Underwriting is a crucial process used by many financial institutions. Insurance companies, banks, lenders, and for that matter, any organization can undertake this process which has been explained below.
The process of underwriting is a method of bearing a certain debt, investment, financial service, facility, product, etc., with the help of a person’s or organization’s eligibility. In common terms, it aims at marketing, surveying, assessing, and selling financial products to financially capable subjects (subjects can be companies, individuals, and organizations. In some parts of the world they can also be communities and families).
The origins of underwriting can be traced back to the imperial era of Great Britain. In those times, marine trade and shipping were highly risky processes, and lack of funds played the most crucial role in multiplication and increase in the rates of return.
The merchants, investors, and bankers who financed the voyage, would write down their names and shares below the total risk, that they would be capable of bearing. The pioneering use of this system is often credited to the Lloyd’s of London organization. The amount that was received as a down payment for the risk bearing, was often referred to as the ‘premium’ of the venture.
In the modern era, this term has gained further scope and the process is now used in a number of fields. Prominent financial operations where it is used include mortgage and loans, insurance, and securities.
Overall, it is used to calculate and anticipate risks and returns of a certain loan. Mortgage loan underwriting is a process, where the borrower’s creditworthiness and the ability to make installments on time are analyzed. The borrower’s source of income, income projection, other debts, and credit reports are thoroughly studied. The second aspect of loan underwriting is the property value that’s been financed. The appraisal and decline of real estate which is to be financed, is also studied.
Thus, as a consumer, you must also know that real estate loans, home loans, and auto loans are scrutinized by underwriters, and this is done by taking many factors into consideration. The credit score and report are some of the factors that are analyzed. The main principle of insuring a mortgage, or any other loan, is ascertaining and auditing the returns over the risk, that is borne by the lender. Apart from approval, underwriters also suggest some terms and conditions for the loan and permute a series of interest rates, fees, and fines, in accordance with the person’s income projection.
This process is a bit different, and is often referred to as ‘actuarial science’, where the underwriters use some selected procedures to ascertain the probability of claims. For example, if it’s an auto insurance, then the probability of an occurrence of an accident is determined. Some processes such as life insurance and medical insurance underwriting are complex and involve some complicated medical examinations. Insurance for business involves the study of the market position of the establishment.
As a matter of trivia, marine and business insurance are the earliest policies that were underwritten. The second aspect of insurance policy underwriting is checking the premium rate. This is done on the basis of income and financial performance of the person or organization. Insurance brokers underwrite simpler and inexpensive insurance policies. On the other hand, larger polices such as business and marine insurance are more difficult, and they are scrutinized and underwritten by actuarial firms and insurance companies.
This process in case of securities is a bit different and complicated. It is usually completed by investment banks and private specialist corporate stock underwriters, who act as agents of the company. Modern business organizations raise capital with the help of the general public’s investments. The common man is allotted ‘shares’, which are tradeable in stock exchanges. These shares are a contribution by the common man into the company’s capital, which is referred to as the stock.
Through the security and stock markets, financial instruments such as bonds, general securities, additional shares, and preference shares are issued to the public. The shares and securities of the companies are either sold to the general public, or are tackled by the underwriter himself. The final result is that the composite risk is undertaken by an insurance agent and the company gets the capital on time to start its operations.
There are several other underwriting procedures that are undertaken by banks and financial institutions. These processes, that are conducted throughout any economy, cater to the timely transfer of funds and capital to its productive sources, thereby giving momentum to the economic growth and development.