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what is under reporting | under reporting is a term describing the crime of intentionally reporting less income or revenue than was actually received companies and individuals chiefly under report their incomings in an effort to avoid or reduce their respective tax liabilities under reporting is not a victimless crime in fact the billions of dollars of tax loss revenue caused by under reporting reduces the funds the federal government relies on to finance social security medicare and a host of other programs understanding under reportingif a struggling public company experiences a sharp drop in its share price it may report even lower revenues for a fiscal quarter than it actually earned during that time period this is done merely for optical purposes the trick is to hide revenues and then subsequently lump those hidden figures with the revenues in the following quarter s earnings statement so that onlookers are led to believe that the company has rebounded and is now in much better shape the appearance of a more successful quarter can inspire investors and ultimately boost a company s stock price naturally this form of under reporting is also an illegal practice companies listed on stock exchanges aren t the only culprits in fact in most cases it s usually self employed filers and those who earn cash income that are most likely to under report their incomes the primary goal here is to reduce tax liabilities and pocket a higher percentage of any money made wage and salary employees typically do not under report their incomes because their earnings are usually directly reported to the irs by third parties namely their employers during the 1990s the internal revenue service irs estimated that as much as 84 of cash tips worth hundreds of millions of dollars each year were going unreported and in 2019 the u s tax authority revealed that under reporting accounted for about 352 billion of the united states 441 billion tax gap the difference between taxes owed and taxes actually paid in the 2011 2013 tax years under reporting accounted for approximately 80 of the u s tax gap in the 2011 2013 tax years consequences of under reportingindividuals and companies that are caught under reporting may be subject to fiscal penalties and in extreme cases might even face criminal charges however it s important to remember that under reporting is only a crime if offenders willfully disregard the tax code if this action occurs due to negligence or calculation errors the irs could penalize the under reporting company or individual without initiating criminal action against those parties for example if a waitress one night distractedly back pockets a few bills rather than consolidating them with the rest of her take this act of negligence won t likely result in criminal punishment only if investigators determine that willful tax evasion or fraud has occurred will that waitress be at risk of a felony conviction | |
what is underapplied overhead | the term underapplied overhead refers to a situation that arises when overhead expenses amount to more than what a company actually budgets for in order to run its operations underapplied overhead is normally reported as a prepaid expense on a company s balance sheet and is balanced by inputting a debit to the cost of goods sold cogs section by the end of the year costs of goods sold are the direct cost associated with the production of goods sold by a company the amount of underapplied overhead is referred to as an unfavorable variance understanding underapplied overheadbefore looking at how underapplied overhead works it s important to define overhead costs the term overhead is used to describe the costs associated with running a business more specifically these are expenses that a business incurs for its day to day operations but are not directly linked to the creation of a product or service overhead is important for businesses for a number of reasons including budgeting and how much to charge their customers in order to realize a profit underapplied overhead occurs when a business doesn t budget enough for its overhead costs this means the budgeted amount is less than the amount the business actually spends on its operations for example when a company incurs 150 000 in overhead after budgeting only 100 000 it has an underapplied overhead of 50 000 this is referred to as an unfavorable variance because it means that the budgeted costs were lower than actual costs put simply the business went over budget making the cost of goods sold more than expected as noted above underapplied overhead is reported on a company s balance sheet as a prepaid expense or a short term asset this debit item on the balance sheet must be offset at a future date in order to reconcile this the company s accounting department generally inputs a debit by the end of the year to the cogs section and a credit to the prepaid expenses section | |
when underapplied overhead appears on financial statements it is generally not considered a negative event rather analysts and interested managers look for patterns that may point to changes in the business environment or economic cycle should unfavorable variance or outcomes arise because not enough product was produced to absorb all overhead costs incurred managers will first look for viable reasons these may be explained by expected hiccups in production business or seasonal variation | the initial predetermined overhead cost rate is calculated by taking the budgeted overhead costs divided by the budgeted activity special considerationsanalyzing underapplied overhead takes on greater significance for certain businesses such as manufacturing often as part of standard financial planning and analysis fp a activities careful review on underapplied overhead can point to meaningful changes in operational and financial conditions these can be useful in assessing capital budgeting decisions and the allocation of limited resources from time money and human capital advancements in electronic inventory and production management systems have greatly eased the burden of comprehensive operational reporting often including underapplied overhead analysis these improvements allow managers to better assess key operational metrics underapplied overhead vs overapplied overheadunderapplied overhead is the opposite of overapplied overhead overapplied overhead occurs when expenses incurred are actually less than what a company accounts for in its budget this means that a company comes in under budget and achieves a lower amount of overhead costs during the accounting period businesses must account for overapplied overheads as well this is recorded in the opposite manner that underapplied overhead is on the balance sheet first noted as a credit to the overhead section which is then offset by a credit on the cogs section and debit on the overhead section by the end of the fiscal year | |
what does underbanked mean | underbanked refers to individuals or families who have a bank account but often rely on alternative financial services such as money orders check cashing services and payday loans rather than on traditional loans and credit cards to manage their finances and fund purchases 1 this may be because they lack access to convenient affordable banking services or because they need or prefer to use alternatives to traditional financial services understanding the underbankedthe majority of people use banks to conduct routine financial transactions banks offer public checking accounts for everyday use to make deposits withdrawals and transfers and to pay bills savings accounts and other investment vehicles offer consumers a place to store their money and earn interest banks also offer consumers a variety of credit facilities such as loans and mortgages people who have a bank account but also tap into alternative financial services such as short term payday loans check cashing services and prepaid debit cards are typically referred to as the underbanked some households are considered unbanked because they don t use banks or financial services at all | |
how many people are underbanked in the u s | according to a 2021 federal reserve frb report on the economic well being of u s households in 2020 13 of adults in the u s were underbanked while 5 were unbanked 2 those results marked an improvement on 2018 when the frb found that 16 of u s adults were underbanked and 6 were unbanked 1the federal deposit insurance corporation fdic runs its own survey on how households use banking services the fdic revealed that an estimated 5 4 of u s households were unbanked in 2019 meaning that 94 6 of u s households had at least a checking or savings account 3in its 2019 report the fdic broke down the financial services activities of the population but unlike in previous years stopped short of providing a specific percentage figure of underbanked households 4 in 2017 the government agency put its estimate of underbanked at 48 9 million adults or 18 7 of u s households down from 19 9 in 2015 5the frb and the fdic s numbers cannot be directly compared as they define the underbanked somewhat differently 6who are the underbanked the frb has stated that both the unbanked and underbanked are more likely to have low income less education or be in a racial or ethnic minority group 1 among the underbanked 21 had a family income of under 25 000 vs 5 with incomes over 100 000 and 24 didn t have a high school degree vs 8 with a bachelor s degree or more in terms of race ethnicity 27 of blacks and 21 of latinx were underbanked vs 9 of whites 2 | |
when it comes to applying for credit the frb survey showed that americans with incomes under 50 000 per year were much more likely to be denied traditional bank credit than those with incomes over 100 000 39 vs 9 respectively in every income bracket black and latinx individuals were more likely to experience an adverse credit outcome than white applicants 2 | community development financial institutions cdfis provide loans to home buyers and businesses in rural impoverished and disadvantaged communities the fdic study came to similar conclusions regarding links between the underbanked and lower income lower education levels and less access to credit it also explored bill payment methods finding that 11 9 of households used money orders 5 5 used cashier s checks and 4 9 used bill payment services such as those offered by western union and moneygram to pay their bills 7both the frb and the fdic have found over the years that households with less predictable and more volatile income were more likely to be underbanked than those with a steady paycheck 24 | |
what is an underbanked customer | an underbanked customer is someone who has a bank account but often relies on alternative sources such as money orders check cashing services and payday loans to manage finances | |
what is the difference between unbanked and underbanked | underbanked households have a bank account but regularly use alternative financial services unbanked households on the other hand do not even have a checking or savings account | |
why are so many people underbanked | there are lots of possible explanations an obvious one is that traditional financial services are not always accessible to everyone for example banks may have deposit minimums or fees that are a barrier or they may have stringent loan criteria whereas payday loan operators are generally more lenient moreover banks may not advertise their services much or at least not as aggressively as alternative sources do | |
what is undercapitalization | undercapitalization occurs when a company does not have sufficient capital to conduct normal business operations and pay creditors this can occur when the company is not generating enough cash flow or is unable to access forms of financing such as debt or equity undercapitalized companies also tend to choose high cost sources of capital such as short term credit over lower cost forms such as equity or long term debt investors want to proceed with caution if a company is undercapitalized because the chance of bankruptcy increases when a company loses the ability to service its debts | |
how undercapitalization works | being undercapitalized is a trait most often found in young companies that do not adequately anticipate the initial costs associated with getting a business up and running being undercapitalized can lead to a significant drag on growth as the company may not have the resources required for expansion leading to the eventual failure of the company undercapitalization can also occur in large companies that take on significant amounts of debt and suffer from poor operating conditions if undercapitalization is caught early enough and if a company has sufficient cash flows it can replenish its coffers by selling shares issuing debt or obtaining a long term revolving credit arrangement with a lender however if a company is unable to produce net positive cash flow or access any forms of financing it is likely to go bankrupt undercapitalization can have a number of causes such as examples of undercapitalization in small business | |
when starting a business entrepreneurs should conduct an assessment of their financial needs and expenses and err on the high side common expenses for a new business include rent and utilities salaries or wages equipment and fixtures licenses inventory advertising and insurance among others since startup costs can be a significant hurdle undercapitalization is a common issue for young companies | because of this small business startups should create a monthly cash flow projection for their first year of operation at least and balance it with projected costs between the equity the entrepreneur contributes and the money they are able to raise from outside investors the business should be able to be sufficiently capitalized in some cases an undercapitalized corporation can leave an entrepreneur liable for business related matters this is more likely when corporate and personal assets are commingled when the corporation s owners defraud creditors and when adequate records are not kept | |
what is undercast | undercast is a type of forecasting error that occurs when estimates turn out to be below realized values these estimates could apply to sales an expense line item net income cash flow or any other financial account understanding undercastcompanies try to predict their financial performance for the upcoming year they typically use forecasting models based on a variety of inputs including the economic environment past performance and any changes in legislation that could impact the business forecasts and budgets help a company determine how to best allocate resources confirm areas in the company that are working efficiently and highlight areas that need correction in the business process when a company in the private sector government agency or nonprofit organization prepares its budget for the upcoming year it relies on its best and most up to date information to estimate what the operational numbers will look like for the next 12 months typically the two main areas that a business aims to estimate are its revenues and its expenses this will indicate what it expects its profits to be for the upcoming year managers of businesses pull together all relevant information and make assumptions sometimes these assumptions are subject to greater degrees of uncertainty which may ultimately cause an undercast or overcast | |
when a company s actual results fall short of what was expected they have undercast that specific account an undercast situation is akin to budgetary slack and if undercasting occurs frequently the causes should be investigated | undercasting could be a reflection of a cautious or conservative management team particularly if its market or the general economy is in a state of flux continuous undercasting is a problem for a company as it means it does not strongly understand the business environment or its operational processes and is ineffectively deploying its resources based on poor estimates it should also be determined if undercast estimates are a result of compensation motives for example if the bonuses paid to managers are linked to how well they outperform the budget estimates they may purposely undercast the budget thereby ensuring that the actual results are better than the estimates examples of undercasta steel manufacturer forecasts 3 billion in sales for the year however due to the imposition of tariffs to protect the domestic industry from foreign imports which increases domestic sales the company realized 3 5 billion in sales the undercast amount of 500 million was due to an unforeseen change in legislation that helped the business as another example the management team of a technology firm estimates that profits will be 50 million however they also know that their bonuses will be tied to beating the estimated profit number therefore in reporting its profit estimates the management team reports 35 million ensuring that the actual profits will beat the reported estimate this 15 million undercast was done on purpose in a dishonest way so that management could secure their bonus that is tied to performance | |
what is underconsumption | underconsumption is the purchase of goods and services at levels that fall below the available supply understanding underconsumptionunderconsumption is an economic theory referring to recession and stagnation in this theory inadequate consumer demand in relation to the production of a particular good or service results in underconsumption underconsumption theories date back hundreds of years and have been largely replaced by modern keynesian economics and the theory of aggregate demand which is the total demand for goods and services in the economy at a particular time and price level underconsumption vs keynesian theoryunderconsumption asserts that consumption of less than is produced is caused by insufficient purchasing power and results in business depression furthermore the theory of underconsumption claims that because workers are paid a wage lower than they produce they cannot buy back what they produce therefore resulting in an inadequate demand for the product this can be rectified by government intervention specifically spending on public programs to restore the balance between production and consumption the keynesian theory addresses total spending in the economy and its effects on output and inflation and it was developed by the british economist john maynard keynes during the 1930s in an attempt to understand the great depression keynes advocated increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the depression keynesian economics is considered a demand side theory that focuses on changes in the economy over the short run the theory of underconsumption deems inadequate consumer demand to be the only source of recessions stagnation and other aggregate demand failures and therefore a capitalist economy tends toward a state of persistent depression because of this in contrast modern economic theories find that inadequate consumer demand does not automatically cause a recession because other factors including private fixed investments in factories machines and housing and government purchases and exports may counteract this situation example of underconsumptionan example of underconsumption is the automobile industry during the great depression during the 1920s increases in disposable income and the new affordability of automobiles resulted in more people purchasing cars increased demand led to the creation of a large number of independent auto dealers and manufacturers | |
underemployment is a measure of the total number of people in an economy who are unwillingly working in low skill and low paying jobs or only part time because they cannot get full time jobs that use their skills | underemployment as well as unemployment is counted in u s government reports in order to provide a truer picture of the health of the job market understanding underemploymentunderemployment is calculated by dividing the number of underemployed individuals by the total number of workers in a labor force there are two types of underemployment visible underemployment is underemployment in which an individual works fewer hours than is necessary for a full time job in their chosen field due to the reduced hours they may work two or more part time jobs in order to make ends meet the second type of underemployment is invisible underemployment it refers to the employment situation in which an individual is unable to find a job in their chosen field consequently they work in a job that is not commensurate with their skill set and in most cases pays much below their customary wage a third type of underemployment refers to situations in which individuals who are unable to find work in their chosen field quit the workforce altogether meaning they haven t looked for a job in the last four weeks per the bureau of labor statistics bls definition of not in the labor force 1the number of these workers skyrocketed during the onset of the economic crisis and lockdown in early 2020 which ultimately resulted in a substantial change in working conditions and coincided with a crash in the markets 234 it is statistically difficult to measure the third type of underemployment causes of underemploymentunderemployment can be caused due to several factors the period during and after a recession when companies downsize and lay off qualified workers is characterized by underemployment underemployment jumped to its highest levels in the recession resulting from the global outbreak crisis 5according to a bls report the number of underemployed individuals in the u s economy decreased from 9 million during the fourth quarter of 2018 to 8 2 million in the same period a year later on an overall basis the agency estimated that there were 95 million people not in the labor force including discouraged workers who had stopped looking for work in q4 19 6another cause of underemployment is changes in the job market due to shifts in technology as job descriptions change or jobs are automated laid off workers can be retrained or retired from the workforce those who do not have the resources or means to retrain themselves are generally susceptible to underemployment weaknesses of the unemployment ratethe unemployment rate counts those workers who are part of the labor force and actively seeking work but are currently without it the unemployment rate receives the majority of the national spotlight but that can be misleading as the main indicator of the job market s health since it does not account for the full potential of the labor force the u s unemployment rate was 13 3 as of may 2020 but at the same time the u s underemployment rate was 22 8 75 the unemployment rate is defined by the bls as including as a percentage of the labor force the labor force is the sum of the employed and unemployed 1 a measure of underemployment is needed to express the opportunity cost of advanced skills not being used or being underutilized | |
what s more the unemployment rate is calculated based solely on the labor force which does not include persons who are not seeking a job there are many instances in which a person is able to work but has become too discouraged with an unsuccessful job hunt to continue to actively seek a job the labor force participation rate is used to measure the percentage of the civilian population over the age of 16 who is working or seeking work | the bls compiles six different unemployment rates labeled u 1 through u 6 u 3 is the officially recognized unemployment rate but u 6 is a better representation of the job market as it accounts for discouraged workers who have left the labor force workers who are not utilizing their full skill set and workers who have part time employment but would rather be employed full time 1example of underemploymentfor example an individual with an engineering degree working as a pizza delivery man as his main source of income is considered to be underemployed also an individual who is working part time at an office job but would prefer to instead work full time is considered underemployed in both cases these individuals are underutilized by the economy as they in theory can provide a greater benefit to the overall economy | |
what is underemployment equilibrium | underemployment equilibrium also referred to as under employment equilibrium or below full employment equilibrium is a condition where employment in an economy persists below full employment and the economy has entered an equilibrium state that sustains a rate of unemployment above what is considered desirable in this state the unemployment rate remains consistently above the natural rate of unemployment or non accelerating inflation rate of unemployment nairu because aggregate supply and aggregate demand are in balance at a point below full potential output an economy that settles into an underemployment equilibrium is how keynesian theory explains the occurrence of a persistent depression in an economy the term underemployment in this sense simply refers to the fact that total employment is under the level of full employment underemployment itself is a distinct term that refers to employed workers who are working fewer hours than they would like or in jobs that require lower skills and often come with lower pay than their education level and experience would indicate underemployment may be included as one component of the general unemployment rate but is otherwise unrelated to the concept of an underemployment equilibrium though these two uses are often mistakenly conflated by those unfamiliar with economics understanding underemployment equilibriuman economy in long run equilibrium is one that is said to be experiencing full employment when an economy is below full employment it is not producing what it would have were it in full employment this state of underemployment means that there is a gap between actual and potential output in the economy in keynesian macroeconomic theory when an economy for whatever reason falls into a recession from a state of full employment it can then get stuck in a persistent situation where it finds a new balance between aggregate supply and aggregate demand with a lower total volume of output the original keynesian explanation for this revolved around the idea that uncertainty and fear in the wake of a recession could induce businesses and investors to reduce their level of investment in favor of holding cash or other liquid assets more or less permanently this reduction in investment would lead to both a reduction in aggregate demand from reduced investment spending on capital goods and a reduction in aggregate supply as the level of employment and general output fell as a result the economy would not bounce back and recover from a temporary recession but could settle into a steady state of elevated unemployment as aggregate demand and aggregate supply reached a new equilibrium at a lower level of output and employment this theory is in contrast to others such as walrasian general equilibrium which suggest that through the adjustment of prices and the actions of entrepreneurs pursuing opportunities the economy will adjust back toward equilibrium at full employment minus some natural rate of unemployment once the the recession and its associated negative real and financial shocks have passed keynes disputed these theories and later keynesian economists came up with further explanations as to why markets might not adjust back toward full employment after a recession such as the idea of price stickiness advocates of keynesian economics suggest that a solution to an underemployment equilibrium state is a fiscal policy of deficit spending and to a lesser extent monetary policy to stimulate the economy underemployment vs underemployment equilibriumthe term underemployment refers to a type of labor under utilization where a worker is employed but not producing at their full potential or working as much as they would like to underemployed workers may be working in part time jobs when they would prefer to work full time or may be working in low skilled low productivity jobs while they posses more advanced skills educational credentials or experience broad measures of unemployment reported by government statistical agencies may account for underemployment in addition to joblessness underemployment may have many of the same causes as unemployment but often also results from an oversupply of higher education relative to job opportunities or a mismatch of skills and education to available jobs beyond its contribution to the total rate of labor under utilization however underemployment itself is not related to the concept of an underemployment equilibrium and the two terms should not be confused with each other | |
what is an underfunded pension plan | an underfunded pension plan is a company sponsored retirement plan that has more liabilities than assets in other words the money needed to cover current and future retirements is not readily available this means there is no assurance that future retirees will receive the pensions they were promised or that current retirees will continue to get their previously established distribution amount an underfunded pension may be contrasted with a fully funded or overfunded pension understanding an underfunded pension plana defined benefit pension plan comes with a guarantee that the promised payments will be received during the employee s retirement years the company invests its pension fund in various assets in order to generate enough income to service the liabilities posed by those guarantees for both current and future retirees the funded status of a pension plan describes how its assets versus its liabilities stack up underfunded means that the liabilities or the obligations to pay pensions exceed the assets that have accumulated to fund those payments pensions can be underfunded for a number of reasons interest rate changes and stock market losses can greatly reduce the fund s assets during an economic slowdown pension plans are susceptible to becoming underfunded funding a pensionunder current irs and accounting rules pensions can be funded through cash contributions and by company stock but the amount of stock that can be contributed is limited to a percentage of the total portfolio no more than 5 of pension assets can be in any one company s stock 1companies generally contribute as much stock as they can in order to minimize their cash contributions however this practice is not sound portfolio management because it results in an overinvestment in the employer s stock the fund becomes overly dependent on the financial health of the employer even with the 5 limit such an amount in one company can make its success have a significant impact on the pension s success an underfunded pension plan should not be confused with an unfunded pension plan the latter is a pay as you go plan that uses the employer s current income to fund pension payments a plan is considered at risk for a plan year if the funding target attainment percentage for the preceding plan year is less than 80 and for the preceding year is 70 2the need to make this cash payment could materially reduce the company s earnings per share and therefore its stock price the reduction in company equity could even trigger defaults on corporate loan agreements this has serious consequences ranging from higher interest rate requirements to bankruptcy determining if a pension plan is underfundedfiguring out whether a company has an underfunded pension plan can be as simple as comparing the fair value of plan assets to the accumulated benefit obligation which includes the current and future amounts owed to retirees if the fair value of the plan assets is less than the benefit obligation there is a pension shortfall the company is required to disclose this information in a footnote in the company s 10 k annual financial statement 3there is a risk that companies will use overly optimistic assumptions in estimating their future obligations assumptions are necessary when estimating long term obligations a company may revise its assumptions as time goes on to minimize a shortfall and avoid the need to contribute additional money to the fund for example a company could assume a long term rate of return of 13 which would increase the funds expected to come from investments and reduce the need for a cash infusion in real life the long term return on stocks is about 10 and the return on bonds is even lower making the portfolio s overall return less than 10 4underfunded vs overfunded pensionsthe opposite of an underfunded pension is of course an overfunded pension a fund that has more assets than liabilities is overfunded actuaries calculate the amount of contributions a company must pay into a pension based on the benefits participants receive or are promised and the estimated growth of the plan s investments these contributions are tax deductible to the employer 5 | |
how much money the plan ends up with at the end of the year depends on the amount they paid out to participants and the investment growth they earned on the money as such shifts in the market can cause a fund to be either underfunded or overfunded | it is common for defined benefit plans to become overfunded in the hundreds of thousands or even millions of dollars an overfunded pension plan will not result in increased participant benefits and cannot be used by the business or its owners | |
when a defined benefit plan is overfunded it means that the plan has more assets than it needs to meet its payout obligations to employees this provides security for the future and can help the plan be prepared for more difficult times however the money is often trapped in the plan companies cannot pay it out to shareholders without incurring huge penalties they may be able to seek a balance sheet credit for it depending on the situation however pension funds are usually not considered a full asset | can i withdraw money from a defined benefit plan generally no you cannot withdraw money from a defined benefit plan before the allowed legal age some types of plans may have hardship withdrawals but the criteria is often extremely restrictive furthermore this is not allowed if a plan is underfunded people can however take loans against their defined benefit plan | |
what is the underground economy | the underground economy refers to economic transactions that are deemed illegal either because the goods or services traded are unlawful in nature or because transactions fail to comply with governmental reporting requirements the underground economy is called the shadow economy the black market or the informal economy understanding the underground economyit is difficult to accurately gauge the size of underground economies because by nature they re not subject to governmental oversight therefore the economic activity does not generate tax returns or appear in official statistical reports however tracking outgoing expenditures even though the transactions are cloaked can give a sense of statistics in other words the money spent that s not accounted for in recorded transactions theoretically represents the breadth of black market activity the american underground economy was estimated to have reached 1 trillion in 2009 representing approximately 8 of u s gross domestic product gdp however by 2013 largely due to the long term effects of the 2008 financial crisis and the resulting contraction of the formal economy underground economic expenditures reached an estimated 2 trillion estimates vary but studies show that the u s underground economy is 11 to 12 of gdp making the underground economy approximately 2 5 trillion in 2021 123global underground economiescompared to most other nations america s underground economy has stayed relatively flat according to findings published by a 2018 international monetary fund study which explored the shadow economic activity of 158 countries between 1991 to 2015 some of the chief takeaways of the report are as follows depending on the context the impact of underground economies can range from harmful to helpful for example in developing countries with large shadow economies the uncollected tax revenue can slow economic growth and hamper the creation of public programs however in other cases participants in underground economies who retain income that would usually go to taxes can boost overall economic activity and stimulate demand this situation holds especially true in nations where the withheld tax revenues would have been siphoned off by corrupt government officials | |
what is considered underground | the list of activities deemed to be underground economic transactions varies depending on the laws of a given jurisdiction for example in some countries alcohol is banned while other nations encourage legal brewery distillery and distribution operations similarly while drugs are illegal in most countries some nations plus an increasing number of u s states have legalized the sale and use of cannabis in the early 1900s mexican immigrants introduced recreational marijuana use to the united states during the great depression high unemployment rates triggered fears of marijuana consumption which coupled with racist sentiments at the time led to research that linked marijuana to violent crime 5consequently by 1931 29 u s states outlawed the drug nonetheless many people deemed the plant to be harmless and continued buying and selling it illegally subsequent studies refuted the idea that marijuana was linked to crime while declaring that the drug was neither addictive nor a gateway to other drugs instead proponents argue marijuana has proven to be therapeutically helpful in treating illnesses such as cancer and aids 6as of 2022 37 states and the district of columbia have legalized the plant for medical use which is now abundantly present in some food products as well as many topical and oral medications as of 2022 18 states and d c allow for non medical regulated cannabis 7the irs considers money earned from babysitting as taxable self employment income and when the amount is greater than 400 for the year as of 2022 must be reported when the individual files their tax return 8meanwhile an estimated 53 2 of cigarette sales in new york state in 2018 latest figures were facilitated through underground economic transactions although tobacco is legal in new york city the product carries an exorbitant sin tax and so many sales go unreported or under the table 9all such under the table transactions in which participants fail to report their income to the irs or the state are technically considered to be underground economic activities this status can even apply to babysitters who don t report the cash that they pocket after watching a neighbor s child down the street other primary examples of underground economic activity include the untaxed sale of physical goods and the smuggling of goods into a country to avoid paying duties at the border human trafficking operations also comprise the underground economy as do the markets for copyrighted materials endangered animal species antiquities and illegally harvested human organs | |
which country has the largest underground economy | zimbabwe has the largest underground economy with approximately 60 6 of its economy made up of underground activities switzerland has the smallest underground economy making up 7 2 of its economy 4 | |
what are the characteristics of an underground economy | underground economies do not just include illegal activities such as the purchase and sale of banned drugs or the illegal sale of weapons it also includes any unreported income such as paying restaurant employees under the table or jobs such as babysitting that go unreported similarly any bartering that does not involve the exchange of cash and is not reported is considered part of the underground economy | |
why do people engage in the underground economy | there are a variety of reasons why people engage in the underground economy these reasons can be as simple as obtaining items that they can not legally buy such as outlawed drugs and weapons it can also be to avoid taxes labor laws and administrative paperwork | |
what is underinsurance | underinsurance refers to an insufficient insurance policy a good insurance policy won t prevent any of life s calamities but it should make the financial consequences easier to bear however underinsurance can leave the enrollee liable for a large financial expense if a serious event occurs whether it s a home damaged by a hurricane or fire or an insured person experiencing a serious disease or accident insurance should ideally cover enough of the expense that the policyholder can manage the difference | |
what happens when you re underinsured | you can be underinsured if your policy has gaps or exclusions that leave you without coverage or it could be that your claim exceeds the maximum amount that the insurance policy can pay out a lower benefits policy may seem attractive because you pay lower monthly insurance premiums but if the policy leaves you underinsured then the loss arising from a claim may far exceed any marginal savings in insurance premiums underinsurance can cause a serious financial crisis depending on the asset that is insured and the extent of the shortfall in insurance inflation extreme weather events and an increase in people s risk consciousness due to the covid 19 pandemic will trigger above average insurance premium growth in 2022 according to global insurance provider swiss re group 1underinsurance and residential insuranceinsurance costs for home and rental properties are on the upswing from 2017 to 2021 premiums reportedly rose an average of 12 2 nationwide lots of natural catastrophes coupled with more people moving into disaster prone regions and rising home repair and rebuilding costs are considered the main drivers of this rise in insurance costs 2the average annual homeowners insurance premium in 20213underinsurance for your home can cause a serious financial crisis depending on the amount of damage and the extent of the shortfall in insurance take for example a house and its contents that are insured against all risks for 250 000 with a deductible of 20 000 the house is subsequently destroyed in a fire and the cost to replace the residence and its contents comes to 350 000 that will require the homeowners to make up the difference of 100 000 plus the 20 000 deductible from their own resources if you can t purchase a policy because you live in a high risk area consider buying one through a fair access to insurance requirements fair program available in many states 4underinsurance and health insurancethe percentage of u s adults with no health insurance decreased from 20 in 2010 to an estimated 13 in 2020 thanks mainly to the affordable care act aca or obamacare however the percentage of adults who are underinsured increased from 16 in 2010 to 21 in 2020 5 | |
when individuals and families are underinsured they may have to take on debt to pay deductibles and medical bills they may postpone needed care avoiding seeing a doctor when they re sick skipping a test or treatment recommended by a doctor not seeing a specialist or not filling a prescription because of the cost | a person is considered underinsured if their out of pocket healthcare expenses are equal to or exceed 10 of their annual income 5 is they are considered low income or if their health plan deductible is more than 5 of their annual income according to the commonwealth fund roughly one quarter of americans with employer sponsored health insurance were underinsured in 2020 6choosing a health insurance plan often involves striking a balance between lower monthly premium levels which often mean higher deductibles and higher co pays and more comprehensive coverage this applies to choices in healthcare plans offered by an employer plans selected at healthcare gov and medicaid gov medicare supplement medigap policies and medicare part d prescription drug coverage in a lower premium bronze plan at healthcare gov for example you are responsible for 40 of your covered healthcare costs and the insurer pays about 60 in the highest premium platinum plans you pay 10 and the insurer pays 90 of your covered healthcare costs 7short term health plans were traditionally marketed to people who experience temporary gaps in coverage these plans are less costly than the lowest level plans at healthcare gov and can deny or restrict coverage for preexisting conditions in 2017 the trump administration changed the regulations so that anyone can sign up for a short term plan and expanded the length of time that these plans could be renewed 8short term health plans are not required to cover the package of 10 essential health benefits found in the aca 9 many of these plans don t cover maternity care or in many cases substance abuse treatment outpatient prescription drugs or mental health services people in short term healthcare plans are more likely to have coverage gaps when services are covered cost sharing may be very high for example a may 2020 study by the commonwealth fund calculated out of pocket costs for covid 19 patients who had short term plans in georgia louisiana and ohio for patients with a moderate case of the virus patient costs ranged from 14 600 to 17 750 for a severe case of covid patient costs ranged from 28 600 to 35 000 10 | |
what is meant by underinsurance | underinsurance basically refers to a person having insurance coverage but with a policy that won t pay out enough to cover the full expenses incurred when filing a claim for example if roy has his house insured for 200 000 but the cost to repair it in the event of a bout of bad weather would be at least 300 000 then he is underinsured in this case by 100 000 | |
how many americans are underinsured | according to the commonwealth fund 21 of u s adults had inadequate health insurance coverage in 2020 5who is most likely to be underinsured people most likely to be underinsured include those struggling to make ends meet and those without a decent understanding of how these products work insurance though a relatively simple concept is often wrapped in complex jargon and pages of fine print if not properly read and understood this could lead to big discrepancies between what is expected and what is actually offered | |
what is underinsured motorist coverage uim | underinsured motorist coverage is a type of auto insurance it protects you if you re in an accident caused by someone who doesn t have sufficient insurance of their own in general if the at fault driver s policy has a limit that s lower than the cost of the damage to your vehicle or your medical bills and you have uim coverage your insurance company will cover the remaining amount the definition of underinsured and how uim coverage works varies by state underinsured motorist coverage is required in some states and can be purchased as an endorsement on your car insurance policy in others 12underinsured motorist coverage is different from uninsured motorist coverage which covers cases in which the at fault driver has no insurance at all | |
how underinsured motorist coverage works | let s say you re in a car accident that wasn t your fault after making sure everyone s ok you exchange information with the other driver take photos of the damage and file a claim with your insurance company but when your insurer contacts the other driver s insurer for payment it turns out that they only carried the minimum amount of liability coverage which won t be enough to cover the repairs to your damaged car if you have underinsured motorist coverage it will kick in to cover the additional costs up to the limit of your policy underinsured motorist coverage typically includes two parts 2however in some states only uim bodily injury coverage is available 3you can t file a claim for more than the actual costs you had as a direct result of the accident benefits of underinsured motorist coverageliability insurance which pays for the cost of damages due to an accident for which you re at fault is required in every state except new hampshire virginia lets drivers opt out of purchasing insurance if they pay a 500 annual fee 4 each state sets its own required minimum coverage amounts but the state minimum amount may not be enough to cover the costs of repairing or replacing your car after a serious accident or to pay for medical bills as you recover from your injuries that s where underinsured motorist coverage can prove beneficial if you re in an accident where the driver who was found to be at fault does not have enough insurance to cover the cost of damages from the crash your uim coverage will pay for the rest up to your own policy limits 2some states and insurance companies allow you to stack or combine your coverage limits for um uim bodily injury coverage when you have multiple vehicles on the same policy for example if your policy covers two vehicles and each has a 35 000 uim coverage limit you may be able to stack them to create a limit of 70 000 after an accident 5 | |
where is underinsured motorist coverage required | uim coverage is required in connecticut kansas maine maryland minnesota nebraska north carolina north dakota oregon south dakota and vermont 1it s also required in new hampshire and virginia if you choose to purchase car insurance and in rhode island if you choose to carry more liability coverage than the state minimum 67 illinois requires you to buy uim coverage if you choose a um coverage limit higher than the state required minimum 8 new jersey requires uim if you choose a standard auto policy but not a basic policy 9 | |
what is covered by underinsured motorist coverage | underinsured motorist coverage typically has two parts uim bodily injury covers medical bills and may cover lost wages and uim property damage covers the costs to repair or replace your vehicle both coverages apply to costs over the limit of the at fault driver s insurance however only uim bodily injury coverage is available in some states 3 if you re not sure what s required where you live ask your state s department of motor vehicles or your insurance agent | |
does underinsured motorist insurance cover hit and runs | no uim coverage doesn t apply to hit and run accidents because this type of coverage applies when the driver doesn t have enough insurance since a hit and run driver wasn t identified they re typically classified as an uninsured motorist and um coverage usually applies in some states you may also need collision coverage if you re not sure check with your insurance agent 10the bottom lineunderinsured motorist coverage protects you when after an accident caused by a driver who doesn t have enough insurance to cover the costs of your medical bills and property damage it s required in some states and available as an optional endorsement in others | |
what is the underinsured motorist coverage limits trigger | the underinsured motorist coverage limits trigger is one of the two triggers that can be specified by an insured party to protect against losses caused by an accident with a driver who has insufficient insurance the underinsured motorist coverage limits trigger ensures coverage in the event of an accident caused by a driver with inadequate insurance and when the underinsured driver s liability limit is lower than that of the insured person or policyholder the other trigger for underinsured motorist coverage is known as the damages or coverage trigger understanding the underinsured motorist coverage limits triggerdrivers purchase auto insurance for several reasons such as the risk of their car becoming damaged in an accident the risk of damaging another person s car or the risk of killing or injuring another person but one risk that is sometimes neglected by drivers is the possibility that they might be injured or have their car damaged by another driver who has failed to take out adequate auto insurance in that instance the policyholder might have a legitimate claim against the at fault driver but be unable to collect damages after all if the at fault driver does not have the necessary assets or insurance they might simply declare bankruptcy leaving little or nothing for the victim to collect to protect against this risk drivers can purchase underinsured motorist coverage as part of their auto insurance policy this supplemental insurance covers property damages bodily injury to the policyholder as well as injuries to insured family members or passengers if a claim needs to be filed the endorsement can cover the difference between the coverage paid by the at fault driver s insurance and the full amount owing under vs un insured motorist coveragenote that underinsured motorist coverage is not the same as uninsured motorist um coverage which would cover a situation in which the at fault driver did not have any insurance however these two types of coverage are often bundled together either separately or together they are usually a relatively inexpensive add on to an auto insurance policy but provide beneficial coverage in 2015 approximately one out of eight drivers were under insured according to the insurance research council which tracks data on drivers 2 in many states being uninsured is illegal in fact every state with the lone exception of new hampshire makes it illegal to not carry some form of auto insurance 1 underinsured coverage is better than no coverage at all example of underinsured motorist coverage limits triggerassume an insured person has underinsured motorist coverage up to 500 000 with a limits trigger in the event of an accident with an at fault driver who only has 100 000 of insurance coverage an insurance claim of 150 000 would result in the policy holder s underinsured motorist coverage kicking in because of the limits trigger | |
what is an underinsured motorist endorsement | in the insurance industry an underinsured motorist endorsement is a type of supplemental insurance commonly purchased as part of an automobile insurance policy its purpose is to provide additional coverage to the policyholder in the event of an accident resulting from another driver whose policy does not cover the total costs of the accident | |
how underinsured motorist endorsements work | drivers purchase auto insurance for several reasons such as the risk of their car becoming damaged in an accident the risk of damaging another person s car or the risk of killing or injuring another person but one risk that is sometimes neglected by drivers is the possibility that they might be injured or have their car damaged by another driver who has failed to take out adequate auto insurance in that instance the policyholder might have a legitimate claim against the at fault driver but be unable to collect damages after all if the at fault driver does not have the necessary assets or insurance they might simply declare bankruptcy leaving little or nothing for the victim to collect to protect against this risk drivers can purchase underinsured motorist endorsements as part of their auto insurance policy this supplemental insurance policy covers property damages bodily injury to the policyholder as well as injuries to insured family members or passengers if a claim needs to be filed the endorsement can cover the difference between the coverage paid by the at fault driver s insurance and the full amount owing in a scenario where the at fault driver has no insurance and no personal assets to pay for the claim the endorsement would therefore cover the entire amount of the claim up to the maximum coverage level specified in the policy in many states drivers are required by law to purchase underinsured motorist endorsements although it is sometimes referred to using different terms in some cases this coverage only applies when the at fault driver has no auto insurance at all as opposed to covering the gap between their coverage and the claim amount although the precise insurance requirements vary from state to state they typically last from six to twelve months and are renewable thereafter as with most insurance policies the insurance premiums associated with the coverage will vary based on factors such as the policyholder s age years of driving history and history of claims real world example of an underinsured motorist endorsementto illustrate consider a situation where driver a gets into an accident with driver b the at fault driver in this scenario is driver a and the full damages associated with the incident amount to 175 000 unfortunately driver a only has 100 000 of coverage but thankfully driver b has an underinsured motorist endorsement for this reason driver a s insurance pays 100 000 out of the 175 000 total whereas driver b s insurance pays the remaining balance of 75 000 because driver b purchased an underinsured motorist endorsement he is able to receive the full 175 000 and be made whole | |
what is the underinvestment problem | the underinvestment problem is an agency problem proposed by financial economists that exists between shareholders and debt holders in which a leveraged company foregoes valuable investment opportunities because debt holders would capture a portion of the benefits of the project leaving insufficient returns to the equity shareholders the underinvestment problem explainedpotential conflicts of interest between managers stockholders and debtholders influence capital structure corporate governance activities and investment policies these types of agency problems in turn can give rise to inefficient managerial decisions and suboptimal investments that generally fall under the categories of problems of underinvestment and overinvestment the underinvestment problem in corporate finance theory is credited to stewart c myers of the sloan school at mit who in his determinants of corporate borrowing article 1977 in the journal of financial economics hypothesized that a firm with risky debt outstanding and which acts in its stockholders interest will follow a different decision rule than one which can issue risk free debt or which issues no debt at all myers adds that the firm financed with risky debt will in some states of nature pass up valuable investment opportunities opportunities which could make a positive net contribution to the market value of the firm the underinvestment problem moves into focus when a firm frequently passes up net present value npv projects because the managers acting on behalf of shareholders believe that creditors would benefit more than owners if cash flows from a prospective investment go to creditors then there would be no incentive to equity holders to proceed with the investment such an investment would increase the overall value of the firm but it does not happen hence there is a problem contradicting the modigliani miller theoremthe underinvestment problem theory is at conflict with the theoretical assumption in the modigliani miller theorem that investment decisions can be made independent of financing decisions managers of a leveraged company myers argues do in fact take into consideration the amount of debt that needs to be serviced when evaluating a new investment project according to myers the value of the firm can be influenced by financing decisions in contradiction to modigliani miller s central tenet the underinvestment problem and debt overhangone instance of the underinvestment problem is known as a debt overhang when a firm has a very large level of debt there comes a point when it can no longer borrow from creditors any longer the debt burden is so large in fact that any and all earnings that come into the company immediately go directly to paying off existing debt instead of going into new investments or projects limiting the growth of the company it leads to underinvestment in the firm as a result shareholders lose out both to creditors in the present and to future lost growth potential as well debt overhangs also apply to national governments where the sovereign debt of a nation exceeds its future capacity to repay it a debt overhang can lead to stagnant growth and the degradation of living standards from underinvestment in critical areas such as healthcare education and infrastructure | |
what is underlying | underlying when used in equity trading is the common stock that must be delivered when a warrant is exercised or when a convertible bond or convertible preferred share is converted to common stock the price of the underlying is the main factor that determines the prices of derivative securities warrants and convertibles therefore a change in the price of the underlying results in a simultaneous change in the price of the derivative asset linked to it understanding underlyingunderlying applies to both equities and derivatives derivatives contracts are typically structured around the price or value of another asset such as a stock price in this case the stock is the underlying asset of the derivative when the price of the underlying stock goes up the market price of the derivative may go up or down as well in futures contracts the underlying is a commodity such as gold oil or wheat if those commodities markets face a disruption the futures that use that commodity as an underlying will also be affected convertibles are also structured around an underlying asset sometimes using derivative like features these are debts that may be repaid like bonds or under certain conditions may also be repaid in company shares since the value of the shares will affect the value of the convertible the shares are described as the underlying asset to the convertibles while commonly used to refer to assets an underlying can also be an interest rate a benchmark or even another derivative financial derivativesthe term underlying appears most often in relation to derivative contracts which are often structured around another asset options trades represent one of the most popular derivatives trades in which traders make sophisticated bets on the future price of certain stocks or commodities if the terms of the contract are met the trader can make a profit however the underlying of a derivative is not always an asset there are also derivatives whose underlying is a benchmark index interest rate or another important financial metric when this metric rises or falls the derivatives that use the metric as an underlying see price gains or drops the underlying can even be another derivative many interest rate swaps use the secured overnight financing rate sofr to exchange cash flows between two entities when the sofr benchmark rate rises the value of the swap changes as well pros and cons of underlying | |
when investing in derivatives it is important to understand the investment characteristics of the underlying asset or index each asset bears its own risk profile that also affects the contracts that use it as an underlying stocks are affected by investment risk bonds carry default risk and other derivatives are affected by market risk | however underlying assets tend to be less volatile than their derivatives the value of a call or put option could fall to zero as it approaches expiration while stock prices can also swing they are unlikely to lose value entirely | |
when an asset is used as the underlying of a derivative or futures contract this has the advantage of providing additional liquidity and volume to the market for that asset that might not have been available in the spot market | for example when a trader buys or sells an options contract they are trading an obligation to buy or sell the underlying security if the option is exercised someone will have to buy that security thereby increasing the liquidity of the market the main disadvantage is the danger that underlying assets could be adversely affected by speculation in the derivatives markets during the 2007 housing crisis real estate prices soared due in part to speculative trading in mortgage backed securities and highly complicated derivatives contracts when the derivative bubbles collapsed prices of the underlying assets crashed as well derivatives trading provides additional liquidity and volume to underlying spot marketsunderlying assets benefit from having a well organized and structured trading market underlying assets tend to be less volatile than their derivatives speculative behavior can adversely affect underlying assets each underlying asset has its own risk profile that can affect its derivatives types of underlyingsunderlyings can vary in many different ways based on the derivative contract some of the more common here are the main types of underlyings limitations of underlyingsthe concept of a derivative market would not be able to exist without underlying however there are some constraints regarding the execution of derivative contracts for instance the fact that a security may be illiquid may simply change the value of the derivative contract though that may not necessarily be the point of the contract in certain markets participants may actually be able to manipulate the underlying asset there may be some logistical challenges with underlyings for commodity underlyings physical storage and delivery present practical challenges for other forms of physical underlying it may be challenging to store insure protect and ensure the asset does not go obsolete or stolen as the derivative contract runs its course on the other hand technological risks are pertinent for digital and cryptocurrency underlying despite even the most robust cybersecurity efforts hacking fraud and technical failures can severely impact asset values or cause underlying assets to be lost there may be many efficiencies to trading digital underlying but electronic assets present themselves unique challenges as well example of underlyingtwo of the most common types of derivatives are referred to as calls and puts a call derivative contract gives the owner the right but not the obligation to buy a particular stock or asset at a given strike price if company a is trading at 5 and the strike price is hit at 3 the price of the stock is trending up the call is theoretically worth 2 in this case the underlying is the stock priced at 5 and the derivative is the call priced at 2 a put derivative contract gives the owner the right but not the obligation to sell a particular stock at a given strike price if company a is trading at 5 and the strike price is hit at 7 the price of the stock is trending down the put is trading 2 in the money and is theoretically worth 2 in this case the underlying is the stock priced at 5 and the derivative is the put contract priced at 2 both the call and the put are dependent on price movements in the underlying asset which in this case is the stock price of company a | |
what happens when the price of an underlying asset increases | price changes to an underlying asset usually cause price changes to their derivatives as well for example a call option represents the right to buy a certain stock for a certain price if the underlying stock is priced 3 higher than the strike price the option has a price of around 3 if the underlying falls below the strike price at the time of expiration the option has a value of 0 | |
is a share an underlying asset | shares can be underlying assets if a derivative is structured around them shares are commonly used as the underlying asset for call and put options which represent sophisticated bets on the future stock price shares can also be underlying for convertible debt which can be converted to shares if certain conditions are met | |
what are the primary underlying assets | the most common underlying assets are stocks commodities bonds and currencies however there are also derivatives with more abstract underlying values such as interest and benchmark rates the bottom lineunderlyings in financial derivatives are the assets or securities from which derivatives derive their value these can be assets ranging from equities commodities currencies interest rates indices or real estate to name a few | |
what is an underlying asset | underlying asset are the financial assets upon which a derivative s price is based options are an example of a derivative a derivative is a financial instrument with a price that is based on a different asset | |
what is underlying debt | underlying debt is a municipal bond term that relates to an implicit understanding that the debt of smaller government entities might have backing from the creditworthiness of larger government entities in the jurisdiction understanding underlying debton their own these smaller entities might have a hard time raising funds if they don t have a robust financial position however the implicit backing of larger entities facilitates borrowing by smaller entities and allows them to obtain lower interest rates on their obligations people consider the municipal bonds to be the underlying debt of the backing entity the underlying debt situation of smaller municipal debts being implicitly backed by larger governmental entities is quite common in practice this occurs where smaller entities like cities and school districts offer bonds to the public to finance operations and new initiatives if a smaller entity is unable to repay its debts it is unlikely that the city or school district will simply be allowed to become insolvent and cease operations rather it is expected that the state will intervene to provide emergency funding to continue debt service and maintain essential services underlying debt applies to general obligation municipal bonds which are backed by the taxing authority of the issuer or in the case of underlying debt the authority of the larger government entity this sharing of credit responsibilities generally acts as a credit enhancement for the bond issuer when ratings agencies such as standard poor s and moody s assign an underlying rating for these issuers the ratings reflect the characteristics of the issuer on a standalone basis 12in addition the carrying of underlying debt is considered in the rating of larger municipal issuers specifically their ability to meet all financial obligations including underlying debt and to make scheduled interest payments on time if a smaller entity is having trouble meeting its obligations the rating of the larger entity carrying the underlying debt can be negatively impacted examples and risks of underlying debtseparate municipalities within a city or country may issue their own debt obligations to finance projects such as hospitals roads schools or sanitation facilities in many cases the city or county carries these obligations as underlying debt this is the case in illinois where the state relies on the taxing authority of the legislature to back bonds issued by chicago underlying debt can create additional risks for the larger entity backing the debt as was the case in the state of new york in the 1970s when new york city nearly went insolvent 3 | |
what is an underlying mortality assumption | underlying mortality assumptions are projections of expected death rates used by actuaries to estimate insurance premiums and pension obligations this is based on mortality tables which are statistical tables of expected annual mortality rates because of the critical importance of the underlying mortality assumption actuaries have to follow guidelines set by pension and insurance regulators in deciding on an appropriate assumption also called the mortality assumption understanding the underlying mortality assumptionthe underlying mortality assumption is a key variable in estimating life expectancies which in turn determines the cost of insurance for an insurer and the long term obligations of a pension fund if the underlying mortality assumption is too low a life insurer may underestimate the actual cost of insurance and may have to pay out more in death benefit claims than it had forecast conversely if the underlying mortality assumption is too high the actuary may underestimate life expectancies of the pension plan members and hence the long term obligations of the pension fund for most people death is the last thing they want to think about for life insurers and pension administrators it s the first thing they think about any good actuary can tell you that people often misjudge the statistics about mortality they don t understand that mortality at birth and mortality in advanced age are two different things special considerationsaccording to the centers for disease control 2020 data the death rate per 100 000 population is 835 4 life expectancy at birth was 77 years and the infant mortality rate was 541 9 deaths per 100 000 live births 1the leading causes of death were 2for males life expectancy changed from 76 3 in 2019 to 74 2 in 2020 for females life expectancy fell from 81 4 to 79 9 the life expectancy for females was consistently higher than it was for males 1once you make it to advanced age a new set of statistics comes into play in 2020 life expectancy at age 65 for the total population was 18 5 years a decline from 19 6 in 2019 for males life expectancy at age 65 was 17 0 in 2020 down from 18 2 in 2019 and for females it was 19 8 down from 20 8 in 2020 1 | |
what is underlying security | an underlying security is a stock or bond on which derivative instruments such as futures etfs and options are based it is the primary component of how the derivative gets its value understanding underlying securityin derivative terminology the underlying security is often referred to simply as the underlying an underlying security can be any asset index financial instrument or even another derivative the infamous collateralized debt obligations cdos and credit default swaps cds which were front and center in the financial crisis of 2008 are also derivatives that depend on the movement of an underlying not all stocks will have underlying option chains the role of the underlying security is merely to be itself if there were no derivatives traders would simply buy and sell the underlying however when it comes to derivatives the underlying is the item that must be delivered by one party in the derivative contract and accepted by the other party the exception is when the underlying is an index or the derivative is a swap where only cash is exchanged at the end of the derivative contract there are many widely used and exotic derivatives but they all have one item in common which is their basis on an underlying security or underlying asset price movements in the underlying security will necessarily affect the pricing of the derivative based upon it for example a call option on alphabet inc googl stock gives the holder the right but not the obligation to purchase alphabet stock at a price specified in the options contract in this case alphabet stock is the underlying security traders use derivatives to either speculate on or hedge against the future price movements of the underlying the more complex a derivative the more significant the degree of speculation and hedging for example options on futures are bets on the future price of the futures contract which in itself is a bet on the future price of the underlying underlying security examplelet s say we are interested in buying a call option on microsoft corp msft buying a call gives us the right to buy shares of msft at a certain price during a certain period of time generally speaking the value of the call option will increase alongside an increase in the share price of msft because the call option is a derivative its price is tied to the price of msft in this case msft is the underlying security the underlying is also crucial to the pricing of derivatives the relationship between the underlying and its derivatives is not linear although it can be generally speaking for example the more distant the strike price for an out of the money option is from the current price of the underlying the less the option price changes per unit of movement in the underlying also the derivative contract may be written so that its price may be directly correlated or inversely correlated to the price of the underlying security a call option is directly correlated a put option is inversely correlated | |
what is underlying profit | underlying profit is a calculation made internally by a company to show what it believes is a more accurate reflection of how much money it generates the number focuses on regular accounting cycle events and often excludes one time charges or infrequent occurrences underlying profit differs from the required accounting profit that is recorded on financial statements and other mandatory documents that follow preset practices rules and regulations | |
when companies publish their financials generally accepted accounting principles gaap require them to disclose how much profit they generated this is calculated by subtracting all dollar costs from revenue the same calculation used to determine how much income tax to pay | often companies will choose to supplement this figure with their own calculation underlying profit is designed to offer a more useful indicator of performance on a year by year basis stripping out unusual non recurring costs such as natural disaster damage charges irons out random fluctuations and should in theory make it easier for investors to get a better idea of how the company s profit from its everyday standard business operations varies over several fiscal years companies often use underlying profit figures for business planning purposes the goal here is to eliminate any distractions caused by random occurrences losses or gains that do not regularly crop up such as restructuring charges or the buying or selling of land or property are usually not taken into account because they do not occur often and as a result are not deemed to reflect the everyday costs of running the business in general only regular operating expenses considered to be predictable or required will be deducted from gross sales in order to arrive at the underlying profit they can include the following example of a one time event removed for the calculation of underlying profitif a company is in full ownership of two buildings and one is currently in use while one is sitting vacant it may choose to sell the vacant building while the sale of this asset must be recorded for standard accounting purposes it is excluded from the calculation of underlying profit the sale of a large asset such as a building is not a standard part of the business s operation and is not expected to occur again soon though it has resulted in a form of income it is not likely to be repeated in subsequent accounting cycles for the company advantages of underlying profitaside from giving investors an indication of how much money a company makes from its standard business operations underlying profit is also used by management for business planning a business plan is a functional road map providing direction as to how the company will operate and is often the founding document drafted by new ventures from an accounting perspective the business plan also denotes the expected expenses that must be covered over a particular period of time | |
when determining what operating costs can be reasonably covered a business may prefer to remove any one time or highly irregular financial transactions that may falsely inflate profit norms this creates a plan based on more common occurrences that can be anticipated | disadvantages of underlying profiteach company has its own version of underlying profit taking the accounting profit and then making adjustments as it sees fit without clear guidelines on how to report underlying profit these figures cannot be relied on to compare different firms full freedom also means some of these calculations can be called into question on occasions firms exclude items that have a negative impact on gaap earnings over several quarters and then promote their underlying profit figure actively as if it is the only number that merits attention it is important for investors to recognize the difference between accounting profit and underlying profit and gain a solid understanding of how the latter was calculated companies will disclose this information in their financial statements using the underlying profit figure can come in handy alongside other financials when assessing whether to invest in a company that said approach with caution and be sure to determine exactly why certain expenses were ignored before taking the figure at face value | |
what is underlying retention | underlying retention is the net amount of risk or liability arising from an insurance policy or policies that is retained by a ceding company after reinsuring the balance amount of the risk or liability the degree of underlying retention will vary depending on the ceding company s assessment of the risks involved in retaining part of the policy liability and the profitability of the insurance policy understanding underlying retentionunderlying retention enables an insurer to avoid payment of the reinsurance premium the insurer will generally retain the most profitable policies or their lowest risk components while reinsuring less profitable higher risk policies reinsurance also known as insurance for insurers or stop loss insurance is the practice of insurers transferring portions of risk portfolios to other parties by some form of agreement to reduce the likelihood of paying a large obligation resulting from an insurance claim reinsurance allows insurers to remain solvent by recovering some or all of amounts paid to claimants reinsurance reduces net liability on individual risks and catastrophe protection from large or multiple losses it also provides ceding companies the capacity to increase their underwriting capabilities in terms of the number and size of risks by covering the insurer against accumulated individual commitments reinsurance gives the insurer more security for its equity and solvency and more stable results when unusual and major events occur insurers may underwrite policies covering a larger quantity or volume of risks without excessively raising administrative costs to cover their solvency margins in addition reinsurance makes substantial liquid assets available for insurers in case of exceptional losses underlying retention in reinsuranceunder proportional reinsurance the reinsurer receives a prorated share of all policy premiums sold by the insurer when claims are made the reinsurer bears a portion of the losses based on a pre negotiated percentage the reinsurer also reimburses the insurer for processing business acquisition and writing costs with non proportional reinsurance the reinsurer is liable if the insurer s losses exceed a specified amount known as the priority or retention limit as a result the reinsurer does not have a proportional share in the insurer s premiums and losses the priority or retention limit may be based on one type of risk or an entire risk category excess of loss reinsurance is a type of non proportional coverage in which the reinsurer covers the losses exceeding the insurer s retained limit this contract is typically applied to catastrophic events covering the insurer either on a per occurrence basis or for the cumulative losses within a set time period under risk attaching reinsurance all claims established during the effective period are covered regardless of whether the losses occurred outside the coverage period no coverage is provided for claims originating outside the coverage period even if the losses occurred while the contract was in effect example of underlying retentionsuppose that an insurance company has a reinsurance treaty limit of 500 000 it chooses to retain 200 000 worth of insurance risk as its underlying retention that retained portfolio consists mostly of policies that are worth much less and carry significantly lower risk for example the company may choose to retain claims less than 100 000 which carry significantly less risk in its portfolio on the other hand policies that for greater amounts averaging say 100 00 in payouts are reinsured thus the reinsurer saves money on premium payments for low risk policies | |
what is underlying security | an underlying security is a stock or bond on which derivative instruments such as futures etfs and options are based it is the primary component of how the derivative gets its value understanding underlying securityin derivative terminology the underlying security is often referred to simply as the underlying an underlying security can be any asset index financial instrument or even another derivative the infamous collateralized debt obligations cdos and credit default swaps cds which were front and center in the financial crisis of 2008 are also derivatives that depend on the movement of an underlying not all stocks will have underlying option chains the role of the underlying security is merely to be itself if there were no derivatives traders would simply buy and sell the underlying however when it comes to derivatives the underlying is the item that must be delivered by one party in the derivative contract and accepted by the other party the exception is when the underlying is an index or the derivative is a swap where only cash is exchanged at the end of the derivative contract there are many widely used and exotic derivatives but they all have one item in common which is their basis on an underlying security or underlying asset price movements in the underlying security will necessarily affect the pricing of the derivative based upon it for example a call option on alphabet inc googl stock gives the holder the right but not the obligation to purchase alphabet stock at a price specified in the options contract in this case alphabet stock is the underlying security traders use derivatives to either speculate on or hedge against the future price movements of the underlying the more complex a derivative the more significant the degree of speculation and hedging for example options on futures are bets on the future price of the futures contract which in itself is a bet on the future price of the underlying underlying security examplelet s say we are interested in buying a call option on microsoft corp msft buying a call gives us the right to buy shares of msft at a certain price during a certain period of time generally speaking the value of the call option will increase alongside an increase in the share price of msft because the call option is a derivative its price is tied to the price of msft in this case msft is the underlying security the underlying is also crucial to the pricing of derivatives the relationship between the underlying and its derivatives is not linear although it can be generally speaking for example the more distant the strike price for an out of the money option is from the current price of the underlying the less the option price changes per unit of movement in the underlying also the derivative contract may be written so that its price may be directly correlated or inversely correlated to the price of the underlying security a call option is directly correlated a put option is inversely correlated | |
what is an underpayment penalty | an underpayment penalty is a fine charged by the internal revenue service irs when taxpayers don t pay enough of their estimated taxes due during the year don t have enough withheld from their wages during the year or pay late the underpayment is reported and the fine is applied when the taxpayer completes the annual tax return taxpayers must generally pay at least 90 of their taxes due during the previous year to avoid an underpayment penalty the fine can grow with the size of the shortfall taxpayers can consult irs instructions for form 2210 to determine whether they re required to report an underpayment and pay a penalty | |
how underpayment penalties work | the tax law requires that taxpayers make payments as they receive income throughout the year for employees estimated taxes are withheld from paychecks based on information the employee provides in a w 4 form self employed people and business owners are required to file quarterly tax returns and pay estimated taxes due for the period others who must file quarterly include people with investment income and landlords | |
how to avoid an underpayment fine | the best way to avoid an underpayment penalty is to ensure that your taxes are fully paid on time to avoid an underpayment penalty individuals whose adjusted gross income agi is 150 000 or less must pay the lesser of 90 of the current year s tax or 100 of last year s tax by combining estimated and withholding taxes 1individuals whose agi for the preceding taxable year exceeds 150 000 must pay the lesser of 90 of the tax due for the current year or 110 of the tax on the individual s return for the prior taxable year 2the underpayment penalty is owed when a taxpayer underpays the estimated taxes or makes uneven payments during the tax year that do not correspond to the taxpayer s current income for a period 3a penalty will not be imposed if the underpayment penalty may also be waived for several other reasons including taxpayers with self employment income need to take into account their liability for social security and medicare taxes when calculating the amounts due some taxpayers such as sole proprietors partners and s corporation shareholders must pay taxes in four equal payments during the year although they can do so more frequently taxpayers who receive their income unevenly may be able to pay different amounts quarterly in some cases taxpayers can use irs form 2210 to determine if their payments of withholding and estimated taxes during the year are sufficient to avoid a penalty 3 | |
how the fine works | taxpayers must pay the difference plus a penalty that is calculated based on the outstanding amount owed and how long the amount has been overdue the penalty isn t a static percentage or a flat dollar amount it s based on several factors including the total underpayment amount and the period during which taxes were underpaid underpayments are subject to the failure to pay penalty which is 0 5 of the amount owed for each month and the part of a month for which the tax is not paid 4the underpayment failure to pay penalty is capped at 25 of the unpaid amount 4tax underpayments and overpayments accrue interest as well the irs determines the interest rate every quarter generally basing it on the federal short term rate plus three percentage points for most taxpayers the rates were 8 for individual underpayments and 7 for large corporate underpayments for the fourth quarter q4 of 2023 and the first quarter q1 of 2024 56example of an underpayment penaltyif you owed 5 000 in taxes for the year but only paid 2 000 you would have underpaid your taxes by 3 000 you paid less than 90 of what you owed so you would be subject to an underpayment penalty the penalty would be the federal short term rate at the time plus three percentage points that would add up to about 8 or 240 as of mid 2024 special considerationsyou may qualify for a reduced underpayment penalty even if you don t qualify for the exceptions to the underpayment penalty for example an individual who changes their tax filing status from single to married filing jointly may get a reduced penalty due to the larger standard deduction a reduction might also be extended to taxpayers who generate significant portions of their income late in the calendar year for example if a taxpayer sold an investment in december triggering a substantial capital gains tax the penalty might not be applied 7sometimes the irs might make an error in assessing interest or a penalty against a taxpayer taxpayers can file form 843 to request the correction of the error | |
what were the underpayment penalties for the 2023 tax year | the irs underpayment penalty was 7 for most underpayments and 9 for large corporate underpayments through the first three quarters of 2023 89 it increased to 8 in the fourth quarter 6 | |
what are irs safe harbor rules | irs safe harbor rules allow you to avoid a penalty or pay a reduced penalty if you meet certain conditions an underpayment penalty with the irs can be avoided if you owe less than 1 000 or pay more than 90 of your tax obligation for the year 1can you make estimated tax payments all at once some taxpayers such as sole proprietors partners and s corporation shareholders must pay taxes at least quarterly if they will owe more than 1 000 these payments are referred to as estimated tax payments you cannot pay estimated tax payments all at once unless you do so at the beginning of the year you can pay monthly in advance if that suits your budget better 10the bottom lineyou could end up paying an underpayment penalty if you don t pay enough in estimated taxes tax withholding or taxes due check to see if you qualify for an exemption or reduced penalty if you re charged a penalty the best way to avoid underpayment penalties is to be sure that you pay your taxes on time meaning around the time you earn it not the following april if all or nearly all of your income is from an employer you shouldn t have an underpayment problem if you do check the details on your w 4 form for errors that caused your employer to withhold less than necessary from your paycheck | |
what is underperform | if an investment is underperforming it is not keeping pace with other securities in a rising market for example a stock is underperforming if it is not experiencing gains equal to or greater to the advance in the s p 500 index in a down market a stock that is a falling faster than the broader market is an underperformer underperform is also an analyst recommendation assigned to a stock when shares are expected to do slightly worse than the market return the designation is also known as market moderate sell or weak hold understanding the underperform designationexact definitions vary between brokerages but an underperform rating is worse in general than neutral but better than sell or strong sell a security might receive the underperform designation if it does not meet or exceed a metric it is being compared against the comparison might be against the overall market a competing company or an index a variety of other issues could bring the underperform rating such as concerns about the company s debt levels price to earnings ratios or loss of market share examples of underperform ratingan industry might be described as underperforming for example the utilities industry might receive this designation because the growth of economy may boost the industry yet inflation could result in higher interest rates which would be a negative for the utility sector similarly the real estate market might have seen low interest rates drive investment in real estate investment trusts but rising rates can change that dynamic those factors could create a circumstance where an industry is not generating returns to the full potential and an underperform rating is warranted a specific stock is assigned an underperform rating by an analyst if there are concerns that shares will not keep pace with others for various reasons but those worries do not warrant an outright sell rating for example though a company sees growth or positive earnings for a quarter or for the year those returns might not be on a par with the market so if an automobile manufacturer reports a total return of 12 for its fiscal year while the s p 500 sees a 23 total return for that year the auto manufacturer could be classified as underperform depending on the brokerage house an outlook rating of underperform can have different degrees of meaning at charles schwab for instance an outlook of underperform also carries a sell guidance if a company receives a strongly underperform outlook from the firm it will also receive the sell guidance 1 these ratings can mean there is an expectation that the stocks will not meet benchmarks | |
what is underpricing | underpricing is the practice of listing an initial public offering ipo at a price below its real value in the stock market when a new stock closes its first day of trading above the set ipo price the stock is considered to have been underpriced underpricing is short lived because investor demand will drive the price upwards to its market value understanding underpricingan initial public offering ipo is the introduction of a new stock for public trading on a stock exchange its purpose is to raise capital for the future growth of the company determining the offering price requires a consideration of many factors quantitative factors are considered first those are the numbers real and projected on cash flow nevertheless there are two opposing goals at play the company s executives and early investors want to price the shares as high as possible in order to raise the most capital and reward themselves most lavishly the investment bankers who are advising them may hope to keep the price low in order to sell as many shares as possible since higher volume means higher trading fees for them ipo pricing is far from an exact science so underpricing an ipo is equally inexact the process mixes facts projections and comparables in theory any ipo that increases in price on its first day of trading was underpriced whether it was deliberate or accidental the shares may have been deliberately underpriced to boost demand or the ipo underwriters may have underestimated investor demand overpricing is much worse than underpricing a stock that closes its first day below its ipo price will be labeled a failure an ipo can be underpriced if its sponsors are genuinely uncertain about the reception that the stock will receive after all in the worst case the stock price will immediately climb to the price that investors consider that it s worth investors willing to take a risk on a new issue are rewarded the company s executives are pleased that is considerably better than the company s stock price falling on its first day and its ipo being blasted as a failure whether it was underpriced or not once the ipo debuts the company becomes a publicly traded entity owned by its shareholders shareholder demand will determine the stock s value in the open market going forward | |
what is undersubscribed | undersubscribed refers to a situation in which the demand for an issue of securities such as an initial public offering ipo or another offering of securities is less than the number of shares issued undersubscribed offerings are often a matter of overpricing the securities for sale or on account of poor marketing of the securities to potential investors this situation is also known as an underbooking and may be contrasted with oversubscribed when demand for an issue exceeds its supply understanding undersubscribedan offering is undersubscribed when the underwriter is not able to get enough interest in the shares for sale because there may not be a firm offering price at the time purchasers usually subscribe for a certain number of shares this process allows the underwriter to gauge demand for the offering called indications of interest and determine whether a given price is fair typically the goal of a public offering is to sell at the exact price at which all the issued shares can be sold to investors and there is neither a shortage nor a surplus of securities if the demand is too low the underwriter and issuer might lower the price to attract more subscribers if there is more demand for a public offering than there is supply shortage it means a higher price could have been charged and the issuer could have raised more capital on the other hand if the price is too high not enough investors will subscribe to the issue and the underwriting company will be left with shares it either cannot sell or must sell at a reduced price incurring a loss factors that can cause an undersubscriptiononce the underwriter is sure it will sell all of the shares in the offering it closes the offering then it purchases all the shares from the company if the offering is a guaranteed offering and the issuer receives the proceeds minus the underwriting fees the underwriters then sell the shares to the subscribers at the offering price sometimes when underwriters can t find enough investors to purchase ipo shares they are forced to purchase the shares that could not be sold to the public also known as eating stock although the underwriter can influence the initial price of the securities they don t have the final say on all the selling activity on the first day of an ipo once the subscribers begin selling on the secondary market the free market forces of supply and demand dictate the price and that can also affect the initial selling price on the ipo underwriters usually maintain a secondary market in the securities they issue which means they agree to purchase or sell securities out of their own inventories in order to protect the price of the securities from extreme volatility | |
what is undersubscribed | undersubscribed refers to a situation in which the demand for an issue of securities such as an initial public offering ipo or another offering of securities is less than the number of shares issued undersubscribed offerings are often a matter of overpricing the securities for sale or on account of poor marketing of the securities to potential investors this situation is also known as an underbooking and may be contrasted with oversubscribed when demand for an issue exceeds its supply understanding undersubscribedan offering is undersubscribed when the underwriter is not able to get enough interest in the shares for sale because there may not be a firm offering price at the time purchasers usually subscribe for a certain number of shares this process allows the underwriter to gauge demand for the offering called indications of interest and determine whether a given price is fair typically the goal of a public offering is to sell at the exact price at which all the issued shares can be sold to investors and there is neither a shortage nor a surplus of securities if the demand is too low the underwriter and issuer might lower the price to attract more subscribers if there is more demand for a public offering than there is supply shortage it means a higher price could have been charged and the issuer could have raised more capital on the other hand if the price is too high not enough investors will subscribe to the issue and the underwriting company will be left with shares it either cannot sell or must sell at a reduced price incurring a loss factors that can cause an undersubscriptiononce the underwriter is sure it will sell all of the shares in the offering it closes the offering then it purchases all the shares from the company if the offering is a guaranteed offering and the issuer receives the proceeds minus the underwriting fees the underwriters then sell the shares to the subscribers at the offering price sometimes when underwriters can t find enough investors to purchase ipo shares they are forced to purchase the shares that could not be sold to the public also known as eating stock although the underwriter can influence the initial price of the securities they don t have the final say on all the selling activity on the first day of an ipo once the subscribers begin selling on the secondary market the free market forces of supply and demand dictate the price and that can also affect the initial selling price on the ipo underwriters usually maintain a secondary market in the securities they issue which means they agree to purchase or sell securities out of their own inventories in order to protect the price of the securities from extreme volatility | |
what is undervalued | undervalued is a financial term referring to a security or other type of investment that is selling in the market for a price presumed to be below the investment s true intrinsic value the intrinsic value of a company is the present value of the free cash flows expected to be made by the company an undervalued stock can be evaluated by looking at the underlying company s financial statements and analyzing its fundamentals such as cash flow return on assets profit generation and capital management to estimate the stock s intrinsic value in contrast a stock deemed overvalued is said to be priced in the market higher than its perceived value buying stocks when they are undervalued is a key component of famed investor warren buffett s value investing strategy understanding undervaluedvalue investing is not foolproof however there is no guarantee as to when or whether a stock that appears undervalued will appreciate there is also no exact way to determine a stock s intrinsic value which is essentially an educated guessing game when someone says that a stock is undervalued all they are essentially saying is that they believe the stock is worth more than the current market price but this is inherently subjective and may or may not be based on a rational argument from business fundamentals an undervalued stock is believed to be priced too low based on current indicators such as those used in a valuation model should a particular company s stock be valued well below the industry average it may be considered undervalued in these circumstances value investors may focus on acquiring these investments as a method of pulling in reasonable returns for a lower initial cost whether a stock is actually undervalued or not is open to interpretation if a valuation model is inaccurate or applied in the wrong way it could mean the stock is already properly valued value investing and undervalued assetsvalue investing is an investment strategy that looks for undervalued stocks or securities within the marketplace with the goal of purchasing or investing them since the assets can be acquired at a relatively low cost the investor hopes to improve the likelihood of a return additionally the value investing methodology avoids purchasing any items that may be considered overvalued in the marketplace for fear of an unfavorable return undervaluation subjectivity and efficient marketsthe idea that a stock can be persistently undervalued or overvalued in such a way that an investor can consistently achieve above market returns by trading on these mispriced stocks notably conflicts with the idea that the stock market makes fully efficient use of all available information if a stock were truly of greater intrinsic value than its market price and this was readily ascertainable from its financial statements then all market traders would have an immediate incentive to buy the stock and in doing so bid up the price to its intrinsic value in other words if markets are efficient then finding a truly undervalue stock should be near impossible unless one has inside information not available to other market participants this means that an investor who thinks a given stock is undervalued is inherently making a subjective judgment contrary to the rest of the market barring insider information it also means that the existence of successful value traders who can consistently outguess the market would be a challenge to the idea that markets are efficient value investing vs values based investingvalues based investing is the concept of buying shares in companies based on an investor s personal values it different from value investing that looks for underpriced stocks in this investment strategy the investor chooses to invest based on what they personally believe in even if market indicators do not support the position as profitable this can include avoiding investments in companies with products that they do not support and directing funds to those they do for example should an investor be against cigarette smoking but support alternative fuel sources they would invest their money accordingly this type of investing implies that the investor considers first whether the product and sector are in line with their values | |
what does underwater mean | underwater is the term for a financial contract or asset that is worth less than its notional value more commonly though the term is used in relation to a house or another substantial asset which has an outstanding mortgage or loan on the asset that is a larger amount than what the asset is worth in either case the holder has an asset without intrinsic value in the case of the mortgage or loan the holder of the asset actually owes more than the asset is worth underwater is sometimes also referred to as upside down understanding underwateran asset is underwater if the price paid for it is more than its current market valuation broadly speaking any paper unrealized loss relates to an underwater asset more commonly underwater relates to leverage or borrowing where it means owning an asset that is worth less than an outstanding loan on that asset in securities trading this could happen in a margin account where a trader owns a stock on leverage but the company stock declares bankruptcy and the stock holdings no longer cover the margin or loan the broker provided to buy the stock initially the account is underwater and the investor will need to find funds somewhere else to pay back the money loan they lost in the stock market this is known as a margin call such a situation can also occur with a non financial asset if a new car is purchased with a loan the purchase almost immediately results in the buyer being underwater because the car will depreciate immediately once it is driven off the lot while the loan will be paid down slowly over years eventually as more payments are made and the car depreciates at a slower rate the car will be back above water for example in 10 years the loan is paid off but the owner can probably sell the car for a few thousand dollars depending on the make and condition of the vehicle special considerationsbeing underwater on a loan isn t always a horrible thing as long as payments are made the loan is paid down and the underwater situation may end up being temporary that said underwater situations can be mostly avoided by looking for a margin of safety in regards to the asset being purchased and the loan amount getting a good deal on a house or car where the value of the asset could be sold for more than what is paid given some time will mean the loan amount is smaller and there is a larger buffer between the asset s value and the loan amount this means the asset would need to fall in value more in order to be underwater compare that to a couple that overpays for a house paying 300 000 in a bidding war for a house that is really only worth 280 000 depending on how much they put down they could be underwater immediately or if housing prices fall they could be underwater substantially in a short amount of time missing payments or incurring additional fees for violating the terms of the loan can increase the loan amount owing quickly this can cause a loan to move underwater or deeper underwater lenders are often willing to work out solutions with borrowers if the financial struggles are short term as the lender doesn t want to have to go through the struggle of selling an underwater asset to only partially pay back a loan at a loss if dealing with financial problems talk to a financial planner debt counselor and or the lender to help find a solution before the problem gets worse underwater mortgagesin real estate underwater refers to the situation where a house or other property is worth less than the money owed on the loan an underwater mortgage is thus a home loan with a higher principal than the free market value of the home this situation can occur when property values are falling in an underwater mortgage the homeowner may not have any equity available for credit an underwater mortgage can potentially prevent a borrower from refinancing or selling the home unless they have the cash to pay the loss out of pocket this negative value presents problems for both the homeowner and the holder of the mortgage if the homeowner needs to move the sale of the home will not produce sufficient monies to pay the mortgage holder even before any transaction fees in this case the homeowner must find additional funds or enter into a short sale with a third party these types of problems in turn lead to legal battles and possible difficulties down the road for both the original homeowner and the third party lender while a short sale does complicate the process by which the original lender recovers their money a more significant problem with underwater mortgages emerged after the housing bubble in 2006 07 and bust in 2008 09 homeowners owing more than their home s value quietly walked away from their investments this resulted in mortgage defaults leaving the lending banks with losses and the added expenses of liquidating their acquired homes 1underwater mortgages were a common problem among homeowners around the height of the 2008 financial crisis which among other things involved a substantial deflation in housing prices assume a person sees a house they like listed at 400 000 they have 40 000 for a downpayment or 10 not including other fees and mortgage insurance which will mean some of the downpayment won t be going to the principal for simplicity assume that the buyer gets a loan for 360 000 using the mortgage and downpayment the buyer pays for the house several months after the purchase they notice similar houses in their area are selling for substantially less than 400 000 similar homes called comparables are selling for 350 000 the loan value of 360 000 has only dropped incrementally to 359 000 as much of the initial payments go to interest and not principal yet the house is only worth 350 000 if the house was sold it could not pay off the loan this is referred to as being underwater or upside down if the housing market stabilizes eventually the loan will be paid down and the property loan will no longer be underwater being underwater a small amount or for a short period of time isn t a major issue being underwater for a long time and by a large amount indicates a poor purchase poor timing or poor market conditions possibly all three the house could be underwater for a number of reasons possibly the homebuyer overpaid in the first place the house may have only been worth 350 000 all along but the seller asked more and the buyer was willing to pay it alternatively the property value may have dropped 400 000 may have been a good price at the time but a recent downturn in the economy means fewer jobs and not as many people being able to afford their homes forced to sell property values are driven down property values often deteriorate slowly but can move quickly in certain areas for example a small town may see property values plummet very quickly if the main source of employment say a plant or mine closes | |
what is an underwater mortgage | an underwater mortgage is a home purchase loan with a higher principal than the free market value of the home this situation can occur when property values are falling in an underwater mortgage the homeowner may not have any equity available for credit an underwater mortgage can potentially prevent a borrower from refinancing or selling the home unless they have the cash to pay the loss out of pocket breaking down an underwater mortgageunderwater mortgages were a common problem among homeowners around the height of the 2008 financial crisis which among other things involved a substantial deflation in housing prices 1 while the market has greatly recovered due to support from monetary policy and interest rate stabilization underwater mortgages are still a factor that property owners must follow closely when making a real estate investment generally a mortgage is considered underwater when the value of the home is less than the original mortgage principal 2 depending on the decrease in the value of the home since its purchase the borrower may also have no equity or negative equity equity on a home is associated with the value of the home versus the balance paid a borrower with a 250 000 mortgage that sees their home value decrease to 225 000 is considered to have an underwater mortgage if the borrower has paid half of the principal on their mortgage loan resulting in a principal balance of 125 000 then they still are considered to have positive equity of 100 000 which could be utilized in a home equity loan the 2008 financial crisisthe 2008 financial crisis had numerous effects on the u s economy one such effect was a bursting housing bubble that substantially deflated real estate property values across the market a primary catalyst for the housing value deflation was loose lending standards for borrowers providing for broader mortgage loan approvals this loose lending specifically to subprime borrowers led to a heightened number of defaults and foreclosures which effected real estate property values across the u s market this led to a variety of uncommon situations causing losses for borrowers across the market whose mortgage loan values exceeded their home s fair market value subsequently monetary policy implementation from the federal reserve helped the u s economy to recover and housing prices to rebound lower interest rates following the crisis also helped to reduce mortgage payment burdens and increase some demand for real estate 3assessing home valuegiven new market initiatives from the dodd frank legislation helping to improve mortgage lending standards 4 it is not likely that homebuyers will again see the substantial real estate price drops that occurred in 2008 however the 2008 financial crisis did cause a new sense of market realization and caution across real estate investing as such lenders are now more cautious about the mortgages they approve and homeowners are generally more careful about the mortgage debt they take on even with a new outlook on the market though homeowners still must closely follow home values and mitigate underwater mortgage risks to maintain a good understanding of a home s value a homeowner may choose to have the property appraised annually appraisals are also done regularly to calculate property taxes an appraisal value will be based on a number of factors which may include national market trends recent sales by similar properties in the region and neighborhood as well as the home s individual amenities homeowners can also work to maintain a high home value for their home by doing regular renovations and actively supporting positive community activities in the event that someone finds themselves stuck with an underwater mortgage working with one of the best mortgage refinancing companies is a solid way to potentially rid themselves of this burden | |
what is underweight | underweight refers to one of two situations in regard to trading and finance an underweight portfolio does not hold a sufficient amount of a particular security when compared to the weight of that security held in the underlying benchmark portfolio underweight can also refer to an analyst s opinion regarding the future performance of a security in scenarios where it is expected to underperform understanding underweightwhile an underweight portfolio can be identified through simple mathematics by determining what percentage of a portfolio is directed towards a particular asset an underweight stock is identified on more flexible terms based on the variables chosen by the analyst who is making the determination underweight portfoliosan underweight portfolio occurs when the percentage or weight of a particular security within the managed portfolio is lower than what is held in the benchmark portfolio for example if the benchmark portfolio held a particular security with a weight of 20 and the investor portfolio only held a 10 weight in that security it would be deemed to be underweight in the security in question a portfolio manager can make securities underweight if they believe those specific securities will underperform when compared to the other securities in the portfolio for example consider a security in the benchmark portfolio with a weight of 10 if the manager believes that the security will underperform over a certain time period they can allocate the security a weight of less than 10 say to 8 for that period the 2 that is no longer directed towards that security can be allocated to other securities that have more positive outlooks in hopes of increasing the expected return for the overall portfolio underweight stocksanalysts may refer to a security as underweight when the expected return is below the average return of the industry the sector or the market that has been chosen as a point of comparison in this context being underweight is similar to an expectation of poor performance and may be based on a few selected variables chosen by the analyst making the determination there is no set time frame or specific benchmark for an analyst to make this determination which leads to variances based on analyst opinion and the exact variables chosen as a point of comparison this can cause a stock to be considered underweight compared to one index but not when compared to another leading to two different recommendations example of underweightconsider fund abc which tracks the benchmark index index def index def has a weighting of apple stock as 10 of its portfolio fund abc determines that the future outlook for apple stock is not strong given various metrics its research team used to analyze the company and the outlook of the economy fund abc determines that its percentage of shares that are apple shares will only be 1 5 of the portfolio compared to the benchmark fund abc is underweight in apple stock | |
what does an underweight portfolio mean | an underweight portfolio is a fund whose portfolio holds fewer shares of a particular stock when compared to a benchmark for example a fund might hold 2 of a particular stock as a percentage of its total portfolio whereas the benchmark holds 10 the fund would be underweight in that stock | |
what is an overvalued stock | an overvalued stock is one whose stock price is not in line with its earnings outlook such as its price to earnings p e ratio analysts that believe a stock is overvalued expect that its price will fall | |
what is underwithholding | underwithholding is a term that refers to a specific tax situation in which an individual did not withhold an adequate amount of taxes from their wages during the year to cover the amount of taxes they owe breaking down underwithholdingunderwithholding is a term used to refer to an instance when an individual withheld an inadequate amount of taxes from wages or other income during the year to cover the amount owed to tax authorities withholding itself refers to the portion of an individual s wages that are taken out of his or her paycheck to cover federal state and local taxes 1 the irs calculates the amount of federal taxes withheld from the individual s paycheck based on income marital status and choices made by the taxpayer regarding number of dependents claimed and filing status married couples must decide whether to file jointly or separately a taxpayer may also elect to have additional money withheld for example to cover a side job for which taxes are not being taken out automatically similarly if a taxpayer expects to claim significant deductions on his or her annual taxes a reduction in withholding can be requested 2 taxpayers register these preferences with their employer by completing form w 4 employee s withholding certificate 3 paying taxes on one s income directly from each paycheck reduces the amount of taxes owed when an individual submits an annual tax return 3 if an individual has not paid in enough over the year to cover all of their tax obligations they will have to pay the remaining balance when they file their income taxes in addition a penalty fee may be charged if a taxpayer has significantly underwithheld to avoid this penalty it is necessary to have paid at least 90 percent of taxes owed in the current year or 100 percent of those owed the previous year taxpayers are allowed to use whichever figure is smaller however even if an individual does not meet this threshold it is still possible to avoid a penalty if the amount of unpaid tax is less than 1 000 or if the person had no tax liability the previous year 4 5 | |
why would an individual choose to underwithhold | some individuals deliberately choose to have their taxes underwithheld for example a taxpaper may take some of the funds that would have been withheld and invest that same amount if the individual turns a profit they come out ahead after paying their income taxes however it is important to remember that excessive underwithholding can result in a penalty also a person who reduces their withholdings by purposefully claiming more allowances than they are entitled to on their w 4 form could theoretically be charged with supplying false or fraudulent information 3 underwithholding s opposite overwithholding and its benefitsa taxpayer might also choose to do the opposite of underwithholding and instead overwithhold an individual can accomplish this by withholding more than they will most likely owe in income tax if an individual overwithholds they will then receive a tax refund after they have filed their return 3 but if an individual overpays their taxes they in essence give the internal revenue service an interest free loan | |
what is an underwriter | an underwriter is any party usually a member of a financial organization that evaluates and assumes another party s risk in mortgages insurance loans or investments for a fee usually in the form of a commission premium spread or interest underwriters try to determine the likelihood that a borrower will pay as promised and that enough collateral is available if there s a default in the case of insurance underwriters seek to assess a policyholder s health and other factors and spread the potential risk among as many people as possible 1 | |
what do underwriters do | underwriters play a critical role in many industries in the financial world including the mortgage industry the insurance industry equity markets and some common types of debt securities trading an individual in the position of a lead underwriter is sometimes called a book runner modern day underwriters play a variety of roles depending on the industry in which they work in general underwriters are tasked with determining the level of risk involved in a transaction or other kind of business decision risk is the likelihood that an outcome or investment s actual gains will differ from an expected outcome or return investors rely on underwriters because they determine if a business risk is worth taking underwriters also contribute to sales type activities for example in an initial public offering ipo the underwriter might purchase the entire ipo issue and sell it to investors an ipo is a process through which a previously privately owned company sells its shares on a public stock exchange for the first time 1history of underwritersthe term underwriter first emerged in the early days of marine insurance shipowners sought insurance for a ship and its cargo to protect themselves if the boat and its contents were lost shipowners would prepare a document that described their ship and its contents crew and destination an agreed upon rate and terms were set out in the paper businesspeople who wished to assume some obligation or risk would sign their name at the bottom and indicate how much exposure they were willing to accept these businesspeople became known as underwriters 2types of underwritersthe most common type of underwriter is a mortgage loan underwriter mortgage loans are approved based on a combination of an applicant s income credit history debt ratios and overall savings 3mortgage loan underwriters ensure that a loan applicant meets all of these requirements and they subsequently approve or deny a loan underwriters also review a property s appraisal to ensure that it is accurate and that the home is worth the purchase price and loan amount mortgage loan underwriters have final approval for all mortgage loans loans that aren t approved can go through an appeal process but the decision requires overwhelming evidence to be overturned according to the u s bureau of labor statistics employment of insurance underwriters is projected to decline 4 from 2021 to 2031 4insurance underwriters like mortgage underwriters review applications for coverage and accept or reject an applicant based on risk analysis insurance brokers and other entities submit insurance applications on behalf of clients and insurance underwriters review the application and decide whether to offer insurance coverage insurance underwriters advise on risk management issues determine available coverage for specific individuals and review existing clients for continued coverage analysis 5underwriters administer the public issuance and distribution of securities in the form of common or preferred stock from a corporation or other issuing body in the equity markets perhaps the most prominent role of an equity underwriter is in the ipo process ipo underwriters are financial specialists who work closely with the issuing body to determine the initial offering price of the securities buy the securities from the issuer and sell the securities to investors via the underwriter s distribution network ipo underwriters are typically investment banks that have ipo specialists on staff these investment banks work with a company to ensure that all regulatory requirements are satisfied to gauge interest in the investment the ipo specialists contact a large network of investment organizations such as mutual funds and insurance companies the amount of interest received by these large institutional investors helps an underwriter set the ipo price of the company s stock the underwriter also guarantees that a specific number of shares will be sold at that initial price and purchase any surplus 1underwriters purchase debt securities such as government bonds corporate bonds municipal bonds or preferred stock from the issuing body usually a company or government agency to resell them for a profit this profit is known as the underwriting spread an underwriter may resell debt securities directly to the marketplace or to dealers who will then sell them to other buyers when the issuance of debt security requires more than one underwriter the resulting group of underwriters is known as an underwriter syndicate 6 | |
why are underwriters important | investors need underwriters to determine if a business risk is worth investing in in addition underwriters also contribute to the success of sales activities | |
what are some common types of underwriters | a mortgage loan underwriter is one of the most common types of underwriters their job is to ensure that a loan applicant meets all requirements before approving or denying the loan another common type is insurance underwriters who review applications for coverage and based on their findings accept or reject an applicant underwriters who work in the equity market must administer the public issuance and distribution of securities from a corporation or other entity in the form of common or preferred stock | |
what is a book runner | a book runner is a primary underwriter or lead coordinator in issuing new equity debt or securities instruments these types of underwriters also may coordinate with others to mitigate their own risk for example those representing companies in large leveraged buyouts lbos because they combine the duties of an underwriter while coordinating the efforts of multiple involved parties and information sources book runners become the central point for all information regarding the potential offering or issue the bottom linean underwriter is any party usually part of a larger financial organization that evaluates and assumes for a fee another party s risk in mortgages insurance loans or investments underwriters work in many areas of finance from the insurance industry to mortgage lending they are critical to the mortgage industry insurance industry equity markets and common types of debt securities trading because of their ability to ascertain risk | |
what is an underwriter syndicate | an underwriter syndicate is a temporary group of investment banks and broker dealers who come together to sell new offerings of equity or debt securities to investors the underwriter syndicate is formed and led by the lead underwriter for a security issue | |
when an issue is too large for a single firm to handle an underwriter syndicate is usually formed so that the resources of all the firms can be used to orchestrate the issuance and spread out the risk the syndicate is compensated by the underwriting spread which is the difference between the price paid to the issuer and the price received from investors and other broker dealers when the issuance goes public | an underwriter syndicate is also referred to as an underwriting group banking syndicate and investment banking syndicate understanding an underwriter syndicateunder the firm commitment engagement members of an underwriter syndicate are required to buy the shares from the company to sell to investors as opposed to a company selling the shares directly to investors this removes a significant amount of risk for the issuing company as it is paid upfront for the shares by the syndicate and is therefore not concerned with having to sell the inventory of shares to investors that risk is taken on by the underwriter syndicate the risk that an underwriter syndicate takes on is mitigated especially for the lead underwriter by spreading the risk out among all the participants in the syndicate since the underwriting syndicate has committed to selling the full issue if demand for it is not as robust as anticipated the syndicate participants may have to hold part of the issue in their own inventory which exposes them to the risk of a price decline in exchange for taking the lead role the lead underwriter gets a larger proportion of the underwriting spread and other fees while the other participants in the syndicate receive a smaller portion of the spread and fees firm commitment may be compared to the best efforts underwriting where the underwriter agrees to give their highest personal effort to sell as much as possible of the shares the process of an underwriter syndicatemembers of an underwriter syndicate often sign an agreement that sets forth the allotment of the stock to each participant and the management fee in addition to other rights and obligations the lead underwriter runs the syndicate and allocates shares to each member of the syndicate which may not be equal among the syndicate members the lead underwriter also determines the timing of the offering as well as the offering price and fulfilling any requirements with regulatory issues with the securities and exchange commission sec or financial industry regulatory authority finra in determining the offering price the underwriter syndicate must obtain all the necessary financial information as well as determining the growth prospects of the firm typically a closed bidding process amongst the syndicate members is held to arrive at the price of the initial public offering ipo for popular initial public offerings investors may exhibit a greater demand for shares than there are shares available in this case the ipo is oversubscribed this kind of demand can only be met once shares begin actively trading on the exchange this pent up demand could lead to dramatic price swings during the first few days of trading as such there is significant risk associated with individual investors participating in ipos either receiving shares as the client of an investment bank or by buying and selling shares once they begin trading | |
what is underwriters laboratories | underwriters laboratories ul is a global safety science company the largest and oldest independent testing laboratory in the united states underwriters laboratories tests the latest products and technologies for safety before they are marketed around the world it tests 22 billion different products annually ranging from consumer electronics alarms and security equipment to lasers medical devices and robotics 12founded in 1894 underwriters laboratories offers its services in five strategic areas from product safety environment life and health university and verification services 3the company employs over 14 000 people who live in 40 countries 4 as of 2021 those employees are led by ceo jennifer scanlon 5 in 2012 underwriters laboratories created a for profit subsidiary ul llc 6understanding underwriters laboratories ul underwriters laboratories is a non profit organization funded by the fees it charges manufacturers of products submitted for certification ul charges fees for the initial evaluation process as well as ongoing maintenance fees for follow up service while ul is a profitable enterprise that profit is filtered back into the business as profit is not a stated goal of the company 7ul s operations are global in scope with customers in more than 143 countries 8 twenty two billion ul marks appear annually on products while 8 5 million consumers in asia europe and north america are annually reached by ul with safety messages 19the start of underwriters laboratories can be traced back to the widely attended world s fair held in chicago in 1890 at the fair ul s founder william henry merrill jr a graduate of the mit electrical engineering program was working at his assigned post with the boston board of fire underwriters to assess for any fire risks with all of the new construction going on for the fairgrounds 10at the fair merrill jr meets many insurance underwriters and proposes his idea to create an electrical testing laboratory the underwriters agree that it is a good idea and both western insurance union and the chicago underwriters association give merrill jr funding to form what will soon become the underwriters electrical bureau 10eventually that first bureau became the electrical bureau of the national board of fire underwriters it set its mission even back then on promoting safe working and living conditions for people in 1895 the organization hired its first employees 10the bureau was officially operating with three staff members and a budget of 3 000 annually in 1901 the organization officially became underwriters laboratories and established headquarters in illinois 10founder merrill jr became the manager of ul and a new president henry clay eddy was named in 1903 the ul began establishing its first set of safety standards beginning with tin clad fire doors 10 | |
what is underwriting | underwriting is the process through which an individual or institution takes on financial risk for a fee this risk most typically involves loans insurance or investments the term underwriter originated from the practice of having each risk taker write their name under the total amount of risk they were willing to accept for a specified premium although the mechanics have changed over time underwriting remains a key function in the financial world investopedia joules garcia | |
how underwriting works | underwriting involves conducting research and assessing the degree of risk each applicant or entity brings to the table before assuming that risk this check helps to set fair borrowing rates for loans establish appropriate premiums to adequately cover the true cost of insuring policyholders and create a market for securities by accurately pricing investment risk if the risk is deemed too high an underwriter may refuse coverage risk is the underlying factor in all underwriting in the case of a loan the risk is whether the borrower will repay the loan as agreed or will default with insurance the risk may involve the likelihood that an individual prospective insured might file a claim or that too many policyholders will file claims at the same time with securities the risk is that the underwritten investments will not be profitable underwriters evaluate loans particularly mortgages to determine the likelihood that a borrower will pay as promised and that enough collateral is available in the event of default in the insurance industry underwriters seek to assess a policyholder s health and relatedfactors a driver s safety record or the security of a home they aim to price insurance premiums appropriately while spreading the potential risk among as many people as possible underwriting securities most often done via initial public offerings ipos helps determine the company s underlying value compared to the risk of funding its ipo types of underwritingthere are three major types of underwriting loans insurance and securities all loans undergo some form of underwriting in many cases underwriting is automated it involves appraising an applicant s credit history financial records and the value of any collateral offered along with other factors that depend on the size and purpose of the loan the appraisal process can take a few minutes to a few weeks depending on whether the appraisal requires a human being to be involved the most common type of loan underwriting that involves a human underwriter is for mortgages this is also the type of loan underwriting that most people encounter the underwriter assesses income liabilities debt savings credit history credit score and more depending on an individual s financial circumstances mortgage underwriting typically has a turnaround time of a week or less refinancing often takes longer because buyers who face deadlines get preferential treatment although loan applications can be approved denied or suspended most are approved with conditions meaning the underwriter wants clarification or additional documentation before the agreement can be finalized insurance underwriters receive customer applications and decide whether to offer them a policy on the basis of various criteria if they do approve the application the underwriters also set premiums and coverage amounts 1with insurance underwriting the focus is on the potential policyholder the person seeking health home auto or life insurance in the past medical underwriting for health insurance looked at the applicant s pre existing conditions to determine how much to charge an applicant or whether to offer coverage at all often based on the applicant s pre existing conditions beginning in 2014 under the affordable care act insurers were no longer allowed to deny coverage or impose limitations based on pre existing conditions life insurance underwriting seeks to assess the risk of insuring a potential policyholder based on their age health lifestyle occupation family medical history hobbies and other factors determined by the underwriter life insurance underwriting can result in approval along with a range of coverage amounts prices exclusions and conditions or outright rejection for property and casulty insurance underwriters look at numerous criteria including characteristics of the person and the property being insured for example if someone applies for automobile insurance the carrier looks at their driving record how often their make and model of car is in an accident and the average cost of repairs similarly to ensure a home underwriters focuses on such factors as replacement cost age of the dwelling and any significant risks such as being in an area prone to wildfires to decide whether to offer the applicant homeowners insurance and how much to charge investment securities underwriting which seeks to assess risk and the appropriate price of particular securities most often related to an ipo is performed on behalf of a potential investor often an investment bank based on the results of the underwriting process an investment bank would buy underwrite securities issued by the company attempting the ipo and then sell those securities in the open market underwriting ensures that the company s ipo will raise the capital needed and provides the underwriters with a premium or profit for their service investors benefit from the vetting process that underwriting provides and its ability to make an informed investment decision this type of underwriting can involve individual stocks and debt securities including government corporate or municipal bonds underwriters or their employers purchase these securities to resell them for a profit either to investors or dealers who sell them to other buyers when more than one underwriter or group of underwriters is involved this is known as an underwriter syndicate | |
how long does underwriting take | the time frame for underwriting varies among different investment products as the underwriter will have to spend some time examining the risk profile of each investment personal loans and insurance products are generally fairly simple to underwritem while securities are more complex however underwriting periods for mortages and insurance can vary by state 2for car loans the process is often managed by an algorithm that compares the applicant to other borrowers with a similar profile this process takes only a few days at most and in some cases it is almost instantaneous home mortgages tend to take longer because the underwriter will need to verify the borrower s income employment and credit history which can take some time full approval for a home loan can take up to 45 days although the underwriting process itself accounts for only a small part of this time time the underwriting process can last from a few days to a few weeks 3underwriting insurance is similar to underwriting a loan except that the insurers weigh the probability and size of the average claim compared to the premiums that they expect to collect in the case of property and auto insurance policies this is based on factors like the age of the insured their geographical location and their past history of making claims for homeowners and commercial property coverages they must avoid a large concentration of risks in the same geographic area as a catastrophic event such as a hurricane would mean huge losses for the company life insurance policies are more complicated because they also account for the insured s medical history and other personal details underwriting life insurance can also take a month or longer although most decisions are issued in a few days 2securities are the most complicated products to underwrite when a company issues a bond or a stock offering the underwriter usually an investment bank examines the company s accounts cash flows assets and liabilities and checks for any discrepancies this can take anywhere six to nine months 4 | |
what information do underwriters look at | whether they are lending money or providing insurance underwriters examine the financials of each applicant to determine how much risk they are taking on and the likelihood of losing money this is generally done by comparison to historical data if applicants with a similar risk profile tend to default x of the time then the premiums or interest rate will be priced at a rate that assumes an x probability of default underwriters for personal loans and insurance will look at available data about the applicant for loans they might examine the borrower s income savings employment status and credit history underwriters will also assess the capacity for repaying the loan and the value of any assets that are used for collateral 5 for life insurance they might also look at medical history plus such risk factors as dangerous hobbies hazardous occupations and smoking or drinking habits 6securities underwriters will look at the financial situation of the issuer such as their income statements cash flow debts and any other potential liabilities before pricing a bond or stock issue they will also examine the issuer s credit rating the institutional equivalent of a personal credit score | |
how underwriting sets the market price | creating a fair and stable market for financial transactions is the chief function of an underwriter every debt instrument insurance policy or ipo carries a certain risk that the customer will default file a claim or fail all sources of potential loss to the insurer or lender a big part of the underwriter s job is to weigh the known risk factors and investigate an applicant s truthfulness to determine the minimum price for providing coverage underwriters help establish the true market price of risk by deciding on a case by case basis which transactions they are willing to cover and what rates they need to charge to make a profit underwriters also help expose unacceptably risky applicants such as unemployed people asking for expensive mortgages those in poor health who request life insurance or companies that attempt an ipo before they are ready by rejecting coverage this vetting function substantially lowers the overall risk of expensive claims or defaults it allows loan officers insurance agents and investment banks to offer more competitive rates to those with less risky propositions | |
what is the purpose of underwriting | underwriting whether for an insurance policy or a loan evaluates the riskiness of a proposed deal or agreement for an insurer the underwriter must determine the risk of a policyholder filing a claim that must be paid out before the policy has become profitable for a lender the risk is of default or non payment similarly securities underwriting by investment banks evaluate newly issued shares and bonds to determine their risk adjusted value | |
where did the word underwriting come from | the term underwrite originated in the 17th century when marine vessels would be underwritten for insurance risk for overseas voyages the insurance company would sub scribe literally to write underneath or under write the policy by signing their name at the bottom of the document and acknowledging consent that the policy is in force | |
what is the underwriter s role | an underwriter is a financial professional who researches and assesses the financial risk of a potential insurance policy security or loan to determine whether an institution should take on the risk and if so how much it should charge to ensure a profit can an underwriter deny an insurance policy or loan yes if the riskiness of a borrower or insurance policy applicant is deemed too great the underwriter can either recommend higher rates or else deny the application entirely they must also ensure they are not breaking any anti discrimination laws and are only evaluating objective risk metrics | |
how long does the underwriting process take | with the advent of information technology the underwriting process for insurers and lenders has shortened from a matter of weeks or months to just a few days or even hours in some cases the time frame varies by the type of instrument being underwritten and any applicable state regulations the bottom lineunderwriting is the process of examining the financials of a loan or insurance application to determine how much risk they pose to a lender or insurer this usually means checking the applicant s income assets and credit history to determine the likelihood that they will end up costing the underwriting institution more than the customer pays in premiums | |
what is underwriting agreement | an underwriting agreement is a contract between a group of investment bankers who form an underwriting group or syndicate and the issuing corporation of a new securities issue understanding underwriting agreementthe purpose of the underwriting agreement is to ensure that all of the players understand their responsibility in the process thus minimizing potential conflict the underwriting agreement is also called an underwriting contract the underwriting agreement may be considered the contract between a corporation issuing a new securities issue and the underwriting group that agrees to purchase and resell the issue for a profit as mentioned above the contract is generally between the corporation issuing the new security and investment bankers who form a syndicate a syndicate is a temporary group of financial professionals formed to handle a large financial transaction that would be difficult to handle individually the underwriting agreement contains the details of the transaction including the underwriting group s commitment to purchase the new securities issue the agreed upon price the initial resale price and the settlement date a best efforts underwriting agreement is mainly used in the sales of high risk securities types of underwriting agreementsthere are several different kinds of underwriting agreements the firm commitment agreement the best efforts agreement the mini maxi agreement the all or none agreement and the standby agreement | |
what is underwriting capacity | underwriting capacity is the maximum amount of liability that an insurance company agrees to assume from its underwriting activities underwriting capacity represents an insurer s ability to retain risk it s important for an insurance company to calculate and maintain its underwriting capacity so it will be able to pay out claims to customers when needed so as to avoid insolvency understanding underwriting capacityunderwriting involves assessing the degree of risk associated with offering insurance to an applicant as the provider of the policy the insurer will diligently seek to determine if it s profitable to offer coverage and then based on its research establish a price this price is known as the premium and it is charged in exchange for taking on the risk of covering the applicant against loss through the issuance of new policies an insurer accepts additional hazards and increases the possibility that it may become insolvent though seemingly unlikely there s always a slight chance that too many policyholders will file claims all at once leaving the insurer forced to make a number of large payments beyond its financial means at the same time an insurance company s potential for profitability depends on its appetite for risk the more risk it assumes by underwriting new insurance policies the more premiums it can collect and later invest striking the right balance is essential to maintaining and improving the financial health of the insurer in other words a company s underwriting capacity or the maximum amount of acceptable risk is a crucial component of its operations an insurance company s profitability hinges on the quality of its underwriting underwriting capacity requirementsinsurers are not given free rein to choose how much risk they want to take on to protect policyholders regulators prohibit insurance companies from underwriting an unlimited number of policies by capping their capacity often the insurer will impose even stricter constraints on itself to stave off the threat of insolvency applications can be rejected outright if the risk is deemed too high or revised with new specific individual conditions attached methods used to increase underwriting capacitysmart underwriting practices should generate premiums that exceed losses and expenses increasing the policyholder surplus and capacity to issue more policies listed below are some of the common methods used by insurers to protect themselves from paying out an excessive amount of claims and to help them build up their ability to take on more business an insurance company can increase its underwriting capacity by underwriting policies that cover less volatile risks for instance a company may refuse to write new property insurance coverage in a hurricane prone zone but still cover hazards from fire and theft limiting the risk of policies reduces the likelihood that the company will have to pay out claims insurers are also able to increase underwriting capacity by ceding their obligations to a third party as with reinsurance treaties in a reinsurance contract the reinsurer assumes some of an insurer s liability in exchange for a fee or a portion of the premiums paid by the policyholder the liabilities assumed by the reinsurer no longer count against the ceding company s underwriting capacity enabling the insurer to underwrite new policies special considerationsin the case of sharing the load using reinsurance does not mean that the insurer can abandon the liabilities it cedes in the reinsurance contract the ceding company is still ultimately responsible if a claim should occur in a situation where the reinsurer becomes insolvent the ceding insurer must pay for claims made against its original underwritten policies it is therefore critical for the insurer to be aware of the financial health of the reinsurer including the amount of risk that the reinsurer has agreed to take on through other reinsurance contracts | |
what is an underwriting cycle | the underwriting cycle refers to fluctuations in the insurance business over a period of time a typical underwriting cycle spans a number of years as market conditions for the underwriting business go from boom to bust and back to boom again an underwriting cycle is also known as an insurance cycle understanding an underwriting cyclethe underwriting cycle represents the ebb and flow of business between soft and hard insurance markets at the beginning of an underwriting cycle business is soft due to increased competition and excess insurance capacity as a result of which premiums are low then a natural disaster or other event leads to a surge in insurance claims which drives lesser capitalized insurers out of business decreased competition and lower insurance capacity lead to better underwriting conditions for surviving insurers enabling them to raise premiums and post solid earnings growth as the insurance claims are paid off and the tide of new claims subsides insurance companies slowly return to profitability new insurance companies then enter the market offering lower premiums and looser requirements than the existing companies the existing companies are then compelled to loosen their requirements to stay competitive and the insurance cycle starts all over again the underwriting cycle perpetuates because a majority of insurance companies place short term gains over long term stability selling insurance without concern for what happens when the soft market ends the only way to effectively regulate or insulate an insurance company against the effects of the insurance cycle is to ignore short term profitability and focus on saving capital an insurance company may also consider establishing limits and setting money aside in a rainy day type of account disciplined efficiency can have a considerable effect on a firm s financial stability and long term business prospects managing an underwriting cycleas with most business cycles the underwriting cycle is a phenomenon that is very difficult to eliminate the concept has been an understood phenomenon since at least the 1920s and has since been treated as a core concept in the industry in 2006 insurance giant lloyd s of london identified managing this cycle as the top challenge facing the insurance industry and published a report by surveying more than 100 underwriters about industry issues in response to their survey they were able to identify steps to manage the insurance cycle most insurance industry watchdog organizations believe that underwriting cycles are inevitable due to the inherent uncertainty of matching insurance prices to future losses unfortunately the industry as a whole is not responding to the challenges the underwriting cycle brings the underwriting cycle affects all types of insurance except life insurance where there is enough information to minimize risk and reduce the effect of the underwriting cycle | |
what are underwriting expenses | underwriting expenses are costs and expenditures associated with underwriting activity underwriting expenses include a wide range of expenditures and the exact definition differs for insurers and investment banks as a major expense category the lower these expenditures are as a proportion of underwriting activity the higher the profitability of the insurer or investment bank understanding underwriting expensesunderwriting expenses are primarily associated with insurance companies as the cost of doing business which is underwriting insurance policies for an insurer underwriting expenses may include direct costs such as salaries commissions actuarial reviews and inspections as well as indirect costs such as accounting legal and customer service expenses for an investment bank underwriting usually relates to the process of underwriting securities for a company s initial public offering ipo underwriting expenses would include such costs as due diligence activities research and legal and accounting fees underwriting expenses and the expense ratiofor insurance companies calculating the expense ratio allows for it to determine the portion of insurance premiums revenue that must go towards paying underwriting expenses the expense ratio for an insurer is obtained by dividing underwriting expenses by premiums for a given period since the profitability of an insurer has an inverse correlation with the expense ratio insurers strive to keep this ratio in check in order to remain profitable depending on the insurer the underwriting expenses can be vastly different if the entity is a well known insurer it might not have to advertise as much on the other hand a new insurance company has to advertise significantly as well as incur expenses in starting a new business and paying stronger salaries and commissions to attract premium talent to generate business some insurers have low expense ratios because of economies of scale most notably with large national advertising budgets and well known brand names that help attract customers other insurers employ direct sales techniques to cut out the insurance agents and brokers and the underwriting expenses that come with them 1in the auto insurance industry for example geico a unit of berkshire hathaway brk a and progressive pgr have contributed to their own long term success by eliminating the middleman similar to how dell s dell direct sales method gives it a pricing advantage over competitors given the presence of the internet direct sales methods are more common than they were 1it s important to stress that any claims that insurance companies pay out on insurance policies written are not included as underwriting expenses the expenses are purely the cost of running a business | |
what are underwriting fees | underwriting fees are monies collected by underwriters for performing underwriting services underwriters work in a variety of markets including investments mortgages and insurance in each situation the underwriter s job varies slightly yet each collects underwriting fees in exchange for his or her underwriting services | |
how underwriting fees work | in capital markets underwriting fees are collected by underwriters who administer the issuing and distributing of certain financial instruments when a company issues stock bonds or other publicly traded securities for instance it hires an underwriter the issuing company and the underwriter work closely together to determine the price of an offering after determining the offer structure underwriters assemble a group of investment banks and brokerage firms that commit to selling a certain percentage of the offering after an underwriting agreement is struck the underwriter bears the risk of being unable to sell the underlying securities and the cost of holding them on its books until they can be sold once the underwriter knows it will sell all of the shares in the offering it closes the offering by purchasing all the shares from the company if the offering is a guaranteed offering and the issuer receives the proceeds minus the underwriting fees usually 3 5 to 7 percent of the amount of capital being raised underwriters or underwriter syndicates earn underwriting fees for doing three things negotiating and managing the offering assuming the risk of buying the securities if nobody else will and managing the sale of the shares underwriting fees for mortgage underwritersa mortgage underwriter earns underwriting fees by evaluating and verifying mortgage loan applications and either approving or denying the loan an underwriting fee for the service of evaluating the loan application for approval is a nonrecurring fee or finance charge that the lender may charge in lieu of an origination fee or in addition to it origination fees pay for numerous costs associated with obtaining a loan and could include administrative services such as loan processing and mortgage broker fees other loan fees can include an appraisal a credit report flood certification and a tax service fee when charged apart from origination underwriting costs between 400 and 900 depending on the lender and loan type underwriting fees for insurance underwritersinsurance underwriters collect underwriting fees for identifying and calculating a policyholder s risk of loss and by writing the policies to cover these risks an insurance underwriter s job is to protect the company s book of business from risks that they feel will make a loss and issue insurance policies at a premium that is appropriate for the risk exposure | |
what is an underwriting group | an underwriting group is a temporary association of investment bankers and broker dealers who wish to purchase a new issue of securities from an issuer in order to distribute the issue to investors at a profit the underwriting group shares the risk and aids in the successful distribution of the new securities issue once the issuance goes public an underwriting group is also called a purchase group a distributing syndicate or a syndicate | |
how an underwriting group works | an underwriting group manages the distribution of a new securities issue such as a single company stock or a bond the group buys the issuance from the firm first at a specified price and then sells it to the public as opposed to a company selling the shares directly to investors then the underwriting group resells the issue to investors in order to make a profit for the issuing company having an underwriting group means that they are paid upfront for the shares they are issuing as a result a significant amount of risk is removed from the issuing company and taken on by the underwriting group the issuing company no longer has to sell the inventory of its stock directly to investors the profit or loss for the group is determined by how the new stock performs on the market if there is a profit it is the difference between the purchase price and the resale price this difference is also known as the underwriting spread coming together temporarily as an underwriting group allows investment bankers and institutions to finance a high volume purchase that would be out of reach for one banker or institution however once all the securities are sold off to investors there is no reason for the group to exist anymore at this point an underwriting group disbands and the individual bankers and financial entities are free to come together in underwriting groups for other separate securities issues in an underwriting group there is typically one lead underwriter the lead underwriter is responsible for dealing with regulatory bodies the lead underwriter may also receive the largest portion of the issue for distribution underwriting for investment banking vs underwriting for insuranceunderwriting has applications in both investment banking and the insurance sector however it means different things in these distinct industries an underwriting group is a different entity in investment banking than in insurance in investment banking underwriting is the process of joining together with other financial entities to purchase large volumes of a new security that is being issued after this the shares are resold or distributed to investors this process is transactional underwriting groups come together for a temporary amount of time to buy and then sell a specific security in the insurance industry underwriting is the process of calculating risk and payouts and calculating the costs of purchasing insurance for different objects situations and entities insurance underwriting can be done by a group or an individual and an underwriting group can exist over long periods of time and through multiple contracts and policies with a variety of policyholders the main function of an insurance underwriting group is not to pool funds to purchase securities but to do calculations of risk and determine the correct rate for an insurance policy | |
what is underwriting income | underwriting income is the profit generated by an insurer s underwriting activity over a period of time underwriting income is the difference between premiums collected on insurance policies by the insurer and expenses incurred and claims paid out huge claims and disproportionate expenses may result in an underwriting loss rather than income for the insurer the level of underwriting income is an accurate measure of the efficiency of an insurer s underwriting activities understanding underwriting income | |
when an insurance company writes an insurance policy for a new client or renews a policy for an existing client they receive an insurance premium as payment this is their revenue the costs associated with an insurance company are the ordinary business costs as well as money paid out to clients when they file an insurance claim for an accident or other such event the difference between revenue and costs like any business is the income in this case the underwriting income | an insurer s underwriting income may fluctuate from quarter to quarter with natural and other disasters such as earthquakes hurricanes and fires leading to huge underwriting losses hurricane katrina one of the largest natural catastrophes in u s history caused an underwriting loss of 4 1 billion for the u s property casualty insurance industry in 2005 compared with underwriting profit of 6 billion in 2004 1withstanding extreme events such as earthquakes and hurricanes underwriting income is an indicator of how well an insurance company is performing if the underwriting income is consistently negative the insurance company could not be bringing in enough new business underwriting new policies to generate more revenue conversely it can also indicate that the policies that it is writing are risky resulting in claims being paid out often this might shed light on the fact that the risk analysis an insurance company is performing on a business or individual when underwriting a policy is not accurate it s important for an insurance company to find a balance because if it is constantly paying out claims more than it is bringing in through underwriting revenue this could lead to the inability to pay out future claims or insolvency underwriting income vs investment incomeunderwriting income is calculated as the difference between an insurance company s earned premiums and its expenses and claims for example if an insurer collects 50 million in insurance premiums over a year and spends 40 million in insurance claims and associated expenses its underwriting income is 10 million investment income meanwhile comes from capital gains dividends and other investments related to the purchase and sale of securities it s important when analyzing an insurance company including the company s management that they not look at overall income or profits but also focus on underwriting income to determine how well the business is performing through its core operations underwriting income and the underwriting cyclethe underwriting cycle is the periodic rise and fall of the insurance industry s underwriting income the sources of this cycle aren t completely clear however since the swings in investment income are mild fluctuations in underwriting income drive this cyclical rise and fall the number of insurance company insolvencies is proportional to the fall of underwriting income large drops in underwriting income can indicate that the underlying insurance policies are under priced in the market or that the insurance companies are writing riskier policies resulting in losses insurance companies with solidly performing underwriting income are generally stronger financially because they don t have to make up for poor performance by increasing their risks on the investment side of the business or by underwriting riskier policies |
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