Corporate Finance & Accounting

Underwriting capacity

What is insurability?

Underwriting capacity is the maximum liability an insurance company agrees to assume from its underwriting activities. Underwriting capacity represents the ability of an insurance company to retain risk. It is important for insurance companies to calculate and maintain their underwriting capacity to be able to pay their customers when needed to avoid bankruptcy.

key takeaways

  • Underwriting capacity is the greatest responsibility an insurance company is willing to take from its underwriting activities.
  • When an insurance company accepts additional risk by issuing a policy, its likelihood of bankruptcy increases.
  • The more risk an insurance company takes by underwriting a new policy, the more premiums it can collect and invest later.
  • To protect policyholders, regulators prohibit insurers from underwriting an unlimited number of policies.

Understanding Underwriting Capacity

Underwriting involves assessing the level of risk associated with providing insurance to applicants. As the provider of the policy, the insurance company will work to determine whether it is profitable to provide coverage and then determine the price based on its research. This price is called the premium, and it is charged in exchange for taking the risk of loss for the applicant.

By issuing new policies, the insurer accepts additional risk and increases the likelihood that it could go bankrupt. As unlikely as it may seem, there is always a small chance that too many policyholders will make a claim at one time, forcing insurance companies to pay large sums of money beyond their financial means.

At the same time, the profit potential of an insurance company depends on its risk appetite. The more risk it takes by underwriting new insurance policies, the more premiums it can collect and invest later.

Striking the right balance is critical to maintaining and improving the financial health of insurers. In other words, a company’s underwriting capacity, or maximum acceptable risk, is a critical component of its operations. The profitability of an insurance company depends on the quality of its coverage.

Coverage Requirements

Insurance companies are not free to choose how much risk they are willing to take. To protect policyholders, regulators prohibit insurers from underwriting an unlimited number of policies by limiting their ability to underwrite.

Often, insurers impose tighter restrictions on themselves to avoid the threat of bankruptcy. Applications may be rejected outright if the risk is deemed too high, or if new, specific personal conditions are attached for modification.

Ways to increase coverage

Smart underwriting practices should generate premiums that exceed losses and expenses, thereby increasing the policyholder’s surplus and ability to issue more policies. Listed below are some common methods insurance companies use to protect themselves from overpaying claims and help them build their ability to take on more business.

picky

Insurers can increase their underwriting capacity by underwriting policies with less volatile risks. For example, a company might refuse to take out new property insurance in a hurricane-prone area, but still cover fire and theft hazards. Limiting the risk of a policy reduces the likelihood that a company will have to pay a claim.

load sharing

As with reinsurance treaties, insurers can also increase their underwriting capacity by ceding their obligations to third parties.

In a reinsurance contract, the reinsurer assumes part of the insurer’s liability in exchange for a fee or part of the premium paid by the policyholder. The reinsurance company’s liability is no longer counted in the ceding company’s underwriting capacity, enabling the insurer to underwrite new policies.

special attention items

In the case of shared liability, the use of reinsurance does not mean that the insurer can waive its ceded liability in the reinsurance contract. In the event of a claim, the ceding company still bears the ultimate responsibility.

In the event of insolvency of the reinsurer, the cedent must pay claims against its original underwriting policy. Therefore, the insurer must understand the financial position of the reinsurer, including the amount of risk that the reinsurer agrees to take through other reinsurance contracts.

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