Profit is the primary goal of any business. Profit is welcome, but not a priority, even in so-called non-profit organizations (NGOs).
However, the insurance industry is complicated for the average person. He understands that in order to make a profit, you must buy low and sell high. You sell a service for less than you paid for it.
However, how does an insurance company make money? Premiums are, of course, collected from policyholders. However, if they suffer losses and file claims, the company will compensate them. Will there even be anything left to call profit?
Worryingly, the sum of individual insured/assured premiums may not even cover the total claims when they arise.
So, how does an insurance company make money, if at all?
The “Pool of Premiums” generates revenue for insurance companies.
Premiums are fees paid to an insurance company to protect an insured against specific types of losses.
Even after settling the claims, the company will profit from the money paid in by thousands of policyholders.
The term “pool of risk” refers to the fact that not all policyholders will suffer loss at the same time. In most cases, one out of every fifty insured will suffer a loss during the policy’s term. In contrast, all 50 are paying their premiums on time.
If the insurance company pays off this one client, the compensation could be as little as the total premiums paid by about 5 of the policy’s 50 members.
You should be able to see how your insurance company will profit even if you are not a mathematician.
The net premium income is equal to the total premiums minus the claims. The net premium is the income generated by an insurance company after deducting claims against it in a given year from the gross premium received. This is known as underwriting profits.
And don’t ask me what happens if all of the policyholders suffer losses at the same time. That will not happen in a million years, we both know.
Insurance companies do not pay out on all claims.
Even if you are a policyholder, have paid your premiums on time, and there is evidence of a loss, the company is not required to compensate you.
Yes, you heard correctly. Not all losses are compensable.
For example, if you only insure your car against accidents, you cannot claim payment if it is stolen or requires general repairs.
In the event of an accident, you must still prove that you are not at fault in order to receive compensation.
When a person files a claim with an insurance company, the claims process begins. The insurance company investigates the claim and determines whether or not it is valid. If the claim is valid, the insurance company will send the claimant a letter with a settlement offer.
The claimant may accept or reject the offer. The insurance company sends the claimant a check if he accepts the offer. If the claimant rejects the offer, the insurance company sends him a second letter explaining why he did so.
Insurance companies employ loss adjusters. Their job is to evaluate customer claims and determine whether the customer is entitled to compensation for damages. Loss adjusters do not make payments; rather, they negotiate settlements with claimants.
The company will not lose if the insurance pays for your claims without further bargaining or if you lose to the loss adjuster or investigation. In fact, makes money in both cases.
To make a profit, an insurance company invests premiums equally in financial assets.
From the outside, it may appear that an insurance company’s only investments are in its employees, experts, and structure. If you look inside, you’ll notice that they’re also saving up premiums to earn better interest. Some people put their money into liquid assets and real estate. Some people trade forex and other related investments.
The company is not required to manage all of these assets on its own. It’s also an investor in this case. Other businesses can manage their investments until it is necessary to convert them to pay off claims. It should come as no surprise that some insurance companies continue to insure themselves in larger insurance companies.
The company is more likely to profit from these short-term and long-term investments.
Conclusion
Insurance companies make money in two ways: by charging premiums for insurance coverage and reinvesting those premiums in other financial assets.
As a policyholder (insured/assured), you are probably unconcerned about how it makes its money. What is certain is that the company is profitable in these two main channels and should be able to finance claims if necessary.