What is Underwriting?
What is Underwriting Used For and How Does it Affect Me?
By definition, underwriting is, “the process through which an individual or institution takes on financial risk for a fee. The risk most typically involves loans, insurance, or investments.”
The basics of underwriting in all the industries it is used, is to evaluate risk, which for some industries involves the use of actuaries, who are people, and sometimes computers, who measure risk.
In the banking, insurance and investment industries, there is always risk involved. People default on loans, and there are claims on insurance policies.
If you think of the saying in gambling, “the house always wins”, then this principle is also applied to loans, insurance and in some instances investments.
Banks and lenders, and insurance companies, want to reduce their risk in granting a loan, or issuing an insurance policy. So they underwrite all applications to assess the risk involved, and then make a decision as to grant the loan, or issue the insurance policy.
So in answering the question, what is underwriting used for?
It is used to assess the risk in granting someone a loan, or issuing someone an insurance policy.
Different lenders and insurance companies may have different criteria or factors they review and look at in underwriting an insurance policy or a loan.
So How Does Underwriting Affect You?
Underwriting affects you in a big way.
Insurance companies for example use various underwriting factors depending on what type of insurance policy they are issuing.
Life insurance policies and healthcare policies ask about if you smoke or not, and your general health and any pre-existing conditions.
These factors are a part of the underwriting process to determine if a policy is issued, rated or declined. Rating a policy means one person may receive a higher premium than another person, based on if they smoke, have a less than healthy lifestyle, or have had prior health concerns.
In issuing a car insurance policy, previous claims are a big factor in underwriting an insurance policy, as is the age of the car, where it is parked or stored, and the age of the driver.
All these factors are used, in addition to many others, in underwriting the application for the policy.
Loans: Banks and other lenders when they receive an application for a loan or credit card also underwrite the application in many ways.
The lender will look at the applicants credit score and credit file, and also look at the applicants income and expenses to determine affordability for the loan or line of credit.
If an applicant has a low credit score, or a credit score that doesn’t fit in the top tier of what the lender requires, they may reject the loan, offer the loan at a higher interest rate, or request a guarantor for the loan.
All in the underwriting process to reduce the lender’s risk or exposure on the loan.
Underwriting is a very important part of the process of being approved for most things financial in our lives, insurance and lending are two of the more immediate ones.