HOW INSURANCE COMPANIES MAKE MONEY

Like every for profit business, insurance companies have to find a way to make profit and still be able to pay out claims to its clients. 

Their business is tied around a contract that states that they have to pay a certain sum of money or cover certain risks stated in the contract as long as you pay the premium required. This sounds really simple, but when you take a closer look at their revenue model, you discover that they are making even more money than you think.

There are different avenues profit is made by these companies, keeping them in business for years and happily banking their profit.

Interest Earnings

For the premium collected by the insurance companies, it would be easy to place the money in a savings account till it is time for it to be paid out. But most insurance companies invest these sums in short term assets which generates extra revenue for the company. This creates a buffer against the potential loss that might be incurred from payouts.

Transfer of Risks

This term is commonly called Reinsurance. This term is when insurance companies move some of the risk to other insurance companies to reduce the risk of paying out large sums for claims. This is mostly done by companies to avoid defaulting on payouts of claims.

They basically charge higher premiums from the customer and then re-insure the risks for a lower sum with other insurance companies.

This also means that if an insurance company reinsures the risks for say, natural disaster, if it does happen, they will not go bankrupt paying out the claims

Underwriting Revenues

As insurance is usually based on if the event insured happened or not, there is usually the chance that the amount spent on purchasing an insurance plan is not going to be paid out completely during a claim. This extra money left behind is termed, underwriting revenues.

For example, the sum of 10 million Dollars was paid to Insurance company A  for insurance policy purchases, but for the year, only the sum of 8 million Dollars was paid out as claims. The remaining 2 million Dollars is profit for the company.

For the clients of the Philadelphia Contributionship company, which was the first insurance company created by Benjamin Franklin, they received no claims in the first year of operation because there were no fire outbreaks on anybody’s property. So that was a whole lot of profit for the company.

This is the reason why most insurance companies will happily put forward plans with low risk, as the chances of any claims coming through is very low.

Non Payment of Premiums

A number of times, customers fail to continue the payments on their insurance plans. When this happens, this means that the company gets to keep the sums paid previously, while the customer never puts forward any claims for the previous payments. This allows the customer to take all the risk in this case of failure of premium payments.

So there you have it, insurers make money through premiums which are used in generating more revenue in all the ways detailed.