Underwriting

Definition

Underwriting is a financial process commonly used in insurance and securities industries. It involves assessing and assuming risk on behalf of a client, typically for a fee.

What is underwriting?

Underwriting involves evaluating the risk associated with insuring a person, property, or providing financial coverage for a specific event. Underwriters conduct thorough due diligence to gather information about the entity or individual seeking coverage. This may include financial records, medical history, or other relevant data.

In the securities industry, underwriters consider market conditions, investor demand, and other factors when pricing and issuing new securities. Underwriters must adhere to legal and regulatory requirements that govern their industry, ensuring that all transactions are conducted in accordance with applicable laws.

Underwriters often work closely with brokers, agents, or other intermediaries who bring applications for underwriting. They provide expertise and guidance to these professionals. Furthermore, underwriters must be able to adapt to changing circumstances, such as shifts in economic conditions or emerging risks.

Types of underwriters

The different types of underwriters include:

• Insurance underwriters: Assess risk and determine premiums for insurance policies.

• Loan underwriters: Evaluate and approve loan applications based on creditworthiness and financial stability.

• Securities underwriters: Work with companies issuing stocks or bonds, determining the offering price and buying the securities to sell to the public.

• Mortgage underwriters: Assess property value and the risk of financing real estate transactions.

Example of underwriting

XYZ Corporation, a technology company, plans to issue £100 million in corporate bonds to fund its expansion projects. XYZ Corporation approaches an investment bank to underwrite the bond issuance.

1. Assessment of risk: The investment bank conducts thorough due diligence on XYZ Corporation. Based on this assessment, the investment bank determines the risk associated with underwriting the bond issuance.
2. Structuring the offering: The investment bank works with XYZ Corporation to structure the bond offering, determining key terms such as the bond’s interest rate, maturity date, and covenants.
3. Pricing and allocation: After generating investor interest, the investment bank facilitates the pricing of the bonds based on prevailing market conditions and investor demand.
4. Underwriting commitment: As an underwriter, the investment bank agrees to purchase the entire bond issuance from XYZ Corporation at an agreed-upon price, providing assurance that the bond offering will be successfully completed.

In this example, underwriting plays a critical role in facilitating the bond issuance process for XYZ Corporation by assessing risk, structuring the offering, marketing to investors, and providing a commitment to purchase the bonds.