What Is an Underwriter?

An underwriter is any party that evaluates and assumes another party's risk for a fee. The fee is often a commission, premium, spread, or interest. Underwriters are critical to the financial world including the mortgage industry, insurance industry, equity markets, and common types of debt security trading. A lead underwriter is called a book runner.

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



The Different Types of Underwriters

The term "underwriter" first emerged in the early days of marine insurance. Shipowners sought insurance for a ship and its cargo in case the ship and its contents were lost. Businessmen would meet in coffeehouses and examine a paper describing the ship, its contents, crew, and destination.

Each person 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 signees became known as underwriters.

Underwriters play a variety of specific roles depending on the context. Underwriters are considered the risk experts of the financial world. Investors rely on them because they determine if a business risk is worth taking. Underwriters also contribute to sales-type activities; for example, in the case of an initial public offering (IPO), the underwriter might purchase the entire IPO issue and sell it to investors.

Underwriters don't always purchase IPO-issued stock or guarantee a certain price for it. They only promise to use best efforts to sell the issue to the public at the best possible price.

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 that it is accurate and the home is approximately 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 equity markets, underwriters administer the public issuance and distribution of securities—in the form of common or preferred stock—from a corporation or other issuing body. Perhaps the most prominent role of an equity underwriter is in the IPO process. An IPO is the process of selling shares of a previously private company on a public stock exchange for the first time.

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

IPO underwriters are typically 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, such as mutual funds and insurance companies, to 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, such as government bonds, corporate bonds, municipal bonds, or preferred stock, from the issuing body (usually a company or government agency) to resell them for a profit. This profit is known as the "underwriting spread."

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

Automated underwriting has reduced the need for underwriters.

Key Takeaways

  • Underwriters are the risk experts of the financial world.
  • The term underwriter first emerged in the early days of marine insurance when businessmen agreed to assume some of the risk of shipments during transport.
  • Underwriters are critical to the mortgage industry, insurance industry, equity markets, and common types of debt security trading.