What Is a Third-party Underwriter?

Definition

Underwriting is the process that large financial institutions, such as banks, insurance companies and investment houses, use to determine the eligibility of customers to receive their products. These products range from insurance policies and mortgages to equity capital.

The granting of a loan is preceded by a thorough credit analysis by the bank. This analysis includes employment history, current salary and financial statements, as well as a review of the potential borrower's credit report. The bank as the underwriter of this loan will need to evaluate the borrower's ability to pay back the debt and their respective credit needs.

Insurance underwriters determine the risk and exposures of potential new clients. The company will evaluate how much coverage the prospective client needs, how much should be paid in premiums and, finally, whether or not to assume the risk of insuring the client. This evaluation determines how much premium will be needed to insure the risk the underwriter is taking. These insurance companies "write" policies that will prove profitable to the company and protect its book from risks that can result in losses. Insurance policies cover everything from health, automotive and homeowner's to life insurance.

Securities underwriting is the process by which investment houses raise capital from investors on behalf of corporations and government entities that are issuing either equity or debt securities. This is how newly issued securities whether they be stocks or bonds are sold to investors. The third-party underwriter bears the risk of being able to sell the security and the cost of holding it on the books until it is sold. The investment houses make a profit from the difference in price between what is collected from investors and the price the underwriter paid to the issuer of the security. In many cases, the primary investors for these new issues are brokerage houses and banks that will subsequently sell the securities to their clients. Banks and brokerages on many occasions serve as the underwriter for new securities.