How Do Insurance Companies Make Money?

Insurance Q&A: “How do insurance companies make money?”

You know, dough, clams, bacon, cheddar, moolah…but first a little background.

An insurance policy is a contract, or a promise, between the insured (you) and the insurer (insurance company). The insurance company collects a premium from you for the issued policy and agrees to pay for any covered losses you suffer. It sounds like a pretty simple business model for earning money, but can be quite complicated.

Insurance companies are like any other business in the world. They have to make a profit to stay in business. There are two basic ways this can be accomplished. They can earn underwriting income, investment income, or both.

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 insurance claims for those policies in any given time period.

For example, Insurer “A” may collect $1,000,000 in premium for polices issued or renewed in a given year. If they pay less than $1,000,000 in claims, they have made a profit. If they pay more than $1,000,000 is paid in claims, they suffer a loss.

Insurers have a unique way to earn massive amounts of additional profit. Unlike many other types of businesses, insurance companies collect huge sums of cash throughout the year and may not have to pay on claims on those policies for many years.

Investment Income

This unique situation allows insurance companies to invest that money while it’s not being used. Huge profits can be reaped, or lost, as a result.

This is exactly why Warren Buffet formed the Berkshire Hathaway Insurance Company…so he could generate capital to invest in the stock market.

In fact, insurance companies can knowingly charge too little for insurance policies and plan for an underwriting loss if they believe they can make a profit from investing the money they receive before having to pay claims. In the early 2000s, when the stock market was booming, this practice was taking place.

On the flip side, insurance rates may be raised to make up for stock market losses.

Additionally, some insurance companies may enter a new line of insurance or a new state and purposely charge less than their competitors, causing an underwriting loss, simply to make a name for themselves. Then, the following year, raise their rates and hope to hang on to some of the business they wrote.

Taking all of this information into account, it is recommended that you shop online in order to be certain you are getting the best coverage at the lowest rate available to you.


4 Comments

  1. Kris Nelson August 12, 2016 at 4:54 pm -

    My dad worked in the insurance business for over 30 years and he spent many nights away from his family selling life insurance policies, sometimes while riding alongside a farmer in the cab of a combine because it was the only time the farmer had to spare. He would spend Christmas Day in other families homes to get their policies signed so his agents could win a life contest and be able to take their spouse on a trip to places like Rio or London or Rome. He would spend 11 hours a day driving his entire district in western Kansas every week to make sure the policies his agents issued were right for the insureds.
    Searching online is NOT the best way to find a good company or even to compare rates. Insurance is about people meeting face to face and going over what the person needs and making sure their family is taken care of in case of a loss. Companies need to get back to those ways and stop lying about insureds’ information on applications and then when they have a claim it gets denied and then the insured wants to blame the company when it wasn’t their fault at all, it was the agent.

  2. jeremy August 18, 2016 at 11:32 am -

    We are in the technological age now. The need for traveling insurance sales are no longer needed

  3. Kim October 8, 2016 at 1:43 pm -

    That’s not true. I am an Aflac Sales Agent and regardless of advanced technology we have to travel to our accounts to enroll them and handle issues. Not saying that we dont call or use advanced enrollment plateforms where our clients can make changes to their policies. That’s all great, but nothing will replace the “face to face”. Not only is it necessary in some cases, it’s just good ‘ol fashioned customer service. I don’t know what insurance company Kris’s father worked for, but at Aflac, if one of our clients is a good distance away, we would have an agent, in that area, service the account and we share commission. I wouldn’t have missed time with my family. However, I don’t know his situation, so I shouldn’t judge.

  4. Me October 12, 2016 at 10:07 am -

    Our parents worked hard for their money. Doctors would visit your house when you had a mere cold. Times have changed and not for the better. All about money money money and more I’d pooled in a few hands.

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