Risk Allocation for an Insurance Company - Term Paper Example

The level of risk of an insurance company is measured by the probability to pay out under an insurance policy that they have issued. Identification of risk factors is very important for an insurance company. Actuary studies the insurance payout history and also identifies the risk factor for each and every insurance policy due to which the insurance company has to pay out. For example: - people who are in their sixties may die in next five years than who are in their twenties (Crews, 2009). According to insurance companies, they need to bear the risk of occupancy like common hazards due to heat and power, special hazards due to flammable hazards in manufacturing industry or hazard caused by smoking habit of an individual.

To protect the insured from those hazards, insurance companies provide some protections like improvement in quality of fire department in municipality to protect the interest of public. To protect any individual or any particular organization, they recommend smoke detectors, fire alarm, watchmen and automatic water sprinkler system. Insurance companies also recommend that a high hazardous business should not set up beside a lower hazardous business. Insurance companies choose their risk based on different criteria like- 1.

Lifestyle 2. Behavioral Risk 3. Occupational Risk. Lifestyle risk defines that insurance companies certainly does not like those people who are engaged with Sky diving, car racing or bungee jumping. Because these activities involve high risk and leads difficulty in getting insurance. Insurance companies have identified some behavioral risks like people who have habit of smoking or chewing tobacco as these habits involve risk towards serious illness. Thus insurance companies choose it as their asset risk.

Insurance companies have identified some occupational risk for which they either charge high premium or don’t want to cover it which includes occupations like explosive handling, law enforcement officers. There are also some insurance companies who are specialized in insurance related to high risk with a high premium rates. The premium helps them to cover cost of risk. Insurance companies choose their liability risk such as conditions for coverage which includes risk related to breach of the contract, damage and duty of the contract.

Generally liability depends on its likeliness to happen and on the product. Underwriting Process in Insurance:- Underwriters are those people who assess the capability of a business enterprise or an individual. Underwriting refers to a specific process which is used by financial service providers like banks, insurance companies, and investment house to analyze the ability of a customer to receive equity share, insurance, mortgage and loan. Purpose of underwriting includes achievement and maintenance of profitability of a business and to reduce the adverse effect of risk.

Underwriting also helps to earn adequate surplus over the cost of production by following the guidelines of underwriting. Insurance underwriters analyze the exposure and risk portfolio of the client to decide that whether the client should get the insurance coverage or not and even if he gets then how much should be the premium and the amount of coverage he should receive. Insurance companies have their own set of guidelines which helps the underwriter to decide how much risk the company should accept.