations: If you’re interested in reading more about the other cogs in the machine of carrier solvency, check out the rest of our series.
In a big way, though, solvency starts with underwriting (determining particular insurance risk) and actuarial practices (determining widespread insurance risk). Although underwriting is the more public role, we’re going to start with discussing the actuarial role in insurance, since it’s in many ways the first stop of solvency, developing products and policies to insure risks in the first place.
The role of actuaries in insurance
The very foundation of modern insurance is rooted in calculating the chance of a risk happening, generally, in a way that ensures the insurance carrier can spread those risks amongst a pool and be able to collect enough in premiums to:
1. Pay out claims
What’s an actuary?
An actuary is a human calculating machine: people who get degrees in business, accounting, etc., and then study for and pass a series of exams over the course of a decade that verify their knowledge base in advanced mathematics, computation, and analysis. Essentially, it’s a guy named Kevin who spends all day in a button-up shirt buried up to his eyebrows in formulas and tables and is a desperate hobbyist in his free time to counterbalance… jk. But seriously, it takes years to pass actuarial exams, so when we say math nerds on ‘roids, it’s no joke.
Actuaries use massive amounts of data to calculate various risk profiles. A risk profile is like a bucket – people with certain characteristics will fit into a certain bucket and will need to pay a certain cost to compensate whether they have lower or higher risk. To use life insurance as an example, actuaries are the ones who would use mortality and life expectancy tables to calculate the general population’s risk of dying, and would identify characteristics that make people more or less likely to die, and would identify the cost of various levels of coverage.
The goal for insurance actuaries is to figure out what mix of risk and reward will earn enough money to ensure the insurer can pay out claims while also being able to make a profit.
How do actuaries keep the insurance industry solvent?
Actuaries who do their jobs accurately set up insurers for success by identifying trends for the industry ahead of time and help insurers build policies that will both cover the cost of claims and net enough premiums to make a profit. Developing sound policies is the bedrock of insurance – correctly identifying how far to spread risk and when to pull back on certain types of coverage are key to preventing insolvencies in the first place.
When actuaries get it wrong, as in the case of the first generation of long-term care insurance policies, the results can tank an industry. In the case of long-term care insurance, actuarial failure to account for extreme inflation and use increase led insurers to double premiums, and about 80 percent of insurers offering policies dropped out.
Underwriters in the insurance industry
If you think of actuaries as developing policies and generating risk “buckets” at the macro level for an insurer, underwriters are the people at the micro level who agree the insurer can take on a specific contract, like putting an individual consumer in a particular bucket.
To use the life insurance analogy, if actuaries have developed the pricing models and product specifics at different risk profiles, the underwriter is the one who will go through a single person’s information to determine where they fit. In the course of moving from policy to contract, the underwriter is taking responsibility for a bit of that risk. When someone applies for coverage, they’ll go through a discovery process to determine two factors: financial risk and health risk.
What is financial risk underwriting?
Financial risk is whether someone both needs and can afford the coverage. There’s a reason we don’t all walk around with $1 million of life insurance – often basic term life insurance coverage is based on a valuation of your current assets minus debt plus projected income.
That is what underwriting a person’s financial situation covers. If someone can’t afford a certain amount of insurance coverage, it’s likely they don’t have the asset/income situation to warrant that amount of coverage in the first place. Or, as insurance agents tend to put it, “you shouldn’t ever be worth more dead than alive.” Don’t want those insurance policies incentivizing harm to your health.
What is health risk underwriting?
Health risk is the likelihood of needing that life insurance in the first place. In the case of term insurance, it’s more expensive to insure someone the older or less healthy they are, simply because they are statistically more likely to die and trigger an insurance claim.
To draw back to the actuaries, let’s say an actuary decides on four buckets of risk. Insuring someone in Bucket 1 is relatively cheap – they’re the least likely to die in the term period. Bucket 4 is those with high risk. Underwriters then determine where your age, lifestyle, health history, and other risk profile factors put you? An underwriter is the person who will decide in which buckets a 42-year-old motorcyclist, a 34-year-old with chronic arthritis, or 56-year-old jogger belong.
Underwriting and solvency
Underwriters are in the thick of it in gauging the specific risks and potential costs of individual people and businesses. So it’s important for underwriters to be on the same page and be thorough when vetting insurance applicants. On one hand, they need to underwrite enough people to keep premiums flowing into the pool. On the other hand, they’re the first line of defense in making sure there won’t be more claims than the insurer can handle. It’s a tricky line to walk.
The future of underwriters and actuaries in insurance
One common complaint for insurers is the lack of connection between the actuarial and underwriting teams. Too often in the past, these departments were deeply disconnected.
With the rise of digital technology that allows for widespread data collection and more immediate communication than ever, we see these two roles becoming more intertwined. Both are inclined to operate off the same mass of data, although there will still be a need for insurance carriers to have both macro and micro approaches to data use.
Both roles also may see increasing influence from insurtechs and artificial intelligence. That means increased scrutiny of whether their practices protect privacy, and, particularly for underwriters, whether their role exploits vulnerable populations.
When the Affordable Care Act was enacted, the role of healthcare underwriters changed significantly – no longer could insurers use pre-existing conditions as the basis to exclude coverage, nor could they use gender-rating as the basis for a contract cost (i.e., women no longer had to pay higher rates than men).
Some states extend gender-rating bans to other types of insurance such as life insurance or auto insurance. Underwriters and actuaries can both anticipate a changing and more collaborative role states begin eyeing regulation about data use on both macro and micro levels.
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Insurance Underwriting FAQs
What are the qualifications for an insurance actuary?
An insurance actuary is typically someone who has a bachelor’s degree and, on top of that, has completed or is in the process of passing a series of six to nine different actuarial exams, each with a pass rate of 40 to 60 percent. Those in life and health lines of insurance are most frequently members of the Society of Actuaries, while those in property and casualty lines are most frequently associated with the Casualty Actuarial Society. It can take anywhere from four to seven years to become a fully realized actuary.
What are the qualifications for an insurance underwriter?
An underwriter typically needs a bachelor’s degree that includes math and accounting coursework, and may complete additional professional certifications. However, unlike actuaries, underwriters typically get most of their professional experience through on-the-job training.
How can I tell the difference between an underwriter and an actuary?
There’s a math joke in there somewhere, but the serious answer is that an actuary is dealing in theoreticals and an underwriter is dealing in actuals. Consumers will likely never speak to an actuary, but anyone seeking an insurance contract or a risk-based asset like a mortgage loan will speak directly with or be evaluated by an underwriter. An underwriter has to be very thorough in assessing your personal factors to decide whether you, personally, are worth the risk – and at what price – to their insurer or financial institution. Actuaries instead assess things like whether it is worth it for that insurer or financial institution to even offer a policy or mortgage loan at all.