What Is an Underwriter?

An underwriter is any party that evaluates and assumes another party's risk for a fee. The fee paid to an underwriter often takes the form of a commission, premium, spread, or interest. Underwriters play a critical in many industries in the financial world, including the mortgage industry, insurance industry, equity markets, and聽some common types of debt security trading. An individual in the position of a lead underwriter is sometimes called a book runner.

Key Takeaways

  • An underwriter is any party that evaluates and assumes another party's risk for a fee.
  • Underwriters play a critical in many industries in the financial world, including the mortgage industry, insurance industry, equity markets, and聽some common types of debt security trading.
  • In general, underwriters are tasked with determining the level of the risk, or the likelihood that an outcome or investment's actual gains will differ from an expected outcome or聽return, for various different stakeholders.
  • Underwriters are critical to the mortgage industry, insurance industry, equity markets, and聽common types of debt security trading.

According to the U.S. Bureau of Labor Statistics, the total employment levels of insurance underwriters is projected to decline 5% from 2016 to 2026.

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Underwriter

Understanding Underwriters

The term underwriter first emerged in the early days of marine insurance. Shipowners sought insurance for a ship and its聽聽to protect themselves in the event that the ship and its contents were lost. Shipowners would prepare a document that described their ship, its contents, crew, and destination.

Businessmen who wished to assume some of the obligation or risk would sign their name at the bottom and indicate how much exposure they were willing to assume. An agreed-upon rate and terms were set out in the paper. These businessmen became known as underwriters.

Modern-day underwriters play a variety of roles depending聽on the industry they are working in. In general, underwriters are tasked with determining the level of the risk involved in a transaction or other kind of business decision. Risk is the likelihood that an outcome or investment's actual gains will differ from an expected outcome or聽return.

Investors rely on underwriters聽because they determine if a business risk is worth taking. Underwriters also contribute to聽sales-type activities; for example, in the case of an聽initial public offering (IPO), the underwriter might purchase the entire IPO issue and sell it to investors. An IPO is the process whereby a company that was previously privately-owned selling shares of a previously private company on a public stock exchange for the first time.

Types of Underwriters

Mortgage Underwriters

The most common type of underwriter is a mortgage loan underwriter. Mortgage loans are approved based on a combination of an applicant's income, credit history, debt ratios, and overall savings.

Mortgage loan underwriters ensure that a loan applicant meets all of these requirements, and they subsequently approve or deny a loan. Underwriters also review a property's appraisal to ensure聽that聽it is accurate and the home is worth the purchase price and loan amount.

Mortgage loan underwriters have final approval for all mortgage loans. Loans that are not approved can go through an appeal process, but the decision requires overwhelming evidence to be overturned.

Agents and brokers represent both consumers and insurance companies, while underwriters work for insurance companies.

Insurance Underwriters

Insurance underwriters, much like mortgage underwriters, review applications for coverage and accept or reject an applicant based on risk analysis. Insurance brokers and other entities submit insurance applications on behalf of clients, and insurance underwriters review the application and decide whether or not to offer insurance coverage.

Additionally, insurance underwriters advise on risk management issues, determine available coverage for specific individuals, and review existing clients for continued coverage analysis.

Equity Underwriters

In the equity markets, underwriters聽administer聽the public issuance and distribution of securities鈥攊n the form of common or preferred stock鈥攆rom a corporation or other issuing body. Perhaps the most prominent聽role of an equity underwriter聽is聽in聽the IPO聽process.聽

IPO underwriters are financial specialists who聽work聽closely with the issuing body to determine the initial聽offering price of the聽securities, buy the securities from the issuer, and sell the securities to investors via the underwriter's distribution network.

According to the U.S. Bureau of Labor Statistics, the total employment levels of insurance underwriters is projected to decline 5% from 2016 to 2026.

IPO underwriters are typically聽investment banks that have IPO specialists on staff. These investment banks work with a company to ensure that all regulatory requirements are satisfied. The IPO specialists contact a large network of investment organizations鈥攕uch as mutual funds and insurance companies鈥攖o gauge investment interest. The amount of interest received by these large institutional investors helps an underwriter set the IPO price of the company's stock. The underwriter also guarantees that a specific number of shares will be sold at that initial price and will purchase any surplus.

Debt Security Underwriters

Underwriters purchase debt securities鈥攕uch as government bonds, corporate bonds, municipal bonds, or preferred stock鈥攆rom the issuing body (usually a company or government agency)聽to resell them for a聽profit. This profit is聽known as the "underwriting spread."

An聽underwriter聽may聽resell聽debt securities聽either directly to the marketplace or to dealers (who will then sell them to other buyers). When the issuance of a聽debt security聽requires more than one underwriter, the resulting聽group of underwriters聽is known as an underwriter syndicate.