Defining Underwriting
An underwriter can be understood to be the party responsible for evaluating and assuming another party’s risk. This is based on the understanding that the underwriter in question will be paid a fee for the same which may be in the form of a commission charged, interest, premium, or spread.
Understanding what Underwriting Entails
The contributions made by underwriters are vital in several industries falling within the realm of finance. These include but aren’t limited to industries focused on mortgage, insurance, equity, and those involved with debt security trading. Those in charge of leading underwriting expeditions are referred to as book runners on occasion.
Present-day underwriters partake in a number of roles that vary in accordance with the industry within which they are employed. Ordinarily, however, underwriters are expected to determine the extent of risk associated with a given transaction or a business decision. The risk here refers to the likelihood that the actual outcome or gains pertaining to a given investment will differ from those that were anticipated or hoped for.
Investors make use of underwriters as they help ascertain whether or not a business risk is worth getting involved in.
Additionally, underwriters help with sales-type activities a company may engage in. These include but aren’t limited to initial public offerings (or IPOs) wherein the underwriter might avail of the entire issuing made available under an IPO and then proceed to sell the same to varied investors. An IPO can be understood to be the process via which a previously privately-owned company that sells shares decides to go public and issue its shares on a public stock exchange.
Examining the Provenance of the Term ‘Underwriter’
When examining the evolution of the term underwriter, it first acquired usage when marine insurance first came into being. Shipowners sought to insure their ships and the cargo within them such that they could financially protect themselves in the event that their ships and the cargo they held were lost at sea. Shipowners would therefore create a document that outlined and described the contents, crew, and destination of their ship along with providing details about the ship itself.
Businessmen who were willing to incur some of the risk associated with the journey set to be taken by these vessels would put their name and signature at the bottom of this document and highlight the amount of exposure they were willing to bear. A mutually agreed-upon rate and terms were then stipulated on the document. Over time these businessmen came to be known as underwriters.
Types of Underwriters
There exist a wide variety of underwriters, the more prominent of which have been examined below.
Mortgage Underwriters
These are the most popular forms of underwriters, and they are engaged in dealing with mortgage loans. These loans are provided with approval keeping in mind a number of factors ranging from an applicant’s income and credit history to their debt ratios and the overall savings they have maintained.
Mortgage underwriters are responsible for ensuring that a given loan applicant fulfills all the stipulated requirements. They subsequently choose to either approve or deny a loan. Furthermore, these underwriters are responsible for assessing a property’s appraisal to determine whether it is accurate or not and that the home is worth the amount it is being purchased for, and the loan applicable on the same.
Mortgage underwriters are entitled to approve in finality all mortgage loans. Those loans which aren’t approved of may go through an appeal process, however, such decisions require ample evidence in order to be overturned.
Insurance Underwriters
Insurance underwriters operate in a similar fashion to their mortgage counterparts. They too are responsible for reviewing applications pertaining to coverage and choose to accept or reject an application after analyzing the risk associated with the same. Insurance underwriters are charged with reviewing insurance applications submitted to them by brokers for their clients and determining whether or not insurance coverage ought to be provided or not.
In addition to this, insurance underwriters are charged with providing advice pertaining to management issues, determining the coverage possibilities for certain individuals and reviewing their existing clientele in order to analyze what their continued coverage should amount to.
Equity Underwriters
Underwriters employed under equity markets are responsible for administering the issuance and distribution of varied securities to the public which may exist in the form of common as well as preferred stock via a corporate entity or another issuer. Primarily, however, they are responsible for overseeing the initial public offering.
Operating as financial specialists, IPO underwriters are responsible for determining the initial offering price of the securities in question. Furthermore, they buy the same from the issuer and proceed to sell them to investors by making use of the underwriter’s distribution network.
Ordinarily, investment banks have IPO specialists on board who constitute their IPO underwriters. These banks work in sync with a company in order to ensure that all regulatory protocols are fulfilled. IPO specialists reach out to a wide variety of investment organizations including mutual funds in order to assess the interest that exists with their investments. Based on the interest garnered by these vast institutional investors, underwriters are able to discern what the IPO price of a company’s stock ought to be. Additionally, underwriters are responsible for guaranteeing the sale of a specific number of shares that will be sold at the initial price. Should there exist any surplus, the underwriters are tasked with purchasing the same.
Debt Security Underwriters
Employed under this capacity, underwriters are responsible for purchasing debt securities which may range from government and corporate bonds to municipal bonds and preferred stock. They buy the same from the body responsible for issuing them and then proceed to sell them for a profit. The profit derived via these means is referred to as “underwriting spread”.
Debt securities can be resold by underwriters either directly to a marketplace or can be sold to dealers who will then go on to sell them to different buyers. Should a number of underwriters be involved in the issuance of debt security, they are collectively referred to as an underwriter syndicate.
Conclusion
Underwriters play a vital role in varied industries that fall within the realm of finance as they undertake another party’s risk provided they are paid a fee for the same.
