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How Do Insurance Companies Make Money?

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Providing protection against financial loss has been an incredibly lucrative business for nearly 5,000 years. Some form of insurance is available across nearly every aspect of our lives. From physical property to life itself, there’s always a way to protect what’s important, but how do the insurance companies make any money?

How Do They Make Money?

Insurance protection begins with a contract or “policy” between the insurer and the insured. This contract defines the nature of the relationship between both parties including how and when money will be exchanged.

In the event of a protected loss, the insured will receive compensation from the insurer. In exchange, the insurer will charge the insured a “premium” at regular intervals.

Insurance companies have two types of income, underwriting and investments.

What Is Underwriting Income?

Insurance companies base their annual premiums on a claims prediction. The difference between the amount their customers pay and the money paid in claims is known as underwriting income.

What is Investment Income?

Insurance companies will pool premium payments into guaranteed or low risk security investments. The interest payments from these investment are where insurance companies make the most of their profits.

What Is An Insurance Premium?

A premium is the payment required for insurance coverage. An insurance agency will pool the funds from many customers to protect the losses that may be incurred by a few.

The value of the premium varies with the frequency and severity of the risk. While premiums represent a large sum of money, they are not the primary profit generator for many types of insurance companies.

The majority of auto insurers attempt to set their yearly premiums to match the total value of paid claims and business expenses. “Ultimately, very little, if any profit is made through underwriting (premiums) alone,” Craig Anderson, a Chartered Insurance Professional wrote on Quora. “Rather, the reason for writing policies and collecting premiums is to build an investment pool.”

What Is An Investment Pool?

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When a customer makes a claim, the insurance company will take money from the investment pool to pay the insured. Their main goal is to have enough regular premium payments to keep the investment pool fully funded.