How Do Insurance Companies Make Money
Taking on the risk of others is very tasking but insurance companies have the responsibility for doing that. Insurance companies help cover expenses on behalf of the insured in the occurrence of unexpected events like thefts, accidents and floods and other natural disasters. They provide protection for the insured and in exchange collect premiums which are used for coverage or paid as claims.
Insurance companies need money to run their day to day activities and they generate their revenue either from underwriting profits or from reinvestment or premiums paid by the insured. To make money they ensure that the premiums charged are greater than the claims paid out.
What is an insurance company?
An Insurance company is a company whose primary and most important business is to protect people, properties and other assets from unexpected occurrences. They provide different insurance policies like home insurance, auto insurance, health insurance and life insurance in return for the payment of premiums from the insured which are used to pay claims whenever they are filed for or required by the insured. For instance Mr Johnson decides to do business with Attic Insurance to insure his car against an occurrence of theft or accident Attic insurance charges him a fee to pay as premium after doing a proper analysis through underwriting and in return provides his car protection in a case of theft or accident.
Functions of Insurance Companies
Insurance companies have the responsibility of providing protection and spreading the loss of a particular asset over the persons who are insured against the risk of that asset. The functions of Insurance companies are:
- Protection: Though events happen unexpectedly and the time they would happen cannot be certainly predicted but insuring your properties with an insurance company allows them provide you protection whenever unforeseen circumstances occur. They guarantee you a form of protection when you’re insured which reduces your chances of loss.
- Risk sharing: Risk is something we cannot really do without. Risks are uncertain and it cannot be determined when they would or should happen, but having an insurance policy in place allows the loss to shared by the people exposed to that particular risk.
- Certainty: Insurance companies provides you with a level of certainty that at the occurrence of damages, theft or accidents you would be paid an amount for the coverage of loss that occurred. The insured is certain that a claim would be paid when an unexpected event occur.
- Insurance companies helps to access the level of risk by analysing various components that contribute to the risk. Analysing the risk allows them know the amount that should be charged as premium so that they do not undercharge or overcharge the insured.
- Act in good faith: Insurance companies have the function to act in good faith so as to avoid a breach of contract between them and the insured. They should pay claims as at when due and pay the appropriate amount of claim to the insured.
How do insurance companies make money
Insurance companies are profit making organizations that needs cash to run its daily operations. They generate funds by selling insurance products to customers and in exchange they pay premium. They ensure that the amount charged as premium is greater than the claim paid. Insurance companies get money through the following ways:
- Underwriting Profit: Insurance companies make money from the premiums paid by the insured minus the amount paid out as claim and for running the business. They employ underwriters to analyse the risk of a particular asset and how much should be charged for cover and the risk of of what is insured in the policy. They calculate how much would be paid, under what circumstances would claims be made and how much would be charged as premium. The price of an insurance premium may vary depending on the type of insurance or if the cost of providing protection or certainty increases.
Note: Premiums is a sum of money charged by the insurer and in turn would be paid by the insured for an insurance policy. They can be charged either for home, auto, health and life insurance and the amount charged may vary depending on the insurance company.
- Profits from Investment: The money paid as premiums are invested into other businesses to make more money for the insurance companies. The time an insured would require or file for a claim us uncertain so instead of the cash paid as premium would be left sitting in the bank, insurance companies would rather invest that money in the financial markets that can yield more money and interest.
- Insurance companies also make money from premiums that are not reversed yearly if the policyholder does not file for a claim. In the absence of an occurrence of loss, the premium paid by the insured is not given back which serves as a means of increasing revenue for insurance companies.
- Policy lapses: In some cases policyholders fail to follow up and pay premiums as at when due and when the policy lapses insurance companies make money from this. When a policy lapses occurs, the policy expires without any claims been paid. In situations like this the premiums paid by the insured are retained by the insurer.
Insurance companies are also like any other profit making organization all around the world. They need money to run their daily operations and pay those who work for them. While providing protection for others they also ensure that they make profit so that they can continue to be in operation. This article has covered ways in which insurance companies can generate income and make profits.