Reviewed by Apr 15, 2021| Updated on
Underwriting is a method by which a person or organisation will take-up financial risk at a predetermined cost. The risk generally covers insurance, loans, and investments.
The word 'underwriter' rose from the custom of having every person willing to take a risk to write their names under the overall amount of risk they are going to accept for a predetermined amount of premium. The mechanics have significantly changed over time. Nevertheless, underwriting is a key function even today in the financial world.
Underwriting includes researching and estimating the level of risk of every person and organisation who has submitted an application prior to taking over that risk. This verification will help in setting fair borrowing interest rates for loans and arrive at a suitable premium to appropriately cover the actual cost of providing insurance coverage to the policyholders. It also includes creating markets for securities by correctly pricing the risk of investment. The underwriter may go onto refuse to offer coverage if the risk seems to be very high.
The underlying constituent of all underwritings is the risk involved. When it comes to loans, the risk will deal with the borrowers paying back the borrowed money as agreed or with the chance of defaulting.
With respect to insurance policies, the risk included is the possibility of numerous policyholders filing for a claim at a particular point of time. Concerning securities, the risk involved is the possibility of underwritten investments not yielding good profits.
The underwriters will carefully analyse loans, especially mortgage, to arrive at the chances that a borrower will make the repayments as agreed on and sufficient security for collateral is there at the disposal of the loan issuer when there is a default. When it comes to medical insurance, the underwriters will evaluate the health of the policyholders.