Underwriting
October 1, 2009
Underwriting is a process through which an insurer, bank or an investment house, determines whether a customer is eligible for their products or not. The products could be a mortgage, loan, insurance or shares. The term underwriting came into existence in Britain, when bankers used to take over risks in sea voyages, on payment of a premium, by writing under the information of the risk, their names.
The common usage of underwriting is for bearing the risk of selling securities at a given rate. The underwriter will hold the shares until the time all are sold at the rate mentioned. Securities underwriting has become common and is a way to get investors for new equity capital. The underwriting company will bear the risk of distribution of the securities and if they cannot find such investors, they will themselves hold the securities.
The process of underwriting by banks is a thorough analysis of the credit worthiness of an applicant for a loan. The bank will examine the applicant’s salary certificate, bank statements, tax audits, and other financial information and come to a decision whether he should be given the loan or not. Banks also underwrite by purchasing government securities, corporate bonds and so on, for reselling them to investors or keeping in their own accounts.
In insurance, underwriting is evaluating the risk involved in giving coverage to a particular potential client. Based on this the insurer will either accept of reject giving an insurance policy to the client. The underwriting process will also determine the extent of coverage that the client can receive and the premium he should pay for such coverage. This process of underwriting in different insurance companies is governed by certain guidelines and procedures.
The underwriter of an insurance company will gather information regarding the client and based on certain parameters will evaluate the information and come to a conclusion. For example in automobile insurance, the past driving record of the applicant is very important. If there are accidents and traffic violations in his records the coverage can be rejected, or accordingly the premium amount might be increased. It will all depend on the guidelines followed by that particular insurance company. Insurance companies which provide life insurance and health coverages, depend on medical underwriting to ascertain the state of health of the applicant.
Underwriting guidelines should be practical and take an objective view of the risk classification and arrive at a reasonable premium to provide the coverage, in keeping with the laws.
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