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Underwriting the Underwriter

April 15, 2012 | Comments: 0 | Views: 157

Underwriting is a procedure by which financial service providers or investment bankers comes up with customer eligibility for receiving their offers like insurance, equity capital or credit. It is the process of issuing insurance policies to someone. Excellence in underwriting profession is gained not only through theoretical study but also from long-term experience in dealing with risks and claims.In its best efforts, underwriter uses number of variable options to conclude underwriting policies. An underwriter guarantees a fixed amount (fee charges) for certain number of securities to the security issuing party. An underwriter helps corporations and governments to bring bond issues to the market. It plays key role in purchasing bonds from the issuer and resells them to investors. Definitely it takes financial risks in this way, but makes big profits on the transactions. Now the question is how an underwriter makes profit? The answer is, an underwriter purchases bonds from the issuer and resold them at higher prices. The in between margin money (purchased price and resold price) represent underwriters profit or discount. The profit and discount depends upon market situation. If the interest rate and accurate price of bond moves against the underwriter after the sale, the profit will be lower. Conversely, if interest rate movUnderwriting is a procedure by which financial service providers or investment bankers comes up with customer eligibility for receiving their offers like insurance, equity capital or credit. It is the process of issuing insurance policies to someone. Excellence in underwriting profession is gained not only through theoretical study but also from long-term experience in dealing with risks and claims.In its best efforts, underwriter uses number of variable options to conclude underwriting policies. An underwriter guarantees a fixed amount (fee charges) for certain number of securities to the security issuing party. An underwriter helps corporations and governments to bring bond issues to the market. It plays key role in purchasing bonds from the issuer and resells them to investors. Definitely it takes financial risks in this way, but makes big profits on the transactions. Now the question is how an underwriter makes profit? The answer is, an underwriter purchases bonds from the issuer and resold them at higher prices. The in between margin money (purchased price and resold price) represent underwriters profit or discount. The profit and discount depends upon market situation. If the interest rate and accurate price of bond moves against the underwriter after the sale, the profit will be lower. Conversely, if interest rate moves in favor of underwriter, this will be addition to profit.

Banks and securities agencies have municipal bond departments which carry out underwriting or marketing functions. An underwriter may be independent or it may be a part of securities agencies or banks. Usually investment banks perform municipal bond writing, corporate stock and bond offering. Sometimes it advises companies on margins. Banks never disclose the exact revenue generated by underwriting. But no doubt they have certainly benefited from the issuance of new municipal underwriting.

Often underwriter has to come up with a lot of creativity. It has to develop sense for each policy that determines when the risk should be accepted and when claimed. An underwriter has to provide best advice with respect to risk protection. It is equally involved when a bank designs insurance policies or bonds. In financial services, two types of risks remain always under consideration, the physical risk and moral risk. For example, in building insurance, the construction code will determine the expected damage during earthquake. Similarly, in car insurance, the age of car is an important factor to determine the possibility of theft. These are the cases for physical risks. While on the other hand, moral risk is related to financial position, criminal record and reputation of applicants. Identifying physical and moral risks and through thought process, underwriters evaluates applications for insurance. All the applications received by insurance company are forwarded to the underwriting system. At this point, underwriters determine the probability of risk and classify it according to loss margin. Underwriters get commissions, securities and fee. In an agreement, the price underwriters pay to company for securities are far less than the price offered to the public. The underwriter distributed the securities and assist broker-dealers with the initial fund rising when offering become too large for a company. The underwriter may keep some portion of underwriting. For example, underwriter may keep 20 percent of underwriting spread, and 80 percent for other participants.

Various types of under writings are exists, few of them are described here:

Security Underwriting: the process by which investment banks issues security, stocks or bonds. Due to lack of investors, they take risk of distributing the securities sometimes. As mentioned earlier, underwriters make their profits by purchasing bonds and sell them at higher prices to investors or broker dealers.

Insurance Underwriting: underwriters in insurance companies protect them from acquiring non profitable business. They measures risk boundary and determines premium amount charged to insure that risk. It is responsibility of underwriter to protect the company's book of business from risks and ensure less loss. Every company has its own underwriting guidelines. Underwriter may modify policies according to guidelines whether or not company accepts risk. In case of automobile insurance, the applicants driving record will be under consideration. In health insurance, underwriting may be needs to examine health status of applicant.

Bank Underwriting: credit analysis exceeds to granting of a loan takes place in bank underwriting. Bank underwriters evaluate credit risk whenever customers apply for loan. Borrower furnishes his salary, employment history, financial statements. The lender evaluates borrower's need for money and ability to pay back. Purchase of commercial papers, municipal bonds, government securities and corporate bonds for resale to investors or for its own account is also referred as bank underwriting.

Real Estate Underwriting: Real estate investors need underwriting experts who determines true value of an asset. Underwriter has to come up with property analysis by consider age, location, appearance and market value/rent and accessibility. Construction, adjacent buildings, hazards and distance can provide critical information to underwriter. Additional exposures that real state underwriting should consider are possibility of damage from winds or water, local wildlife risk. Underwriter can determine reinsurance amount by using probable maximum loss (PML) and maximum foreseeable loss (MFL). PML is maximum expected loss that can be in a single loss. It is expressed in percentage of building's value. MFL is an estimate of largest loss due to fire.

Sponsorship Underwriting: this term is used within public profile for television and radio broadcasting. It describes the sources of funding provided by company or organization to television or radio stations for mentioning their products or services broadcasting.es in favor of underwriter, this will be addition to profit.

Source: EzineArticles
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