Risk Management in Banking and Insurance · Managing Risk in Insurance Business

Underwriting Risk and Risk Selection in Insurance

Updated 11 October 2026 · Fact-checked

Underwriting is how an insurer decides which risks to accept, on what terms and at what premium. It protects the insurer against adverse selection and moral hazard. To answer exam questions: identify the risk, classify it, apply guidelines, rate the premium, set terms, then monitor and reinsure the excess.

Understand Underwriting Risk and Risk Selection

An insurer sells a promise to pay future losses for a premium paid today. If it accepts the wrong risks, or prices them too low, claims will exceed premiums. Underwriting is the process that prevents this. It means examining each proposal, deciding whether to accept it, and fixing the price and terms.

Risk selection is the first half of underwriting. The underwriter collects information from the proposal form, medical reports, survey reports, claim history and the intermediary. Risks are then classified into groups with similar expected loss, for example standard lives, substandard lives, or fire risks by construction and occupancy. Some risks are declined.

Adverse selection happens when people with a higher chance of loss are more keen to buy cover than average people, because they know their own risk better than the insurer does. A person with a heart condition buying a large life policy is an example. If the insurer charges everyone the same, the good risks leave and the pool worsens. Underwriting fights this through questions, medical tests, waiting periods and loadings.

Moral hazard is the risk that the insured behaves differently, or dishonestly, because they are covered. It can be a deliberate act, such as overstating a claim or setting a fire. Morale hazard is carelessness, such as not locking a shop because it is insured. Insurers control it through deductibles, co-payment, sum insured limits, claim investigation and the principle of utmost good faith.

Pricing is the second half. Premium rating starts from the expected claims cost for a class of risk and adds loadings for expenses, contingencies, reinsurance cost and profit. Risks worse than standard get an extra premium, a higher excess, restricted cover or exclusions. Good risks may get discounts. Rates must be adequate, not excessive and not unfairly discriminatory between similar risks.

Underwriting also links to law. Under Section 64VB of the Insurance Act, 1938, an insurer cannot assume risk until the premium is received or guaranteed in the prescribed manner, or a prescribed deposit is made. Under Section 101A, an insurer must reinsure with Indian re-insurers a percentage of the sum assured on each general insurance policy, as specified by the Authority with the Central Government's previous approval.

Key rules to remember

Gross premium build-up: Gross premium = Pure (risk) premium + Expense loading + Contingency margin + Profit margin; Pure premium is expected claim cost per unit of risk. Loadings vary by insurer and class.
Pure premium: Pure premium = Probability of loss × Expected loss amount; Use for a simple expected-claims calculation per policy.
Loss ratio: Loss ratio = Incurred claims ÷ Earned premium × 100; Checks whether underwriting and pricing are adequate.
Rating by extra mortality (substandard): Extra premium = Standard premium × (Rating % ÷ 100); A rating of 50% means 50% added to the standard premium.
Section 64VB(1) rule: No risk assumed until premium is received, guaranteed as prescribed, or prescribed deposit made in advance; Applies to business where premium is not ordinarily payable outside India. Sub-section (2): where premium can be ascertained in advance, risk may be assumed not earlier than the date premium is paid in cash or by cheque.
Section 101A cap: Percentage of sum assured to be reinsured with Indian re-insurers ≤ 30% of sum assured on the policy; Specified by notification, may differ by class of insurance. The insurer may reinsure more than this percentage voluntarily.

How to solve Underwriting Risk and Risk Selection questions

Use this sequence for descriptive and case-based questions on underwriting and risk selection.

1Identify the risk and the type of insurance (life, health, fire, motor, marine). Note what the case tells you about the proposer.
2Name the hazard: adverse selection (hidden higher risk before the contract) or moral hazard (changed behaviour or dishonesty after cover). Use the case facts as evidence.
3Classify the risk: standard, substandard (rate up), preferred (discount) or decline. Give the reason for the class.
4Apply underwriting tools: proposal form, medical or survey report, claim history, waiting period, deductible, co-payment, exclusions, sum insured limit.
5Price the risk: start from pure premium, add loadings, then add any extra rating for the substandard risk. Show the arithmetic.
6Check legal and structural points: premium in advance under Section 64VB, and reinsurance of the excess or the compulsory share under Section 101A.
7State a clear recommendation: accept, accept with terms, or decline, with the reason and the control that remains.

Quickest way: Hazard-Class-Price-Protect

When to use it: Use for 2-mark MCQs and short case scenarios where you have under two minutes.

Spot the information gap. Hidden before the contract means adverse selection. Behaviour change after cover means moral hazard.
Match the control: questions, tests, waiting periods and loadings fix adverse selection. Deductibles, co-payment and investigation fix moral hazard.
If numbers are given, compute pure premium or add the loading percentage to the standard premium.
If law is mentioned, recall: 64VB means no premium, no risk; 101A cap is 30% of sum assured.
Eliminate options that mix up the two hazards or overstate the law.

Common mistakes in Underwriting Risk and Risk Selection

Treating adverse selection and moral hazard as the same thing.
Both involve the insured knowing more than the insurer.
Fix: Adverse selection is before the contract (who buys). Moral hazard is after the contract (how the insured behaves).
Saying a deductible solves adverse selection.
Deductibles are strongly linked to risk control in students' notes.
Fix: A deductible mainly reduces moral hazard by keeping the insured's money at stake. Adverse selection is handled through underwriting information, waiting periods and risk-based pricing.
Adding the rating percentage to the wrong base, or forgetting to add it.
Students confuse a 50% rating with a 50% discount, or apply it to the sum assured.
Fix: Extra premium = standard premium × rating %. Gross premium for the substandard risk = standard premium + extra premium.
Saying the insurer can assume risk before receiving premium under Section 64VB.
Students remember the exceptions but forget the main rule.
Fix: State the rule first: no risk is assumed until premium is received, guaranteed as prescribed, or a prescribed deposit is made. Then mention that the Central Government can relax it for categories by rules.
Writing that 30% reinsurance under Section 101A is a fixed rate.
The cap is remembered as the rate.
Fix: The Authority specifies the percentage, and it can differ by class. No specified percentage can exceed 30% of the sum assured on the policy.
Giving a generic answer without a recommendation.
Students recall theory but do not apply it to the case.
Fix: End every case answer with accept, accept with conditions or decline, and tie it to the facts given.

Worked examples

Example 1

A general insurer sells shop fire policies at a standard rate of ₹2 per ₹1,000 of sum insured. A cloth shop in Surat with a sum insured of ₹50,00,000 has a godown storing inflammable synthetic material and no fire extinguishers. The underwriter rates the risk at 60% above standard. (a) Compute the premium. (b) Identify the hazard and suggest underwriting controls.

Show the solution

Standard premium = ₹50,00,000 ÷ 1,000 × ₹2 = 5,000 × 2 = ₹10,000.
Extra premium = 60% of ₹10,000 = ₹6,000.
Total premium = ₹10,000 + ₹6,000 = ₹16,000.
The inflammable stock and missing extinguishers raise the chance and size of loss. This is a physical hazard.
Controls: survey before acceptance; condition requiring extinguishers to be installed; higher deductible; accept the cover only after the condition is met.

Answer: Premium is ₹16,000 (standard ₹10,000 plus ₹6,000 loading). The risk is substandard because of physical hazard. Accept with higher rating, risk-improvement conditions and a higher deductible.

Example 2

A health insurer notices that, after launching a policy with no waiting period and no co-payment, many proposers disclosed pre-existing heart ailments and claims came soon after issue. Explain the problem and how underwriting should respond.

Show the solution

Proposers who know they are high risk are more likely to buy. This is adverse selection, and it pushes claims above the priced level.
Where insured persons use hospitals more because treatment is paid for, that is moral hazard. The case also hints at this through early claims.
Underwriting response for adverse selection: detailed proposal form, medical examination for higher ages or sums, waiting period for pre-existing conditions, and loading or exclusion for declared ailments.
Response for moral hazard: co-payment, sub-limits, pre-authorisation and claim review.
Recheck pricing by loss ratio. If incurred claims ÷ earned premium is above the priced level, revise rates for the class.
Recommendation: relaunch with waiting periods, medical screening and co-payment, and reprice the portfolio.

Answer: The main issue is adverse selection, with some moral hazard. The insurer should use disclosure, medical screening, waiting periods, exclusions or loadings, co-payment and claim controls, and reprice based on the loss ratio.

Exam tips

Learn one-line definitions for adverse selection and moral hazard, plus one insurance example each. MCQs often swap them.
In case questions, quote facts from the scenario as evidence for the hazard before you name the control.
For Section 64VB and 101A, state the rule in plain words and mention the exact limit (30% of sum assured). Do not quote section details you are unsure of.
When a rating or loading is given, show the base, the percentage and the final premium. Marks go for the working.
End descriptive answers with a decision: accept, accept with terms or decline.

Practice questions from Managing Risk in Insurance Business

Underwriting Risk and Risk Selection in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Underwriting Risk and Risk Selection: frequently asked questions

What is the difference between adverse selection and moral hazard?

Adverse selection arises before the contract, when higher-risk people are more likely to buy cover and hide their risk. Moral hazard arises after the contract, when the insured takes less care or acts dishonestly because loss is covered. Different controls apply to each.

How does underwriting manage risk in an insurance company?

It selects acceptable risks, classifies them by level of risk and prices them with suitable loadings or discounts. It also sets terms such as exclusions, waiting periods and deductibles, and arranges reinsurance for large exposures. This keeps claims in line with premiums.

What does Section 64VB of the Insurance Act, 1938 say?

An insurer cannot assume risk until the premium is received, guaranteed to be paid as prescribed, or a prescribed deposit is made in advance. Where premium can be ascertained in advance, risk may be assumed not earlier than the date premium is paid in cash or by cheque. The Central Government may relax this for particular categories by rules.

What is the limit on compulsory reinsurance under Section 101A?

Every insurer must reinsure with Indian re-insurers the percentage of the sum assured on each policy specified under the section. No specified percentage can exceed 30% of the sum assured. The insurer may still reinsure more with any Indian re-insurer or other insurer.