What is Cash Flow Underwriting?
In the insurance business, cash flow underwriting is the equivalent of selling below cost.
How Does Cash Flow Underwriting Work?
For example, let's assume Insurance Company XYZ decides to engage in cash flow underwriting for its auto insurance policies. If it sells a $100,000 auto policy to a customer for $250 per year for 10 years (for total revenue of $2,500) but knows that the person has a terrible driving record and a DUI and is thereby likely to cause the insurer make payouts of much more than $2,500, Company XYZ is engaging in cash flow underwriting.
Why Does Cash Flow Underwriting Matter?
Cash flow underwriting is usually a tactic to drive sales in the short-term. The insurer takes the capital from the increased sales and invests it in places the insurer believes it will earn a high return. The insurer is betting that the higher return will offset the losses down the road. Occasionally, the insurer engages in cash flow underwriting when a client does not qualify for a particular insurance product.