How do Life Insurance companies make money?
Good question to ask, more people should be curious. Each product is priced differently. Whole Life insurance like all plans, is priced by actuarial accountants. These are the people that when you were in university were studying in the room next door while you were playing drinking games. They do calculations based on over a hundred years of mortality and morbidity rates to determine claims experience, cancellations etc. which allow them to build in a profit margin for all products. This particular product builds a cash reserve with all the premiums paid by all policy owners. It is sort of like a massive pension plan from which liabilities are paid (claims,admin costs, commissions, company profits) The residual is paid out to policyholders in dividends or cash value. So the answer is, don't worry the profits are priced in. In the real world this profit is magnified by two main things that very few people in and out of the financial industry are aware of: 1) Life expectancy is always increasing so when you buy the policy at age 35, life expectancy is 82. By the time you get there it will be 88 so the insurance company will end up with 6 more years of premiums than they factored in. 2) Cash values built up through dividends on whole life plans are very enticing to people who don't manage money well so one day when they glance at their statement and see thousands of dollars just sitting there teasing them, they can't resist cancelling the policy and buying that big screen TV they wanted. Bingo, liability ends for the insurance company, they keep all the premiums paid, pay out some of the interest and pocket the rest.
How do insurance companies make money?
No one has given you a full answer but Mr. Enright is the closest thus far. People seem to be focused on premium vs. claims; however, this is most definitely NOT how insurance companies make money. Most insurers try to price their policies such that the total premiums collected each year are equal to the total amount of claims paid + expenses (we call this the combined ratio - claims+expenses:premium). A combined ratio of 1 is seen as ideal because it means they are not over or under pricing their policies; meaning that they are underwriting the risks they want as pricing models are designed to attract what a company identifies as their target market. With regard to automobile insurance, most insurers actually run a loss on premiums, normally paying just over a dollar for every dollar of premium (combined ratio >1); whereas, they normally run just under a 1 ratio on property insurance. Ultimately, very little, if any profit is made through underwriting (premiums) alone; rather, the reason for writing policies and collecting premiums is to build an investment pool. When an insurer collects premiums they put that money into an investment pool. They use the premiums collected to fund investments (generally in guaranteed or low risk securities due to regulatory restrictions). When a claim is made money is then taken from that pool and put into a cash account to pay the claim once the adjustment of it is completed. Where insurers make their money is on the interest and return on investment earned from those premium dollars while they are in the investment pool. The ideal is to have enough premium coming in to keep the investment pool fully funded but the profit itself comes from the return on investment rather than a surplus in the premiums charged vs. claims and expenses paid. Let's look at State Farm Mutual for an example.... in 2011 State Farm collected $32,640,000,000 in premiums; they paid $22,794,000,000 in claims, $4,311,000,000 in claims expenses, $7,527,000,000 in administrative/service expenses; resulting in a LOSS of $1,993,000,000 on underwriting; however, they had investment income of $2.,901,000,000. So while they actually lost $1.9 Billion on premiums vs. claims and expenses (combined ratio of 1.06) they made $2.9 Billion on investement income. As you can see, insurers don't make money through premiums but through investment.
How do bank and insurance companies make money?
I will only answer for the insurance companies which come down to 2 things.UNDERWRITING INCOME (Underwriting income is derived from the difference between how much money is collected for all policies sold versus how much money is paid out in CUSTOMER CLAIMS for those policies in any given time period.)INVESTMENT INCOME (INCOME earned from their investment portfolio professionally managed by their fund managers, usually stocks,bonds,treasuries,etc…this can also be a source of LOST money)
How do insurance companies make money and how do they work?
The main source of income for insurance companies is Premium. Insurance companies collect premium and agrees to indemnify for the loss to the insured if particular event occurs. Premium income comprises of three components viz:Expected Cost of claimAdministrative and other expensesA small element of profitSuppose, there is a premium income of ₹285. Out of that ₹200 is allocated for expected claim amount,₹70 for administrative and other expenses and ₹15 as a part of profitThe main expense component for insurance companies is claim. Claim is the biggest outflow of money for insurance companies.According to the Govt. regulations, the premium which is collected by insurance companies, a part of it has to be compulsorily be invested in govt. securities so as to maintain the solvency or to pay off liabilities in insolvency cases. So the premium collected by insurance companies can by their desire be invested in investment components to earn income from investment other than compulsory investmentMoreover the insurance works on the concept of pooling. Pooling means a group of insureds is formed having a similar risk. Pooling spreads the financial loss or risk of few over many. This reduces the financial burden on few and is shared by many in smaller quantity. So for eg. if a pool of 100 insured persons is formed having fire insurance coverage for their house , the claim will arise approximately suppose for 10–20 houses. Thus the loss of 10–20 insureds is shared by 100 insureds. Here insurance companies takes premium from 100 houses and pay claims only to 10–20 houses, this makes the insurance company profitable. Moreover proper underwriting should also be done to avoid unnecessary huge losses.
How do auto insurance companies make money?
Copied from my answer to a similar question….People seem to be focused on premium vs. claims; however, this is most definitely NOT how insurance companies make money. Most insurers try to price their policies such that the total premiums collected each year are equal to the total amount of claims paid + expenses (we call this the combined ratio - claims+expenses:premium). The goal of a combined ratio of 1 is seen as ideal because it means they are not over or under pricing their policies; meaning that they are underwriting the risks they want as pricing models are designed to attract what a company identifies as their target market. With regard to automobile insurance, most insurers actually run a loss on premiums, normally paying just over a dollar for every dollar of premium (combined ration >1); whereas, they normally run just under a 1 ratio on property insurance. Ultimately, very little, if any profit is made through underwriting (premiums) alone; rather, the reason for writing policies and collecting premiums is to build an investment pool. When an insurer collects premiums they put that money into an investment pool. They use the premiums collected to fund investments (generally in guaranteed or low risk securities). When a claim is made money is then taken from that pool and put into a cash account to pay the claim once the adjustment of it is completed. Where insurers make their money is on the interest and return on investment earned from those premium dollars while they are in the investment pool. The ideal is to have enough premium coming in to keep the investment pool fully funded but the profit itself comes from the return on investment rather than a surplus in the premiums charged vs. claims and expenses paid. Let's look at State Farm Mutual for an example.... in 2011 State Farm collected $32,640,000,000 in premiums; they paid $22,794,000,000 in claims, $4,311,000,000 in claims expenses, $7,527,000,000 in administrative/service expenses; resulting in a LOSS of $1,993,000,000 on underwriting; however, they had investment income of $2.,901,000,000. So while they actually lost $1.9 Billion on premiums vs. claims and expenses (combined ration of 1.06) they made $2.9 Billion on investment income. As you can see, insurers don't make money through premiums but through investment.
How would an insurance company not make money?
Just like any other company would not “make money”.Their income is less than their expenses.An insurance company is not a guaranteed money making machine.There is a delicate balance between adequate pricing, underwriting, expense management and investment performance.The Property and Casualty Insurance Industry as a whole operates at a combined ratio of near 100% (see industry graph), which means, to “make money”, the average company must make some pretty sound investment decisions.As you can see, there are years where the whole insurance property and casualty industry would not “make money”, or more specifically an underwriting profit, unless their investment performance was greater than their underwriting loss.Any one insurance company can make bad pricing decisions, have poor underwriting performance, spend too much on expenses and make undesirable investment choices and/or be hit with an unforeseen catastrophic event.Fortunately, the insurance industry has a stellar track record of financial stability. In part, that is due to insurance being one of the most regulated industries on the planet. State regulation and peer review of the industry provides significant financial oversight protecting the consumer.Thanks for the A2A.
How do General Insurance companies make money?
Previous answer is not strictly speaking correct, in fact it's very misleading. It's true that co's do make money from investment income, but writing for income went out in the 80's. No company can sustain a 110% loss ratio as she suggests...I'm not saying it never happens but they will make a loss when it does. Reserves are there to pay claims, but they don't come from nowhere.... reserves are largely funded by premiums so it's fairly obvious that if you pay out 10% more than you get in you're going to make a loss. Ther's no way investment income can offset a loss like that... that's insurance for beginners stuff. If she or anyone else can show me where you can (or could in the last 10 years) get >10% yield on a high rated bond (or any other 'conservative' investment) I'm all ears... General insurers do make money on premiums pure and simple....any insurer will aim for an NCOR (Net Combined Operating Ratio i.e. claims and expenses as a % of premiums) of <100%. There are a couple of examples below, but any set of decent company accounts will show you the same thing....