Underwriting is the method that is utilized to evaluate the current eligibility of a customer to receive some type of financial product. The range of products include a number of financial devices such as insurance coverage, mortgages for home and business property, venture project financing, or a line of credit. In going through this process of evaluation, the financial entity will determine if the transaction has a good chance of ultimately yield a profit in return for the financial assistance.
When a financial provider such as a bank or insurance company chooses to engage in underwriting, there are two events that are expected to happen. First, the lender or underwriter is indicating a belief in whatever project the borrower wishes to finance, and follows through with the financial support that is requested. Second, in underwriting the mortgage, insurance policy, or venture, the lender is anticipating a return on the investment at some point in the future. The return may take place in incremental payments or as a lump sum at a later date. Finance charges or some other type of compensatory fee such as a premium is normally included in any form of underwriting activity.
Underwriters not only consider the degree of risk that is associated with the applicant. Along with taking steps to ensure the ability of the potential client to honor his or her end of the arrangement, the underwriter will also consider the degree of risk that entering into this new partnership could have for other clients of the firm. The development of standards for acceptance helps to minimize the chance for the firm to be damaged in some manner to the point of not being able to honor commitments to existing clients.
Insurance is an example of one field that utilizes underwriting as a core function of the business. In the case of health insurance, the provider will thoroughly investigate the current and past health of the applicant, within applicable terms. In some cases, the provider may have some reservations due to a past medical incident, but choose to insure the applicant, with some pre-existing conditions omitted from the coverage for a period of time. At other times, the medical history may indicate a degree of risk that is not acceptable to the company, and the provider will choose to not underwrite the health coverage. By not insuring persons who are highly likely to require extensive medical coverage over the long term, the provider is able to maintain a more stable financial base and continue providing services to other clients.
Underwriting is also a common means of financing specific projects or ventures, such as a company that has developed and wishes to market a new technology. Generally, the underwriter will weigh several factors, such as the marketability of the new product, the marketing plan developed by the applicant, the costs associated with producing and marketing the goods, and the changes of making a net profit off each unit sold. The underwriter may wish to receive shares in the company as part of the compensation package, or simply receive a fixed rate of interest on the amount of financial support advanced.