Underwriting explained

Underwriting is the process of measuring a risk of a certain venture and coming up with the price and terms that an institution or investor would require to undertake that risk, explains The Economic Times.

The word underwriting comes from the practice of having risk takers write their name below the total risk that they undertake in return for a specified premium in the early stages of the industrial revolution.

Underwriting is a practice that underpins many ventures spanning numerous industries. Here are some of the common types of underwriting.

Loan underwriting

Whether you are a company or an individual applying for a mortgage or personal loan from a bank or other financial institution, they will underwrite your application to determine appropriate terms for your agreement, explains AgSouth Farm Credit.
The primary goal in loan underwriting is to determine the likelihood that a borrower will repay their loan. Analysts will typically look at the borrower's credit history, financial state, capacity to repay the loan, and general market conditions during the process. This informs their decision around the terms of repayment.

Securities underwriting

In investment banking, underwriting pertains to the process that investment banks follow to raise capital for corporations through securities, like stocks or bonds, says the Corporate Finance Institute.

In this context, underwriters assess the financial health of the organization issuing the security, potential risks, and determine the appropriate pricing for the security, according to Wallstreet Oasis.

Insurance underwriting

Insurance underwriting is a method of quantifying the insurance risk of a certain policy and setting premiums at an appropriate price given that risk. Insurance risk is defined as the potential that the insurer will have to cover the agreed upon insured event, explains Insuranceopedia.

Insurance underwriting helps set premiums by understanding three core factors:

1. The probability that the insured event will happen
2. The severity of the event and financial loss event
3. The amount of risks that the insurer assumes liability for

For a classic example, insurance premiums grow higher as you age because of the overall likelihood of health complications rising with age.

Going back to the definition of underwriting, fundamentally, we are talking about the process of assessing the appropriate cost for an individual or organization to assume the risk of a venture. The specifics can vary widely depending on the type of venture be that a personal loan, mortgage, car insurance, or dealing in securities, according to The Economic Times. The typical framework is something like this:

1. The entity assuming risk will typically ask for documentation about the relevant facts and circumstances around the venture.
2. The underwriter will use these facts to decide whether or not it is appropriate to take the risk and if so, the price of doing so.

Underwriting in insurance is similar to underwriting in other areas. Underwriters determine whether a potential insurer should take the risk of insuring a client, how much insurance should be offered, and whether offering a policy is appropriate to begin with.

Factors that impact car insurance underwriting

The factors that impact car insurance underwriting are vast and constantly changing based on the best available information, according to the NAIC. However, some factors remain fairly consistent, such as:

1. Age. Younger drivers have been shown to get into more accidents on average than older, more experienced drivers.
2. Gender. Males have been shown to get into more accidents than female drivers.
3. How the vehicle is used. If you only drive lightly then your pricing may be cheaper than those who use their vehicle more heavily.
4. Location. If you keep your car secured in a garage. The rate of theft, accidents, or adverse weather may impact your underwriting.
5. Coverage history. If you have gaps in your coverage history it is possible that insurers will charge you more.
6. Driving habits and history. The driving habits of yourself and anyone else on your policy might impact your underwriting. For example, if you have recent traffic violations or have been in an accident.
7. Credit history. Insurance companies may use information about your credit history when they rate your policy.

Factors that impact life insurance underwriting

Like with any other type of underwriting, there are numerous things that are taken into consideration when underwriting life insurance, explains FEDmanager. These factors may include:

1. Age. Generally speaking younger people will have lower rates than older people.
2. Medical history. Your medical history and current conditions can also impact your rates by informing the risk of certain conditions occurring or reoccurring.
3. Family medical history. Your immediate family's medical history also helps inform insurance agencies of the likelihood of a loss event.

Underwriting can be done with manual and automated processes. These processes have different strengths and weaknesses that make them suitable for specific situations.

Manual underwriting

Manual underwriting is when a human underwriter reviews each underwriting case and assesses the risk factors manually. This can be suitable in complex risk assessment situations or in small scale cases.

Pros

1. More personalized evaluation
2. Greater flexibility for navigating complex cases

Cons

1. Manual underwriting takes longer than automated underwriting
2. Can be susceptible to human error

Automated underwriting

Automated underwriting relies on machines to use algorithms and data models to assess risk and make decisions quickly. This can make automated underwriting ideal for less complex underwriting particularly at scale, according to Lonestar Financing.

Pros

1. Reliable, data-driven decisions
2. Fast assessment and approval process

Cons

1. Less flexibility for unique or complex cases
2. Can be rigid in decision making

Underwriting affects many of the ventures people undertake on a regular basis. It determines not only if applicants qualify for mortgages, personal loans, and insurance policies, but also the rates and terms. That means that underwriting impacts individuals' finances in almost all aspects of life from dwelling to driving.

Improving your underwriting profile can lead to better insurance rates and loan approvals. While some of these factors are external, there are some steps that you can take to improve your profile and your results in these endeavors.

For car insurance

The NAIC provides the following tips that may help improve your underwriting profile for car insurance:

1. Drive responsibly, maintain a clean driving record
2. Keep your car in a secure location
3. Maintain good credit or improve it

For life insurance

Improving your underwriting profile for life insurance may require a larger commitment, but the FEDmanager recommends these two things:

1. Maintain a healthy lifestyle
2. Take a proactive approach to healthcare with regular health screenings

For loans

AgSouth Farm Credit recommends these three tips for potentially improving your underwriting profile for loans:

1. Maintain good credit history
2. Pay your loans on time
3. Ensure you have adequate capacity to pay the loan that you are applying for