What is Financial Underwriting?
Financial underwriting is an important part of the process when applying for financial products including mortgages, loans secured against any property, such as in the case of second charge mortgages and insurance products. Understanding a reasonable degree of the detail behind the underwriting process in the UK, what the aim of carrying out financial underwriting is, why it is necessary at all and how it may or may not affect your application is useful throughout your application.
From the outset and even before making an application for a mortgage or any product that entails this decision-making process, it is important to remember that the exact process of underwriting for your chosen product or mortgage will be dependent on the lender that you are taking out the loan or policy with and the product itself.
For example, if the product in question is a second charge or other mortgage, the process will to some extent be governed by Financial Conduct Authority (FCA) standards and regulations, whereas other products may not be so.
What are the Aims of Financial Underwriting?
Underwriting is carried out to ensure that the amount that has been agreed to be lent to a borrower is appropriate, affordable and accurate, by assessing their income and levels of cover that the customer has.
It is ultimately a way of helping to make sure that a customer can make their payments as required as well as to also prevent cases of fraud and money laundering. In summary, financial underwriting assesses suitability for the cover (in the case of insurance) or funding (in the case of loans, lines of credit and mortgages) that has been requested, or if new cover is requested in the case of insurance by a customer, whether the reasons for requesting such cover make financial sense. This is also a strong consideration in mortgages, as not all mortgages for all intended purposes will be funded.
Also, it is lenders rather than brokers who carry out the underwriting process. Financial brokers make the introduction and set the ball rolling between the borrower and the lender. Therefore, the responsibility for underwriting and the necessary lending checks and criteria sit with the lender, although you may find some brokers who may carry out a degree of soft credit check.
The Stages of Financial Underwriting in the UK
The typical process of financial underwriting throughout the UK, generally involves two stages:
- The first stage will involve a financial adviser who makes the decision as to the suitability of the product that the customer has chosen according to their needs
- The second stage involves a financial underwriter who will look at further financial information of the applicant to assess whether they should be approved or declined for credit
Financial underwriting is used to assess personal cover protection, business protection and relevant life cover. In each of these categories, different financial underwriting processes are used and in mortgages, the process and considerations are again, different to other financial products in the UK. Furthermore, specific mortgages such as home improvement loans in the UK are likely to have different underwriting criteria to each other.
Personal Cover Financial Underwriting
Whilst it is possible for a customer to request any level of personal protection cover (within reason) when it comes to insurance, financial underwriters will check to see if the cover requested is in fact based on the individual's needs; providing cover for both now and the required degree of flexibility in the future if circumstances should dictate. This therefore takes affordability into account by looking at incomes as well as liabilities.
For example, someone requesting a life cover insurance policy may entail financial underwriters to look at the applicant’s salary as well as the number of years they have until retirement as part of the process of underwriting. With higher earners, there may be a maximum level of cover that may then be operated.
When it comes to mortgage protection (involving life cover) the underwriter will likely assess the mortgage amount requested too, to assess affordability and repayments for the prospective borrower.
Inheritance Protection Underwriting
When it comes to Life Cover for Inheritance Tax (IHT), the underwriter will look at providing cover that is equal to the applicant's potential inheritance tax liability once all tax relief and any applicable allowances have been taken into consideration.
This may include the following:
- Charitable donations
- Agricultural property
- Business property
Business Protection Financial Underwriting
Whilst the exact rules when it comes to business protection underwriting differ from company to company, the general process remains fairly similar in terms of how they assess clients.
Key Person Protection
With key person protection, a financial underwriter assesses whether the cover given is based on the estimated amount a business owner would need in order to replace lost profits so that profitability is restored, as well as taking into account other costs such as training expenses and recruitment.
The method used is typically based on calculating the loss of turnover as well as savings and any payments for a replacement over the period of expected loss.
However, they may use other methods such as multiplying profits; based on the key person’s absence or upon a multiple of the key person’s salary and any benefits included in this package. It may also be necessary to look at the key person's contribution to the overall turnover of a company.
Other criteria used by financial underwriters in order to determine eligibility may involve the following:
- That the business has been trading for at least three years
- Other than the directors of the company, it should have at least seven employees
- The life that is being insured is less than a 50% shareholder
- The person being covered is a key person to the business
- The business must not be operating at a loss
Share Purchase and Partnership Protection
The amount provided for this kind of life or critical illness cover will most likely be based upon the current value of the company’s shares. Financial underwriters may use a number of different ways in order to determine the valuation of a company’s shares, such as:
- Average Net Profits
- Price Earnings Ratio (PER): this is the share price divided by all the earnings per shareholder
- Net Asset Value (NAV): this is the valuation of a business’s assets by including the value of the building, any stock as well as liabilities