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Insurance is a contract between insured and the insurer to cover a specific risk. There are basically two broad categories of risks; speculative risk, a risk which leads to a profit or a loss or a no change situation and pure risk, a risk which leads to a loss or a no change situation. Insurance basically covers pure risks, be in life or general. Insurance companies now a day’s undertake a process to classify risks into different categories depending on the intensity or probability of the occurrence of the risk covered. Insurance as we all know is a subject matter of solicitation .i.e. one should seek for it and it should not be sold. So the person who wishes to insure his life or his property must submit a proposal in the form of application form to the insurance company from which he wants insurance. The insurance companies then scrutinize these proposals and decide what premium needs to be charged based on the category of risk it falls into. This process of classification is called as underwriting process. This is based on the underwriting standards of an insurance company.
There are basically four categories in which the risk to be covered in the proposal are classified into :
This is a perfect situation as in the premium charged is very nominal. An example would be a life aged 35yrs of age with no ailments seeking for a whole life policy. Any insurance company will accept this policy proposal.
This is slightly riskier than preferred risk category; insurance companies will accept these kinds of proposals for a higher premium.
This is in the high risk zone category only as per the insurance companies standards however; they accept the proposal for very high premium amounts. Say for example a person aged 45yrs of age who is a diabetic for the past 5 years and a BP patient for last 10 years and also has heart problem.
This is the category of risk which the insurance companies will not accept at all. Based on the category the proposal falls into decision as to the acceptance and premium is taken by insurance companies. All insurance companies have their own hired expertise to do the underwriting work. Underwriting plays a crucial role in insurance business because any error in the classification of these risks might lead to losses to the company. Now a day’s re-insurance companies have started involving themselves in the underwriting process of other insurance companies to be assured of the kind of risks they are accepting from these companies.