What is 'Underwriting Capacity'

Underwriting capacity is the maximum liability that an insurance company is willing to assume from its underwriting activities. Underwriting capacity represents an insurer’s ability to retain risk.

BREAKING DOWN 'Underwriting Capacity'

An insurance company’s potential for profitability depends on its appetite for risk. The more risk it assumes by underwriting new insurance policies, the more premiums it collects and later invests. When an insurer accepts additional hazards, through the issuance of policies, the possibility increases that it may become insolvent. A company's underwriting capacity, or the maximum amount of acceptable risk, is a crucial component of its operations. 

To protect policyholders, regulators prohibit insurance companies from underwriting an unlimited number of policies. 

Underwriting capacity represents an insurer’s ability to pay for its obligations. Insurance companies determine their underwriting capacity by evaluating many factors. Relevant factors include the insurer’s pricing strategy, the adequacy of its reserves, the types of assets held, and the volatility of its risk pool. Insurers treat the underwriting capacity as a finite number that is drawn against as new policies are underwritten, similar to a line of credit.

How Insurers Increase Underwriting Capacity

Over time, an insurer’s underwriting capacity can change based on how the factors used to calculate its capacity change. An insurance company can increase its underwriting capacity by underwriting policies that cover less volatile risks. As an example, a company may refuse to write new property insurance coverage in a hurricane-prone zone, but will still cover hazards from fire and theft. Limiting the risk of policies written reduces the likelihood that the company will have to pay out claims. 

Insurers are also able to increase underwriting capacity by ceding their obligations to a third party, as with reinsurance treaties. In a reinsurance contract, the reinsurer assumes some of an insurer’s liability in exchange for a fee or a portion of the premiums paid by the policyholder. The liabilities assumed by the reinsurer no longer count against the ceding company's underwriting capacity, which allows the insurer to underwrite new policies.

Using reinsurance does not mean that the insurer can abandon the liabilities it cedes in the reinsurance contract. The ceding company is still ultimately responsible if a claim should occur. In a situation where the reinsurer becomes insolvent, the ceding insurer must pay for claims made against its original underwritten policies. Therefore, it is critical for the insurer to know the financial health of the reinsurer, including the amount of risk that the reinsurer has agreed to take on through other reinsurance contracts.

RELATED TERMS
  1. Gross Line

    The maximum amount of coverage an insurer is willing to underwrite ...
  2. Over-Line

    Insurance coverage that exceeds the amount typically offered ...
  3. Underwriting

    Underwriting is the acceptance of a specific transaction's risk ...
  4. Adjusted Underwriting Profit

    Adjusted underwriting profit is profit an insurance company generates ...
  5. Underwriting Expenses

    Underwriting expenses are costs and expenditures associated with ...
  6. Portfolio Reinsurance

    A type of reinsurance contract in which an insurer has a large ...
Related Articles
  1. Insurance

    Facultative vs. Treaty Reinsurance: Differences and Examples

    Reinsurance companies offer insurance to other insurers in case the traditional insurer does not have enough money to pay claims against its written policies.
  2. Insurance

    The Business Model of Reinsurance Companies

    Learn about the business of reinsurance, a hidden industry that underpins the entire financial and insurance structure around the globe.
  3. Insurance

    What is Underwriting?

    Underwriting is a term most often used in investment banking, insurance and commercial banking. Generally, underwriting means receiving a remuneration for the willingness to pay for or incur ...
  4. Insurance

    Accelerated Underwriting Makes Life Insurance Easy

    A new development called “accelerated underwriting” is making it faster and easier for people to obtain life insurance.
  5. Tech

    The Reinsurance Industry: An Inside Look (BRK.A)

    Warren Buffett has a major influence on the global reinsurance market, which has seen momentum in 2016 for higher revenue.
  6. Insurance

    Third Point Reinsurance Notes Largest Profit in Years

    Third Point Reinsurance saw a tripling of net income in the second quarter of 2016 over last year.
  7. Insurance

    The Reinsurance Industry: An Inside Look

    Low demand and high regulatory pressures may be problematic for the global reinsurance market following the shrinking margins and declining demand of the first half of 2016.
  8. Investing

    5 Reinsurance Stocks To Watch

    Due to the decline in the reinsurance sector, many stocks within the sector are now trading at historic lows relative to book value. For investors, the time may be right to pounce on the values. ...
  9. Tech

    How Big Data Has Changed Insurance

    No longer confined to technology, big data has become integral to providing solutions to the insurance industry's long standing challenges.
RELATED FAQS
  1. Do underwriters make guarantees to sell an entire IPO issue?

    Underwriters do not necessarily make guarantees concerning selling an initial public offering (IPO). Read Answer >>
  2. What does the underwriter do in a new stock offering?

    Learn the role an underwriter plays for an initial public offering, and the steps an underwriter takes in preparing for an ... Read Answer >>
  3. What is real estate underwriting?

    See how underwriters for major lenders scrutinize real estate loans and manage their risk, and learn the origin of the term ... Read Answer >>
Hot Definitions
  1. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  2. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  3. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  4. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  5. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
  6. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.
Trading Center