An underwriter is a key player in financial markets who evaluates and assumes another party’s risk in areas like mortgages, insurance, loans, or investments, generally for a commission, premium, spread, or interest fee.
Underwriters assess the likelihood of a borrower repaying a loan and whether sufficient collateral is available in case of default. In the insurance field, they analyze a policyholder’s health and other relevant factors to distribute potential risk across many individuals.
Key Takeaways
- An underwriter is a crucial participant in financial organizations who evaluates and assumes risks in mortgages, insurance, loans, or investments for a fee.
- They operate in various finance areas, including the insurance industry, mortgage lending, and equity markets.
- Underwriters help determine the risk level for lenders.
- Their critical roles extend to mortgage, insurance, and equity markets, significantly influencing debt securities trading.
- The term ‘book runner’ refers to a lead underwriter.
What Do Underwriters Do?
Underwriters are indispensable in multiple sectors such as the mortgage industry, insurance, equity markets, and debt securities trading. Depending on their particular industry, their role generally revolves around assessing the risk involved in transactions or business decisions. Risk represents the likelihood of a variation between expected outcomes and actual gains.
Investors turn to underwriters to decide if a business risk is worth taking. They also engage in sales activities; for instance, purchasing the entire issue of an Initial Public Offering (IPO) to sell it to investors. An IPO marks the first time a privately owned company sells its shares publicly.
Historical Roots of Underwriting
The term ‘underwriter’ originated with marine insurance. Shipowners required insurance for their ship and cargo, so they drafted a document describing both. When businesspeople were willing to assume some risk or obligation, they would sign their name and specify their exposure level at the document’s bottom. These individuals came to be known as underwriters.
Types of Underwriters
Mortgage Underwriters
Mortgage underwriters are perhaps the most prevalent type. They approve loans based on a combination of an applicant’s income, credit history, debt ratios, and savings. They ensure that loan applicants meet all requirements, review property appraisals for valuation accuracy, and provide final loan approval. Loans can be appealed if not approved, although overturning a decision requires substantial evidence.
Insurance Underwriters
Similar to mortgage underwriters, insurance underwriters evaluate applications to either approve or decline them based on risk analysis. Insurance applications are submitted by brokers and other entities, and the underwriters decide whether to offer coverage. They offer risk management advice and conduct ongoing analysis of existing clients.
Equity Underwriters
In the equity markets, underwriters manage the public issuance and distribution of securities from corporations or other bodies. A prominent role for equity underwriters is during IPOs. They collaborate closely with the issuing entity to set an initial offering price for securities, which they buy from the issuer and then sell to investors.
Debt Security Underwriters
Debt security underwriters purchase debt instruments like government or corporate bonds to resell them for a profit, known as the underwriting spread. They may sell these securities directly to the market or to dealers. When multiple underwriters are involved, the group is called an underwriter syndicate.
The Importance of Underwriters
Underwriters help investors evaluate the feasibility of business risks, significantly influencing trading and financial markets. Their involvement supports the success of sales activities, thereby enriching financial ecosystems.
Common Types of Underwriters
Among the commonly found underwriters: mortgage loan underwriters, who verify if a loan applicant meets all criteria before granting or denying the loan; and insurance underwriters, who scrutinize applications for insurance coverage and either approve or reject them. Equity market underwriters also play vital roles by facilitating the public issuance and trading of securities.
What is a Book Runner?
A book runner is the primary underwriter or lead coordinator in the issuance of new debt, equity, or securities instruments. They often work with others to reduce risk, serving as the central point for all information regarding the potential issue.
Conclusion
Underwriters are integral to financial organizations, where they evaluate risks in mortgages, insurance, loans, or investments. Their work spans various finance areas including insurance, mortgage lending, and equity markets. Offering crucial insights into risk assessment, underwriters contribute significantly to how various financial activities unfold.
Related Terms: collateral, default, risk, return, shares, stock, mortgage, insurance, IPO, investment banks.
References
- Cornell Law School - Legal Information Institute. “Underwriter”.
- RiskResource. “The History of Insurance Underwriting Explained in 2 Minutes”.
- State of Nevada. “Mortgage Processors and Underwriters”.
- U.S. Bureau of Labor Statistics. “Occupational Outlook Handbook: Insurance Underwriters: Summary”.
- U.S. Bureau of Labor Statistics. “Insurance Underwriters”.
- LexisNexis. “Debt Securities—What Is the Role of the Underwriters/Managers”?
