How do Insurance Companies Make Money

Although there are variations between insurance products and insurance companies, the basic principles they use to make money are the same. To provide insurance, insurers charge a surcharge, that is, the price of insurance. You can pay surcharges in various ways, depending on the type of insurance and your preference. For example, car insurance used to be paid every six months. Currently, many companies also allow monthly or annual payments. These surcharges constitute the money that insurers receive from their clients.

Insurance surcharges

Although there are variations between insurance products and insurance companies, the basic principles they use to make money are the same. To provide insurance, insurers charge a surcharge, that is, the price of insurance. You can pay surcharges in various ways, depending on the type of insurance and your preference. For example, car insurance used to be paid every six months. Currently, many companies also allow monthly or annual payments. These surcharges constitute the money that insurers receive from their clients.

Insurers expenses

An insurer must pay according to the terms of the insurance when a certain event occurs to an insured. In the case of people with insured houses, the company can pay in case of fire. In general, the maximum amount the company will pay is set in its policy. These payments represent the expenses of the insurers.

Shared risk and large numbers

If a customer pays a $500 surcharge for their car insurance, but does not have an accident, the insurer saves the $500. Likewise, if a client pays a $500 charge to insure his car and has an accident that causes US $50,000 of damages, the insurer will pay US $50,000 regardless of whether the customer pays much less.

This concept is called shared risk. In the previous example, if the insurer has 100 clients who pay US $500 per year surcharge, but those clients do not have any claims for each client who has US $50,000 in claims, the insurer would not earn or lose money. Each customer over 100 for one represents a profit, or each dollar charged over US $500 represents a profit.

Of course, the real world is not so orderly. However, statistics are emerging on a large number of insured clients. With larger numbers, these statistics are increasingly accurate.

Bookings

As claims are not filed on a regular basis, there are times when the insurer will have more money in reserve than it needs to pay claims. In our previous example, if one in 5 people files an average claim of US $ 5,000 a year, it would mean that in one year there could be five claims of US $100 each (and other years in which they will be older). In this year, the insurer will have received US $ 5,500 in surcharges and will only have paid US $500 in claims. The additional US $ 500 charged in the required amount remains a gain. However, the company has acquired US $4,500, which statistics will later need to pay claims. Then, the company will save that money as a reserve. This money is not a gain.

Reserve Investment

The reserves of an insurer are not saved in a savings account. Instead, the insurer invests them. If the insurer has a positive return on this investment, that money would be a gain. So, if the company gets a return of 10 percent of the US $4,500 before needing that money, it would make US $450 in extra profit just by saving their reserves.

The combination of charging profitable surcharges, plus the money they earn with the investment of reserves is the way insurers make money.

Selection and Rejection of Coverage

For the model to work, an insurer must have a way of statistically measuring the risk involved in any insurance product. If you cannot measure this risk, an insurer cannot sell a certain product to a certain segment of the population or area. In addition, if the company can project the risk, but cannot find a way to offer the product that covers such risk profitably, the insurer will not be able to offer the product.

For example, many companies have stopped drafting home insurance policies in areas where there are usually hurricanes, such as in Florida’s coastal areas. In this case, insurers determined that there are no profitable ways to offer such policies because the surcharges should be so high that few people would buy the insurance, and the shared risk model among many people would not work.