Underwriting is the process of determining the eligibility of an individual to get a loan from a financial institution or benefit from an insurance plan (Catlin, Peter and Walker 11). Financial and insurance companies take this process more seriously than any other process in their operations because they know that messing with it may lead to huge losses for their companies. The underwriting process, usually, falls into different categories depending on the area of service provision. The fields that commonly use underwriting are mortgages, normal loans and insurance (Catlin, Peter and Walker 11). These categories consider different aspects of the borrower when trying to ascertain his or her loan or insurance eligibility.
All the above categories of underwriting, usually, have common considerations when determining their clients’ eligibility. The aspects they share include checking the borrower’s income and financial performance (Catlin, Peter and Walker 11). However, loan and insurance underwriting vary in terms of other aspects of the underwriting process. For example, loan underwriting involves analyzing the borrower’s loan history, debt to income ratio and the nature of their jobs. It also considers their sources of income. On the other hand, insurance underwriting is more concerned with the sizes of risks and the likelihood of their occurrence (Drucker and Puri 12). Both the insurance companies and banks are likely to encounter losses in case problems occur in the process of repaying the loans and remitting their premiums. The losses are likely to occur because of “deteriorations in the terms and conditions, the gap between the target and the technical price, negotiation leakages and the likelihood of retaining the account during the renewal process” (Catlin, Peter and Walker 11). This paper analyzes the similarity between banks and insurance companies. Precisely, it looks at how they take risks with the purpose of making profits.
Firstly, both the insurance companies and banks give loans without paying much attention to the possible deterioration of the terms and conditions between them and their clients. Many of such institutions give out their services basing on current financial and physical conditions. However, the terms and conditions can change either in favor of the lender or the borrower. Sometimes, the terms change but none of the two parties benefits from the change. In case the terms and conditions change in favor of the borrower, the lender is likely to incur unforeseen losses (Catlin, Peter and Walker 11). In the context of banks, the value of the currency used in the initial transactions may change suddenly due to inflation or other factors. Sometimes, the government also decides to lower the interest rates for all the banks in the country. Such changes can also cause huge losses to very many banks. Insurance underwriting can also cause serious losses when companies make errors during the underwriting process. Sometimes, insurance companies confirm that certain risks will not occur in the lifetime of an individual only for it to occur after agreeing to cover the individual (“Life Assurance” 25).
Secondly, both the insurance companies and banks analyze the amount of income an individual makes every month. This information helps insurance companies determine the amount of money their clients need to pay as down payments and monthly premiums. They also consider other financial aspects of the client in order to arrive at their absolute monthly income. Knowing the client’s net income ensures that the premiums they come up with are realistic (Drucker and Puri 9). On the other hand, banks consider their clients’ monthly income and debt-income ratios before agreeing on the amounts the clients should pay as principal and monthly payments (“Life Assurance” 25). They also consider other sources of income in their analysis. However, many risks can still occur and prevent the clients from remitting their payments according to the agreement. For example, the client can be retrenched and become unable to pay the monthly installments or premiums. Switching of jobs or resignation may also complicate matters because the new occupations are likely to change the terms of the agreement between the lender and the borrower.
Thirdly, both the insurance companies and banks always consider the future when making agreements with their clients (Malinovskii 887). For example, the insurers always work out the probability of the occurrence of certain risks before accepting to cover their clients against them. Therefore, the underwriting process aims at helping them avoid risks that may require large amounts of money (Catlin, Peter and Walker 12). It also helps them determine the most appropriate insurance plan for each of their clients. In many occasions, they cover their clients against risks that are less likely to occur. Similarly, banks that offer mortgages and other loans prepare for unforeseen risks by asking their clients to provide securities for their loans (Drucker and Puri 8). In the provision of mortgages, banks use the assets they buy for their clients as securities. In case the borrowers are not able to repay the loans as agreed, the bank sells the property with the purpose of retrieving their money.
Insurance companies also risk making losses due to their pricing (Catlin, Peter and Walker 11). Sometimes, the lack of consistency in the process of underwriting forces companies to set their prices below their target prices (Catlin, Peter and Walker 12). Some banks lower their lending rates with the purpose of attracting more customers only to realize that their rates are not good enough to earn profits (Malinovskii 887). Worse still, natural catastrophes may occur and force both the banks and insurance companies to alter their prices. For example, Hurricane Katarina forced insurance companies to review their prices in order to avoid losses caused by an increase in the number of people in need of medication. Banks also encountered many unpaid loans due to the inability of the victims of the hurricane to repay the loans.
In conclusion, underwriting is a crucial process to the insurer, bank and the borrower. Insurance companies and banks benefit from underwriting since it helps them determine whether an individual is eligible for loans and insurance covers or not. Therefore, they must be thorough because carrying out the underwriting process inappropriately may lead to serious losses in banks and insurance companies. Such losses are likely to occur if the banks and insurance companies give loans to people who do not qualify for them. Both banks and insurance companies take risks when offering their services to their clients because the terms and conditions can change before the borrowers are through with the repayment process. Worse still, mistakes in the pricing of their services can also cause massive losses. Hence, there is need for caution when carrying out the underwriting process.
Catlin, Tanguy, Peter John and Peter Walker. Managing through the P&C Cycle. New York: McKinsey & Company, 2008. Print.
Drucker, Steven, and Manju Puri. The Tying of Lending and Equity Underwriting. Cambridge: National Bureau of Economic Research, 2004. Print.
“Life Assurance: Underwriting.” Journal of the Staple Inn Actuarial Society, 27 (1984): 25. Print.
Malinovskii, Vsevolod. “Reflexivity in Competition-Originated Underwriting Cycles.” Journal of Risk and Insurance, 81.4 (2013): 883-906. Print.