What is underwriting and how does it provide certainty?
Underwriting started over 325 years ago in London at Edward Lloyd’s coffee house when it became the place to obtain risk cover for ships and cargo.
From these humble beginnings grew Lloyds of London, the most famous of all insurance markets, but it also started a global underwriting industry.
Nowadays, underwriting is a service provided by a wide range of different types of organisations, such as banks, insurance firms and investment and finance companies.
What is underwriting?
With insurance, underwriting refers to “signing and accepting liability under a policy and therefore guaranteeing payment in case of loss or damage”.
For other financial risks it refers to “undertaking to finance or otherwise support, or guarantee, something such as a financial transaction or investment.” (investopedia.com)
It’s clear that underwriting is all about providing certainty.
Being able to, in some way, control what is ahead is important as it enables organisations to plan with the peace of mind that support is available if risks eventuate.
Where the benefit to the underwritten policy holder is certainty, for the Underwriter there’s an opportunity for commercial gain through providing a valued service. In general terms, underwriting means receiving a remuneration for the willingness to pay for, or incur, a potential contingent risk.
Underwriting in the finance and property investment industry
The principal of guaranteeing or underwriting risk is a fundamental principle for investment.
For instance, when a property investment company identifies a high quality and commercially viable asset, it needs to act swiftly to secure it for its investor base. Timing is everything. The firm most likely to succeed with a purchase is the one that acts quickly and confidently – it’s essential to have your financial ducks in a row.
Facilitating the purchase process is where the Underwriter is used – in return for a fee, the Underwriter provides the initial capital to complete the purchase. This secures the asset so it can be offered to investors.
The next stage involves investors securing interests in the property and this is when the Underwriter is repaid. The commercial opportunity for the Underwriter is to earn fees from this process, as well as having the opportunity to own a proportion of the investment itself, at a discount.
This is a very common use of an Underwriter – another one is “pre-sales underwriting” where a property developer needs to demonstrate to a lender there is sufficient demand for a development and that there will be funds available at completion for repayment.
In this case, the developer needs to show a certain proportion of the development is “pre-sold”. This provides certainty and cash-flow, and confidence about repayment. If a developer is not able to confirm this, an Underwriter can fill the gap by guaranteeing the purchase of any unsold units.
Underwriting is a tool that brings benefits
For organisations in the finance sector, and their clients, underwriting is a way of delivering benefits ranging from peace of mind and confidence, to providing investment products to help secure people’s financial future.
While it usually operates behind the scenes it is important for investors to understand the supporting role it plays. Underwriting is one of the most tried and tested financial processes with a simple heritage that started with a problem needing a solution and now supports people, companies and industries across the world.
Underwriting is just as relevant today as it was in the swashbuckling era of the 17th Century.
For more information on underwriting, please contact the team at Taurus
+64 3 366 6087
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