Underwriters, Underwriter functions

As can be understood from the above anecdote, an underwriter is someone who assumes the risk of another party. In reciprocation of their services, they receive a fee, called a premium, commission, interest, or spread, depending on the industry.

Similarly, based on the industry, an underwriter also performs an array of job roles. Underwriters usually work for organisations involved in mortgage loans, insurance policies, equities, and debts. The essential point to the underwriter meaning across industries is that they analyse and assume risks of customers against a specific payment.

An underwriter is any party, usually a member of a financial organization that evaluates and assumes another party’s risk in mortgages, insurance, loans, or investments for a fee in the form of a commission, premium, spread, or interest.

Agents and brokers represent both consumers and insurance companies, while underwriters work for insurance companies.

Underwriters play a critical role in many industries in the financial world, including the mortgage industry, the insurance industry, equity markets, and some common types of debt security trading. An individual in the position of a lead underwriter is sometimes called a book runner.

Modern-day underwriters play a variety of roles depending on the industry in which they work. In general, underwriters are tasked with determining the level of risk involved in a transaction or other kind of business decision. Risk is the likelihood that an outcome or investment’s actual gains will differ from an expected outcome or return.

Investors rely on underwriters because they determine if a business risk is worth taking. Underwriters also contribute to sales-type activities; for example, in an initial public offering (IPO), the underwriter might purchase the entire IPO issue and sell it to investors. An IPO is a process whereby a previously privately owned company sells its shares on a public stock exchange for the first time.

History of Underwriters

The term “underwriter” first emerged in the early days of marine insurance. Shipowners sought insurance for a ship and its cargo to protect them if the boat and its contents were lost. Shipowners would prepare a document that described their ship and its contents, crew, and destination.

An agreed-upon rate and terms were set out in the paper. Businesspeople who wished to assume some obligation or risk would sign their name at the bottom and indicate how much exposure they were willing to accept. These businesspeople became known as underwriters.

Underwriters possess specialised knowledge concerning the intricacies of industries they function in. They apply this knowledge to assess and evaluate the risks involved in a transaction or business decision. Based on their understanding, they either accept that risk or deny it, whatever works to the benefit of such organisation which they represent.

Insurance Underwriter

Insurance underwriters asses the risk of insuring a home, car or driver. They also assess individuals who are applying for life insurance policies. Insurance underwriters determine if the contract is profitable for the insurer. They consider if the applicant meets certain criteria to qualify for an insurance policy. From there, they establish the type of policy for which an applicant is eligible. Finally, they provide an outline of what the policy covers for the applicant’s unique circumstances.

Insurance underwriters are insurance professionals. They understand insurance risks and how to avoid them. They use their risk assessment to decide if they will insure someone and under what terms they’ll provide a policy.

In cases without special circumstances, underwriting is done through an automated system. Underwriting programming is similar to a quoting system. It’s able to determine if an applicant meets the insurer’s specific requirements for coverage.

Equity underwriters

In general, the job role of an equity underwriter dictates overseeing the issuance and distribution of stocks on behalf of companies. But, perhaps it is most pronounced in the IPO stage.

When companies are going from private to public, they need to determine at what price they will issue such shares. This is where an underwriter comes into play. Companies approach investment banks in regards to the Initial Public Offering.

While investment banks at large ensure regulatory compliance, their underwriters in specific oversee the task of analysing the demand of such stocks. Therein, they contact different institutional investors, like insurance companies and mutual funds, to evaluate a company’s IPO market demand.

Standing on those findings, underwriters determine IPO prices for different organisations. Additionally, they also guarantee the purchase of a specific number of shares. In case they do not sell as per guaranteed, underwriters cover that risk, which is such deviance in estimation.

Mortgage underwriters

The acceptance or rejection of mortgage loan application hinges on this category of underwriters. Much similar to its insurance counterpart, mortgage underwriters review applications to reckon the risk involved.

They primarily assess an applicant’s repayment history, exposure to credit, debt-to-income ratio, etc. They also evaluate such pledged asset’s value to determine whether it’s sufficient to cover losses in the event of default.

Thus, a mortgage underwriter’s say in the matter of approval is ultimate. Underwriters also play a crucial role in determining interest rates, both for secured and unsecured loans.

Debt security underwriters

These underwriters buy debt instruments, like corporate bonds, municipal bonds, etc. from the issuing body and sell them to other entities at a profit. This profit is called the spread. Such individuals can sell debt securities directly or via dealers. In some cases, a group of underwriters are involved in executing the whole process, called underwriter syndicate.

	Underwriter	Brokers/Agents
	They assess, evaluate, and assume risk on behalf of other parties.	They act as portals between customers and organisations.
Authority	They hold the final say on whether to assume risk or not.	They submit applications from clients but have no significant weight on the matter of approval or rejection.
Scope of functioning	These individuals solely represent the interests of the company they work for.	These entities represent the interests of both the customer and their employers.

Functions of a Broker in Underwriting:

Broker is a person who helps in subscribing the shares. A broker is one who finds buyers for the shares or debentures of the company and gets the brokerage on the number of shares or debentures subscribed by the public through him. Underwriter is different from a broker. An underwriter is a person who agrees to take a specified number of shares or debentures, in case, not subscribed by the public.

That is, an underwriter is liable to take up shares in case the public fails to subscribe whereas a broker is not liable. Underwriter gets underwriting commission and a broker gets brokerage. Underwriter gives a guarantee whereas a broker does the service of placing the shares.

Thus, the function of an underwriter is of great economic significance since he himself assumes the risk of uncertainty on behalf of the company making public issue of shares or debentures. A broker, on the other hand, does not assume any such risk. Underwriting acts as a sort of insurance or guarantee against the danger of not receiving minimum subscription.

Sub Underwriting:

An underwriter may himself enter into a sub-agreement with other persons, called sub- underwriters, whereby he transfers a part of his underwriting risk. Just like re-insurance, sub- underwriting helps in spreading the risk. An underwriter may appoint several underwriters to work under him. However, the sub-underwriters have no privacy of contract with the company. They get their commission from the underwriter and are also responsible to him.

The process of underwriting involves four basic functions:

1) Selection of risks

2) Classification and rating

3) Policy forms

4) Retention and reinsurance.

By performing these four functions the underwriter increases the possibility of securing a safe and profitable distribution of risks.

Risk Selection

In this step the underwriter decides whether or not to accept a particular risk. It involves securing factual information from the applicant, evaluating that information, and deciding on a course of action. The underwriter is typically aided by a list of acceptable and prohibited risks.

Classification and Rating

Once the risk has been accepted, the underwriter then classifies and rates the policy. Several tentative classifications are usually assigned before a final decision on classifying the risk is reached. The purpose of using classifications is to separate risks into homogeneous groups to which rates can be assigned. Insurers may have their own classification and rating system, or they may obtain a system from a rating bureau.

Policy Forms

After determining the acceptability of an applicant and assigning the proper classification and rating, the underwriter is ready to issue an insurance policy. The underwriter must be familiar with the different types of policies available as well as be able to modify the form to fit the needs of the applicant.

The first three underwriting functions risk selection, classification and rating, and policy selection are interdependent. That is, the underwriter determines that a certain risk is acceptable when specified rates and forms are used. The underwriter also performs a fourth separate function on every risk before the underwriting is complete: reinsurance.

Retention and Reinsurance

Reinsurance involves protecting the insurance company against a certain portion of potential losses. Every risk presents the possibility of loss that will equal or exceed the policy limits. It is up to the underwriter to protect his or her company from undue financial strain. The underwriter does this by retaining only a certain portion of the risk and securing reinsurance for the remainder of the risk.