Underwriting is an overall process followed by financial institutions. Though it sounds complicated, underwriting is the process of verifying your income and assets before the lender finally approves the loan for you. An underwriter works for insurance, investment, and other financial companies.
If you are willing to know What is Underwriting, firstly, you have to understand the reason behind the name. The name ‘underwriting’ came from the practice of writing the name of the risk-takers underneath the entire risk that they are undertaking for an absolute premium in the early days of the industrial revolution. Risk is thus the word that goes best with the process of undertaking.
The process and the different types of underwriting take place behind the scenes, but you have a lot to do with it. After looking into all your documents, your lender may ask for more documents. The underwriter guides the company with its findings and based on it, the investment or the insurance company decides whether they will take your contract or not. So, before settling for an insurance policy or taking a loan for your dream house, consult your financial advisor for sure.
Who is an underwriter?
The underwriter is an essential member of a financial company. An underwriter generally works on the mortgage, loan, insurance, or any other investment. When you apply for any one of the services mentioned above, the underwriter will review, estimate, research, and then assume the risk. For this, they will charge a fee, which you have to pay in the form of premium, interest, or commission. You are actually asking for approval for the insurance or loan you applied for with this fee. The answer to the question-‘What is Underwriting’ is mostly dependent on who underwriters are.
Underwriters must have a minimum bachelor’s degree with proper industry training. The majors that underwriters commonly have are finance, economics, or business. These majors help them to grasp their area of specialization with precision. Underwriters are experts in their respective fields. They are bound to understand the basics and complexities of every field and know to assess the risk of the applicant. They determine whether giving loans or issuing an insurance policy to the applicant will be beneficial for the company or not.
If any underwriter approves a loan or insurance that is too risky, he will be responsible for the loss that the company faces and he has to make up the deficit.
What does an underwriter do?
Underwriting is not a one-person task. There are different types of underwriting and each underwriter is different from one another depending on the field they are working. That means an expert underwriter for loan approval may not have proper knowledge for issuing health insurance. The fields are different and so are their knowledge and work.
Case-1
Let us assume you are willing to take a loan to buy a house you have selected. When your future home is undergoing an appraisal, the underwriter will dive into your finances and assesses the risk that the lender had to take if they decide to approve a loan to you.
The underwriter will analyze four significant areas- your income, your credit, your asset, and your home’s appraisal. There are certain things that he can ask for.
1. He can scrutinize your credit history, look into your credit scores and may also see if you have late payments, bankruptcy, or any other discrepancies.
2. He will order an appraisal. He will assess whether the amount for the loan offered by the lender is matching up with the actual value of the property.
3. He will ask you to prove your employment and income. Verification of your income and employment is essential for the underwriter.
4. He will verify your savings account. The underwriter will ensure that you have enough funds in your savings account that can supplement your down – payment and income during closing time.
5. The last thing that the underwriter looks into is your DTI ratio. The debt-to-income ratio is the percentage that your lender must know. It is the ratio of the amount of money you spend on the amount of your income. The underwriter will check and ensure that you have sufficient cash flow to cover your monthly loan repayment.
Case-2
Let us now assume that you are looking for health insurance. The function of the underwriter is much different from the previous case. That is why there are different types of underwriting, which is why it is difficult to define ’What is Underwriting’ in a single line.
In this case, the underwriter will review your age, medical history, and family history of any diseases. If the underwriter finds that your age or medical history is not tallying with the policy applied, he might not proceed further. He will let the company know about the risk associated.
Different types of underwriting
The process of underwriting depends on several factors and it is essential to assess the risks involved. Different types of underwriting have thus emerged and it is vital to know the differences between them.
1. Firm underwriting
Infirm underwriting agreement, the underwriter himself takes up a certain number of shares of the firm. The underwriter subscribes for the securities along with the securities which remain unsubscribed by the public. The underwriter is liable to take the shares agreed, no matter the issue is fully subscribed or oversubscribed.
2. Sub-underwriting
In this type of underwriting agreement, the underwriter appoints some sub-underwriters to protect him. Sometimes while underwriting the securities, the underwriter may feel that he alone cannot assess the risk. This action is mainly taken to diffuse the risk among other sub-underwriters.
The sub-underwriters do not connect with the applicants directly here. They are only liable to the main underwriter only for their part of the amount of security. In the prospectus, all the underwriters’ names are mentioned along with the amount of securities they have agreed upon.
3. Joint underwriting
When the issue is too large and too risky to be assessed by one underwriter, the company appoints more than one underwriter. This is done to reduce the pressure on a single underwriter. Here, all underwriters are liable and write a specified amount in a specific ratio.
4. Syndicate underwriting
As the name ‘syndicate’ suggests, it is an underwriting agreement where more than one underwriter joins to form a group and work as a unit. In this type of underwriting, the underwriters fix the amount and ratio of securities among themselves in advance and underwrite them as decided.
There is a difference between joint underwriting and syndicate underwriting. In joint underwriting, the company appoints the underwriters to underwrite the amount and ratio of securities as allotted. While in syndicate underwriting, the underwriters work as a single unit. Here, the whole unit is accountable to the lender.
5. Partial underwriting
In partial underwriting agreement, the underwriter takes the responsibility to underwrite only a part of the company’s issue of shares. Here, a single underwriter or more than one underwriter agrees to assess the risk of that specific amount only.
6. Complete underwriting
Under complete underwriting agreement, the underwriter alone or with many others agrees to underwrite the company’s full amount of shares. Whether alone or in numbers, the underwriter assesses the risk to the specified amount of total securities.
The job of an underwriter is very complicated. As a result, they are liable for the level of risk acceptance and guiding the company to make a decision. Based on their words, the company will grant a loan or issue insurance. The process of underwriting is sometimes too complicated and that is the reason there are different types of underwriting. While answering the question, ‘What is Underwriting’, you must primarily understand that your financial matter should match with the company policy if you are willing to take a loan or insurance. Therefore, when you are talking to your agent or company, do not hesitate to ask about their underwriting process. The more you will understand this, the more quickly you can solve your problem.
