At first glance, it seems complicated to understand how insurance companies make money. Insurance companies deal with having to pay out large sums of insurance damages each year. So how can they make this work?
Insurance Companies Underwrite Their Profits
Each applicant must qualify for an insurance policy by undergoing a detailed underwriting process conducted by the insurance company. The rates for each applicant are determined by several factors, such as the applicant’s age as death rates are higher among the older population.
Often, insurance companies will gain profit from underwriting income. For example, Company X can earn $20,000,000 in premiums per year for insurance policies they issued within that year. If Company X pays less than $20,000,000 in claims that year, they will be making a profit.
Some of the income from premiums will be invested in stocks and bonds resulting in investment income for the insurance companies.
They Raise Insurance Rates
Sometimes, when the stock market performance is poor, insurance companies can suffer losses in their investment returns. If necessary, insurers can increase the rates to make up for such losses. Additionally, insurers are known for deliberately charging low prices for insurance policies while planning for an underwriting loss to invest the money they receive quickly, before being obliged to pay out claims.
Insurance Company Coverage Can Lapse
Lapses occur in two ways: when an insurance policy expires without the death benefit being paid, and when policies are given up on due to financial difficulties of the client, i.e., inability to pay the premiums. In these cases, the insurance companies receive the premiums and don’t have to pay any claims. According to some surveys, approximately 2% of insurance policies are paid out to the clients. The rest of them lapse or are canceled.