Definition of Underwriter
An underwriter has a multifaceted role with responsibilities across insurance and financial sectors:
1. Insurance Underwriter:
A person or entity who examines a risk to decide if it can be insured, and if so, determines the premiums to be charged. This decision is typically informed by the frequency of similar past claims. Underwriters are often employed by insurance companies or are members of organizations like Lloyd’s.
2. Financial Underwriter:
A financial institution, often a merchant bank, guarantees to buy a proportion of any unsold shares when a new issue is offered to the public. This role involves underwriting the risk of new issues to ensure successful public offerings. Underwriters work for a commission and may collaborate with other underwriters to purchase all unsold shares, provided the minimum subscription in the prospectus is met.
3. Guarantee Provider:
In broader financial contexts, an underwriter can be a person or entity offering a guarantee for a financial transaction, ensuring that the transaction will proceed even if certain conditions are not fully met.
Examples
Example 1: Insurance Underwriter
An insurance company employs underwriters to review applications for automobile policies. Based on data showing the frequency and type of past auto claims, the underwriter decides whether to approve the application and what premium to charge.
Example 2: IPO Underwriter
A merchant bank acts as an underwriter for a company’s initial public offering (IPO). The underwriter guarantees to buy any shares not sold to the public, providing a safety net for the issuing company. In return, the bank receives a commission for shouldering this risk.
Example 3: Mortgage Underwriter
A mortgage underwriter evaluates a borrower’s application to determine if they meet the criteria for a home loan. They verify the borrower’s income, debt, and overall financial stability before approving the mortgage and setting the terms.
Frequently Asked Questions (FAQs)
What qualifications are needed to become an underwriter?
Underwriters typically require a bachelor’s degree in finance, economics, business, or a related field. Professional certifications like the Chartered Property Casualty Underwriter (CPCU) can also be beneficial.
How do underwriters assess risk?
Underwriters use a combination of statistical data, past claims history, and industry standards to evaluate the likelihood of a risk occurring and its potential financial impact.
What is the role of an underwriter in an IPO?
In an IPO, underwriters guarantee the purchase of a certain number of shares, thus ensuring the company raises its desired capital even if public demand is insufficient. They are responsible for pricing the shares, creating marketing materials, and gauging investor interest.
How does an underwriter differ from an insurance broker?
An underwriter assesses and decides on insurance applications, setting premiums and terms. In contrast, an insurance broker acts as an intermediary between the client and the insurer, advising clients and helping them find the best coverage options.
Can underwriters work independently?
While many underwriters are employed by insurance companies or financial institutions, there are opportunities for experienced underwriters to work as independent consultants.
Related Terms
Risk Assessment
The process of identifying, analyzing, and evaluating risks to determine their potential impact and probability.
Premium
The amount charged by an insurer for coverage, calculated based on the assessed risk.
Merchant Bank
A financial institution specializing in underwriting, facilitating mergers and acquisitions, and providing advisory services for large businesses.
Initial Public Offering (IPO)
The process through which a private company offers shares to the public for the first time.
Commission
A fee paid to underwriters for their services, typically a percentage of the amount underwritten.
Online References to Online Resources
- Investopedia: Underwriter
- The Balance: What Is an Underwriter and What Do They Do?
- Corporate Finance Institute: What is Underwriting?
- Insurance Information Institute: Underwriting
Suggested Books for Further Studies
- “The Essentials of Risk Management” by Michel Crouhy, Dan Galai, and Robert Mark
- “Risk Management and Insurance” by Scott E. Harrington and Gregory R. Niehaus
- “Handbook of Insurance” edited by Georges Dionne
- “Essentials of Corporate Finance” by Stephen A. Ross, Randolph W. Westerfield, and Bradford D. Jordan
Accounting Basics: “Underwriter” Fundamentals Quiz
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