Underwriting

Underwriting is the process of evaluating a risk, deciding whether to accept it, and setting the price for taking it on. The term appears in two major contexts — insurance and securities — and both stem from the same idea: a party agrees to bear financial risk in exchange for compensation.

In insurance, the underwriter reviews an application to determine whether the applicant meets the company's standards and, if so, how to classify and price the risk. For a life policy, that means weighing factors like age, health history, occupation, and lifestyle; for property and casualty coverage, it means assessing the property, location, loss history, and hazards. Based on this review, the underwriter may accept the risk at standard rates, accept it on modified terms (a rated policy, exclusions, or a higher premium), or decline it. Sound underwriting protects the insurer against adverse selection — the tendency of higher-risk applicants to seek coverage most eagerly.

In securities, underwriting is how investment banks bring new issues to market. In a firm commitment underwriting, the syndicate buys the entire issue from the issuer and resells it to investors, keeping the spread as compensation and bearing the risk of unsold shares or bonds. Municipal bond underwritings, for example, may be won through competitive bids or negotiated directly with the issuer.

Underwriting is tested on both insurance licensing and securities exams. Property and casualty and personal lines exams cover the insurance underwriting process and risk classification, while the Series 7 tests securities underwriting, including municipal bond syndicates and the primary market process.