how underwriting works
underwriting involves conducting research and assessing the degree of risk each applicant or entity brings to the table before assuming that risk this check helps to set fair borrowing rates for loans establish appropriate premiums to adequately cover the true cost of insuring policyholders and create a market for securities by accurately pricing investment risk if the risk is deemed too high an underwriter may refuse coverage risk is the underlying factor in all underwriting in the case of a loan the risk is whether the borrower will repay the loan as agreed or will default with insurance the risk may involve the likelihood that an individual prospective insured might file a claim or that too many policyholders will file claims at the same time with securities the risk is that the underwritten investments will not be profitable underwriters evaluate loans particularly mortgages to determine the likelihood that a borrower will pay as promised and that enough collateral is available in the event of default in the insurance industry underwriters seek to assess a policyholder s health and relatedfactors a driver s safety record or the security of a home they aim to price insurance premiums appropriately while spreading the potential risk among as many people as possible underwriting securities most often done via initial public offerings ipos helps determine the company s underlying value compared to the risk of funding its ipo types of underwritingthere are three major types of underwriting loans insurance and securities all loans undergo some form of underwriting in many cases underwriting is automated it involves appraising an applicant s credit history financial records and the value of any collateral offered along with other factors that depend on the size and purpose of the loan the appraisal process can take a few minutes to a few weeks depending on whether the appraisal requires a human being to be involved the most common type of loan underwriting that involves a human underwriter is for mortgages this is also the type of loan underwriting that most people encounter the underwriter assesses income liabilities debt savings credit history credit score and more depending on an individual s financial circumstances mortgage underwriting typically has a turnaround time of a week or less refinancing often takes longer because buyers who face deadlines get preferential treatment although loan applications can be approved denied or suspended most are approved with conditions meaning the underwriter wants clarification or additional documentation before the agreement can be finalized insurance underwriters receive customer applications and decide whether to offer them a policy on the basis of various criteria if they do approve the application the underwriters also set premiums and coverage amounts 1with insurance underwriting the focus is on the potential policyholder the person seeking health home auto or life insurance in the past medical underwriting for health insurance looked at the applicant s pre existing conditions to determine how much to charge an applicant or whether to offer coverage at all often based on the applicant s pre existing conditions beginning in 2014 under the affordable care act insurers were no longer allowed to deny coverage or impose limitations based on pre existing conditions life insurance underwriting seeks to assess the risk of insuring a potential policyholder based on their age health lifestyle occupation family medical history hobbies and other factors determined by the underwriter life insurance underwriting can result in approval along with a range of coverage amounts prices exclusions and conditions or outright rejection for property and casulty insurance underwriters look at numerous criteria including characteristics of the person and the property being insured for example if someone applies for automobile insurance the carrier looks at their driving record how often their make and model of car is in an accident and the average cost of repairs similarly to ensure a home underwriters focuses on such factors as replacement cost age of the dwelling and any significant risks such as being in an area prone to wildfires to decide whether to offer the applicant homeowners insurance and how much to charge investment securities underwriting which seeks to assess risk and the appropriate price of particular securities most often related to an ipo is performed on behalf of a potential investor often an investment bank based on the results of the underwriting process an investment bank would buy underwrite securities issued by the company attempting the ipo and then sell those securities in the open market underwriting ensures that the company s ipo will raise the capital needed and provides the underwriters with a premium or profit for their service investors benefit from the vetting process that underwriting provides and its ability to make an informed investment decision this type of underwriting can involve individual stocks and debt securities including government corporate or municipal bonds underwriters or their employers purchase these securities to resell them for a profit either to investors or dealers who sell them to other buyers when more than one underwriter or group of underwriters is involved this is known as an underwriter syndicate 