Definition
Underwrite is a term that varies in meaning depending on the context in which it is used:
Insurance
In the field of insurance, underwriting refers to the process by which an insurer evaluates the risks of insuring a given person or asset and determines the terms and conditions of the insurance policy. The insurer, known as the underwriter, assumes the risk in exchange for a premium paid by the policyholder.
Investments
In investments, underwriting involves an investment bank or group of investment bankers (the underwriting group) that agrees to buy a new issue of securities from a corporation or government entity. The underwriter then resells the securities to the public, either directly or through dealers. The profit margin for underwriters, known as the underwriting spread, is the difference between the price paid to the issuer and the public offering price.
Examples
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Insurance Underwriting:
- Home Insurance: An underwriter assesses the value and risk level of insuring a home to set the premium.
- Health Insurance: An underwriter evaluates individual health risks to determine the premium rates.
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Investment Underwriting:
- Initial Public Offerings (IPOs): Investment banking firms underwrite shares of a company going public, purchasing the shares from the company and reselling them to the public.
- Bond Underwriting: Underwriters purchase bonds from issuers and resell them to investors.
Frequently Asked Questions
What does an insurance underwriter do?
An insurance underwriter evaluates applications for insurance, analyzing the level of risk involved in covering a customer or asset, and determines appropriate coverage and premium rates.
What is the underwriting spread?
The underwriting spread represents the difference between the amount paid by the underwriter to the issuer and the amount at which the underwriter sells the securities to the public. This spread compensates the underwriters for their risk and efforts.
How do underwriters assess risk?
Underwriters assess risk by analyzing various factors such as the applicant’s history, health, financial status, or asset value, along with current market conditions and risk mitigation potential.
Who are the primary participants in the underwriting process?
Primary participants include the issuer (company/government), the underwriter (insurance company or investment bank), and the investors or policyholders.
What is an underwriting agreement?
An underwriting agreement is a contract between the issuer and the underwriter outlining terms, conditions, and the amount to be offered for sale, including price ranges and underwriting fees.
Related Terms
- Investment Banker: A financial professional who assists companies in raising capital by underwriting and issuing securities.
- Premium: The amount of money paid by a policyholder to ensure coverage under an insurance policy.
- Risk Assessment: The identification, analysis, and evaluation of risks, a crucial process in underwriting.
- Initial Public Offering (IPO): The first sale of stock by a private company to the public, often facilitated by underwriters.
- Bond: A fixed-income instrument representing a loan made by an investor to a borrower.
Online References
Suggested Books for Further Studies
- “Principles of Risk Management and Insurance” by George E. Rejda and Michael McNamara
- “Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisitions” by Joshua Rosenbaum and Joshua Pearl
- “The Insurance Professional’s Practical Guide to U.S. Insurance Law” by Tim Dodge
- “Winning at Active Management” by Alex Shahidi
Fundamentals of Underwriting: Insurance and Investments Basics Quiz
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