How do Insurance Companies Make Money?

How do Insurance Companies Make Money?

Insurance companies can make money a few different ways depending on the type of insurance or policy offered.

Insurance Companies Make Money
Insurance Companies Make Money

For example, the nature of a permanent life insurance policy is different than a car insurance policy. A permanent life insurance policy will definitely be paid out at some point as long as the person pays their premiums on time, while a car insurance policyholder may never file a claim.

There are three main ways insurance companies make or save money:

Investments

Many people think insurance companies make money solely on charging more in premiums than they intend to pay out.

This isn’t the case.

Most insurance companies actually try to price their plans at just enough to cover payouts. This is because lower rates help insurance companies beat out their competitors.

Instead, the insurance companies invest the premiums they’re paid. This is especially important to companies selling permanent life insurance, as they know they will have to pay out a benefit eventually.

Risks

Plans like term life insurance or car insurance are more of a bet for the insurance company. Unlike a permanent life insurance plan, these types of insurance may not involve a payout.

It’s possible that at the end of 20 year term life insurance plan, the insured hasn’t died, so no death benefit needs to be paid. It’s also possible that in 10 years of insuring someone’s car, they are never in an accident.

If that’s the case, the insurance company doesn’t pay a benefit and they keep the premiums paid to them.

Because of the nature of these policies, insurance companies generally charge you premiums based on how risky it is to insure you.

If you’ve been at fault in four car accidents in the past year, you are riskier to insure than someone with a clean driving record. If you have a medical condition, you are more likely to submit more health insurance claims than someone who only visits the doctor for regular physicals.

In these cases, insurance companies often have to charge the policyholder higher premiums to account for the potential benefits they will have to pay out.

Unclaimed benefits

Though insurance companies probably aren’t relying on you not making claims, not every policy benefit is claimed.

If someone dies, a beneficiary may not know they had a life insurance policy that can be claimed. Or someone with health insurance may not realize their plan covers a certain type of procedure. In these cases, the insurance company may not have to pay a benefit and they keep the premiums paid to them.

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