Insurance companies always pay money at our hard times. But where they get all the money to pay our insurances? If you ever think of how do insurance companies make money, this article has all the answers in detail for you.
An insurance company can be a lifesaver when your life is surrounded by uncertainty. They can be your last or maybe the only option in your old age or youth.
Day by day, insurance companies have earned the trust and people are prone to them more than ever. By definition, it is a contract which represented by a policy, in which an individual receives financial protection against losses from a company.
The company bets clients’ risks to make payments more affordable. Insurance policies are used against the risk of financial losses that may result from damage one’s property, or from liability for damage or injury caused to a third party. These companies may be for profit or non-profit or can be government-owned.
These companies in general, sell their promises to pay for certain expenses in exchange of regular fees. For example, if someone purchases health insurance, they will pay for the client’s medical bills, according to their policy.
Such kind of policies insures a certain amount of money when a client dies, by putting a risk on their own.
The insurance companies make business arrangements with an individual or organization where the insurer promises to pay a specific amount of money for a specific asset loss by the insured, usually by damage, illness, or death, known as premium.
However, insurance companies are paying out massive claims due to COVID-19 nowadays. Let’s take a look into their business policies and ways of how exactly they make money.
Business Policy of Insurance Company:
If you ask how do insurance companies make money, the general answer is – it firstly depends on the business model or the policy.
The business model of insurance companies is basically based on risk. The so-called premium policy is decided by pricing that risk using a specified algorithms and statistical tools which vary on the types of insurance.
Whenever an insurer offers a conditional payout of a huge amount, the payout is calculated and stretched across the entire premium payment duration.
The collected amount as premiums from different people is collectively more than what the insurer has to pay to some of the insured every year.
Because most of the revenue comes from the interest that is generated from investing the premium money in safe.
This somehow generates profits for any insurer and ensures expenses such as commissions, salaries, administrative costs, etc. When a customer files a claim, it is checked for authenticity and accuracy before the payout is made, so that losses due to fraudulent can be covered.
Return of Investment (ROI)
There is a difference in the amount of money collected from premiums and the money paid when a claim is filed in need.
What we pay as a premium is invested so that it accrues interest over time and that is further used to manage the different expenses of the insurer.
Most insurance companies have a well-equipped portfolio and invest in both low and high-risk fixed-income securities.
How Do Insurance Companies Make Money or Profit?
Though premium is for all, the amounts vary for different individuals.
For example, if you have insured your health and are a fully fit individual and your friend has insured his health from the same insurer but he is a drug addict and dealing with underlying health issues. Your friend’s probability of ending up in a hospital would be far higher than yours of course!
As an insurance company, it makes business sense to charge a higher premium from your friend as there is a higher probability of him ending in a hospital.
As we can say, someone as fit as you might never even need to visit a hospital. So the money the insurer gets from people like you is invested for people like your friend.
When an insurance company assumes the greater risk in advance, the corresponding premium goes up accordingly. This is also called loading of premiums and that’s how it works.
Covid-19 and the Insurance Industry:
The coronavirus outbreak is causing widespread concern and doomed economic hardships for consumers, businesses, and vast communities.
Some guidelines should be taken to overcome the current crisis amid COVID-19 and this includes crisis management and response, workforce, operations, and supply chain, finance and liquidity, tax and trade, and strategy and brand.
At the moment insurance companies can play a vital role to minimize economic stress by helping companies and households manage risks and cushion against huge losses.
The ongoing crisis such as Covid-19 affects all the business sectors but it puts the limelight on insurers who can expect to be overwhelmed with general inquiries and claims across multiple different lines, whether that is for health, life or non-life cover.
Managing the need for responding to this activity could be challenging. Of course, countries are at different stages of coronavirus activity but a very few of the countries are left yet to face this upcoming dilemma.
However, without any doubt, insurance companies are facing challenges during the outbreak and many people are looking forward to these companies.
Like others, the insurance industry is facing the threat to cope up their policies in time. Many of us may get benefits from them and many may face unwanted difficulties, more than they realize.