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What is Underwriting?
Underwriting is the process through which risks are accepted by an institution. Underwriting is the assessment of risk or the acceptance of risk after such assessment by a company or bank.
Underwriters in insurance companies will assess a risk prior to the company accepting the risk; once the risk has been accepted the company bears the burden of covering the potential losses associated with the risk. The company is paid a premium for accepting the risk.
The word “underwritten” stems from the historical contract agreements in which the undersigned parties were responsible for the terms of the agreement, in which risk was transferred from one party to another.
Investment banks also engage in underwriting, but it is a different kind than insurance underwriting. Investment bank underwriting attempts to price and market a new issue of a security for a company or municipality.
It is a form of insurance in a way because, especially with an IPO, the investment bank is vouching for the valuation of the young company and putting some of their own resources and reputation on the line to help the company market the issue.
Also, the underwriting syndicate parties may agree to sell a certain allotment of the shares, and may bear the risk that the securities are not sold as promised.
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