7.1 General Risk Selection and Underwriting Evidence

Study Focus

Underwriting selects and classifies risks for appropriate terms and premiums. Proposal information, surveys and records support hazard assessment.

General Underwriting Assessment and Rating Principles

Underwriting is the technical foundation of general insurance. At its core, underwriting is the process by which an insurer evaluates proposals for insurance, decides whether to accept or decline the risk, and determines the equitable terms, conditions, warranties, and premium rates under which coverage will be granted. The word originates from the historical practice at Lloyd's of London, where risk syndicators literally wrote their names and subscribed financial shares underneath the details of a marine voyage.

In modern Malaysian insurance practice governed by Bank Negara Malaysia (BNM) and the Financial Services Act 2013 (FSA 2013), underwriting ensures that the insurer maintains a financially sound, solvent, and well-diversified common pool of risks capable of paying all legitimate claims.

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The Core Objectives of General Underwriting

General insurance underwriters do not seek to avoid all risks; rather, their objective is to curate a profitable, balanced portfolio of insurable exposures. This involves five interconnected functions:

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|                       THE UNDERWRITING PROCESS                           |
|                                                                          |
|  [1. Risk Selection]       --> Avoid adverse anti-selection              |
|            |                                                             |
|  [2. Hazard Assessment]    --> Evaluate physical & moral hazards         |
|            |                                                             |
|  [3. Risk Classification]  --> Group into homogeneous risk classes       |
|            |                                                             |
|  [4. Premium Rating]       --> Calculate equitable, adequate premium     |
|            |                                                             |
|  [5. Terms Imposition]     --> Apply deductibles, warranties & terms     |
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1. Risk Selection and Preventing Adverse Selection

The primary task of the underwriter is to select risks that conform to the insurer's underwriting guidelines and risk appetite. Underwriters must guard vigilantly against adverse selection (anti-selection) — the economic phenomenon whereby individuals or businesses facing above-average risks are more motivated to purchase insurance than those with standard or below-average risks. If an insurer unwittingly accepts a disproportionate volume of high-risk policyholders at standard rates, claims will inevitably outpace collected premiums, jeopardizing solvency.

2. Hazard Assessment

Every proposed risk carries distinct characteristics that affect the probability of a loss occurring (frequency) and the financial magnitude of that loss if it does occur (severity). Underwriters systematically evaluate both the physical environment and the human elements surrounding the risk.

3. Risk Classification

To price risks fairly, underwriters group similar risks into homogeneous categories. Under the principle of equity, each policyholder should pay a premium proportional to the hazard they introduce to the collective pool. Grouping ensures that safe risks do not unduly subsidize reckless risks, while maintaining sufficient volume within each class to satisfy the Law of Large Numbers.

4. Premium Rating

Once a risk is classified, the underwriter establishes the premium rate. In Malaysia, general insurance pricing operates across two regulatory regimes: tariff-rated classes (where minimum rates and structural guidelines are governed by industry agreements approved by BNM, such as parts of the Revised Fire Tariff) and liberalised (de-tariffed) classes (such as Comprehensive Motor and commercial fire packages, where insurers apply actuarial risk-based pricing models).

5. Imposition of Policy Terms, Warranties, and Deductibles

Underwriters rarely evaluate risks on a purely binary accept/reject basis. Many prospective risks that appear uninsurable at standard rates can become acceptable if the underwriter structures customized terms, such as imposing compulsory deductibles, excluding specific vulnerable perils, or requiring technical risk improvement warranties.

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Sources of Underwriting Information

Accurate underwriting depends on the quality, completeness, and timeliness of information regarding the risk. Underwriters gather data from multiple complementary channels:

1. The Proposal Form and Schedule 9 Pre-Contractual Disclosures

The proposal form is the primary legal document submitted by the applicant. It captures essential identification details, the subject matter of insurance, sums insured, location, historical claims, and past insurance history (including whether any other insurer has declined, cancelled, or imposed special terms on the risk).

Under Schedule 9 of the Financial Services Act 2013, the legal duty of disclosure differs between customer categories:

• Consumer Insurance Contracts (contracts entered into by individuals wholly for purposes unrelated to their trade, business or profession): The proposer has a statutory duty to take reasonable care not to make a misrepresentation. The insurer must ask specific, relevant questions on the proposal form, and the consumer is responsible for answering them fully and accurately.
• Non-Consumer Insurance Contracts (commercial, industrial, and corporate policies): The traditional, strict common-law duty of utmost good faith (uberrima fides) applies. Commercial proposers must proactively disclose every material fact that would influence a prudent underwriter in accepting the risk or setting the premium, regardless of whether a specific question was asked on the form.

2. Physical Inspection Surveys

For complex commercial, industrial, or high-value residential risks, underwriters cannot rely solely on the proposal form. An insurance surveyor (in-house or third-party) visits the physical premises to inspect:

• Construction integrity, structural materials, and age of buildings.
• Housekeeping standards, waste management, and storage arrangements.
• Surrounding exposure hazards (proximity to petrol stations, timber yards, or rivers).
• Functionality of security systems, fire alarms, and fire-fighting appliances.

3. Risk Engineering Reports

For large-scale manufacturing facilities, chemical plants, and civil infrastructure, certified risk engineers conduct rigorous scientific analyses. These reports quantify Estimated Maximum Loss (EML) and Maximum Foreseeable Loss (MFL), test industrial pressure vessels, review hazardous chemical handling protocols, and assess structural resistance to windstorms, earthquakes, and flood inundation.

4. Centralised Databases (Insurance Services Malaysia - ISM)

Insurers cross-reference market-wide intelligence via Insurance Services Malaysia (ISM). ISM maintains centralized repositories on motor accident claims, vehicle theft records, total loss registers, and fraudulent claimant profiles. This prevents fraudulent non-disclosure of past claims or simultaneous double insurance.

5. Financial and Credit Intelligence Reports

Underwriters examine corporate financial statements, registered credit ratings (RAM, MARC), and credit reporting agency data (CTOS, CCRIS). A company suffering severe cash-flow deficits, mounting debt defaults, or impending insolvency poses an elevated moral hazard risk of intentional arson, deferred maintenance, or fraudulent claims.

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Physical Hazard vs. Moral Hazard

A hazard is any condition or circumstance that creates, increases, or intensifies the probability or severity of a loss resulting from a peril. Underwriters divide hazards into two distinct categories: physical and moral.

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|                       HAZARD CLASSIFICATION                              |
|                                                                          |
|  PHYSICAL HAZARD: Tangible, measurable, structural conditions            |
|  - Wooden building frames, flammable solvents, overloaded wiring         |
|                                                                          |
|  MORAL HAZARD: Intangible human character, integrity, ethics             |
|  - Fraudulent intent, intentional arson, fabricated claims               |
|                                                                          |
|  MORALE HAZARD: Carelessness, apathy, indifference from being insured    |
|  - Leaving doors unlocked, failing to test fire extinguishers            |
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Physical Hazard

Physical hazards relate to the tangible, observable, and measurable characteristics of the subject matter of insurance, its environment, and its operations. Because physical hazards are objective, they can be inspected, mathematically quantified, and often mitigated through physical alterations.

Moral Hazard

Moral hazard arises from human character, integrity, and ethical conduct. It encompasses the conscious risk that an insured party may deliberately stage a loss, exaggerate damages, or fabricate a claim to profit financially from the insurance contract. A related concept is morale hazard, which denotes unconscious carelessness, negligence, or apathy resulting from the psychological knowledge that an insurance policy will cover any resulting loss (e.g., leaving commercial warehouse doors unlocked at night because "it is insured anyway").

Comparison Across Major Insurance Classes

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