How Exactly Do Insurance Companies Make Money?

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Wait a minute.

Have you ever wondered how these billion-dollar insurance companies make money for themselves despite paying out claims to several people.

This is a question that both the insured and non-insured person keeps asking and you will definitely find the proper answer to the question as you read on.

As we all know, insurance protects us against possible risks like accident, fire or vandalism.

Since the future cannot be determined then there is need to protect all our assets and investment against any foreseeable damages.

Types of Insurance Out There?

  1. Auto Insurance
  2. Health insurance
  3. Education Insurance
  4. Disability Insurance
  5. Homeowners/Renters Insurance
  6. Property Insurance
  7. Travel insurance
  8. Life Insurance

It will surprise you to know that insurance companies make money a lot.

What is Underwriting?

Underwriting is the process of accessing an entity’s risk and deciding how much to charge as a premium. 

The main goal of a successful underwriting operation is to earn more money in premiums than they would pay out in claims.

Check Out Some of the Common Ways Insurance Companies Make Money

Through Premium

What insurance companies do is to provide insurance by collecting premiums from policy holders and indemnifying those policy holders for covered losses that they suffered during the policy period.

Because the actual cost of their product is unknown before the policy period elapses, they must calculate approximately their costs, usually with statistics and historical analysis.

If insurers have sufficient experience or knowledge of past events, they can use statistics to make high-level calculations. 

Related: How GEICO Became the Second Largest Auto Insurance Company in the U.S.

This process is called underwriting which involves calculating the probability of the risk for each insured policyholder or category.

Insurance companies make money using two main methods: making profit from underwriting and investing the leftover money, called a float. 

One of the most important and most difficult aspects to understand in relation to insurance is underwriting. 

Through Shared Risk

This usually happens when a policy holder pays many dollars as premiums in automobile or health insurance but does not register any case of accident or health issue till the validity of the insurance plan.

If no claim was made throughout this period then the insurance company is entitled to keep that amount for their own use.

Related: 3 Insurance Companies You Must Avoid Like a Plague

In the same manner if a policy holder has made a certain amount as premiums in automobile insurance and has registered a case of accident that results in a damage that is more than the premium paid by him then the insurance firm is entitled to forfeit more money in claim payment to him.

Further to the scenario above let’s say for instance, an insurance company received $500 from 500 clients every year but in turn only have to pay for claims from 100 clients, the insurance firm would consider paying the requested claims from the other 400 clients premium paid.

This is why insurance fraud is a clear sabotage on the entire economy.

Through Investment of Premium

This is made possible when insurance companies invest all the premium money while it is not being used.

They collect all premiums and put the money into an investment pool.

They often use the premiums collected to fund investments usually in guaranteed or low-risk securities such as real estate, bonds and money market funds.

Related: 3 Simple Hacks to Sell More Insurance Than Your Competitors

When a claim is made from a policy holder, the money is then taken from that pool and is put into a cash account to pay the claim once the adjustment of it is completed.

If for a reason the insurance company delays in paying the claim, the policyholder might be forced to sue for property damage claim.

This money that is taken from premiums but isn’t being paid out in claims is called the “float” money. 

This money is similar to the money that a bank would get after getting deposits from customers but before lending out the money to other customers.

The insurance companies usually invest this money in a variety of areas, such as the stock market, mutual funds, bonds, securities and other forms of investment available. 

Insurance companies often pull their money out of these investments when they need fund for some rising issues.

Insurance companies make their money from the interest and return on investment earned from those premiums while they are in the investment pool.

Insurance companies usually raise their premiums in an effort to increase profits.

Through Refusal of Claims

Insurance companies that make money by rejecting claims
Rejected insurance claim form

There are many incidents where an insurer can refuse to pay claims.

  • One possible cause is when the claimant did not follow the terms and conditions.
  • The insurer could decline to pay the claims if they found out that the claim is not legitimate.

If you find yourself in a situation where the policy holder presented fake documents demanding for any sort of insurance claim, report the insurance fraud immediately to avoid paying from others premiums.

On the hand, if it’s the insurance company that refused to pay your claim for whatever reason, gather enough document and report the State Insurance Commissioners near you.

Conclusions

The role that insurance companies’ play in the society cannot be overemphasized.

It surely helps in supporting economic activity by helping organizations and individuals to manage their risks.

Given the importance of this role, insurers have the potential and capability to affect company’s financial stability.

I will advise all to start thinking of insuring our health, education, family and car. Our bit is not to concentrate on how the insurers make money because there is no business today that does not make profit.

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