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How Do Insurance Companies Make Money?

Categories: Insurance
How Do Insurance Companies Make Money?

Jay Stillman

5 min read

Insurance companies are for-profit businesses, so the only way they make money is to collect more cash than they pay out to customers. Insurers are betting on risk, and customers are paying to ensure they’ll receive financial compensation in the case of an emergency or disaster. As long as an insurance company has more premium money coming in from customers than it does claim money going out to customers, it makes a profit. Review how this business structure works so you can learn more about how insurance companies make a profit.

Policy Pricing and Risk Assessment

To ensure it’s structuring a business model that will make money, an insurance company must assess each customer’s potential risk factors and price their policy dependent on these factors. This risk assessment occurs before any insurance quote or policy renewal offer is provided, including health, auto, and life insurance. 

For example, if you asked for a quote for motorcycle insurance, the company would look at risk factors like how safe your motorcycle is, the average number of miles you ride it each year, and your driving record. Based on these factors, it may determine how likely it is that you’ll be involved in a motorcycle accident during your policy term or that the bike will be stolen. If the risk seems low, your policy premium might be low, but if there’s a higher risk, the quote you obtain will likely be more expensive.

Health insurance companies make the same risk assessments before offering you coverage. However, they analyze your medical records, age, and health-related behaviors to analyze the likelihood that you’ll need expensive medical treatments during your policy term. 

If you have a chronic medical condition, such as diabetes, and engage in unhealthy activities, such as smoking, your health insurance policy premium will likely be much higher than if you didn’t have any medical conditions and didn’t smoke. By analyzing your risk factors, the insurance company determines you’re more likely to seek medical treatment. To ensure it continues to make a profit, the company offers you a policy with a higher premium to balance out what it thinks it may need to spend on your medical care.

Underwriting

Underwriting is the risk analysis process an insurance company engages in to calculate how much to charge in policy premium for customers. There are specific formulas used in the underwriting process to determine the premium for each customer. These formulas take the policy, claim, and credit history into account when figuring out premiums.

A well-crafted, expansive, and accurate underwriting process is essential for insurance companies so they earn a profit. If their underwriting process doesn’t take important risk factors into account, policy premiums may be set too low for customers. Once these customers are paid out on claims they make under their coverage, these insurance companies will find themselves losing money.

Insurance Claims

A customer reports an insurance claim to the company when they need to utilize insurance coverage on the policy. For an auto insurance customer, an insurance claim is reported when a car or truck accident occurs. A health insurance policyholder makes an insurance claim when they need to seek medical treatment.

Insurance policies usually don’t cover the full expense of the claim. If a health insurance policyholder needs emergency medical treatment and is transported by ambulance, only a portion of the hospital visit may be covered by the health insurance company. The policyholder may be responsible for paying a percentage of the expensive hospital bill.

Insurance claims can also cost consumers money in the underwriting process. If you use your insurance and make a claim, it can be used to identify you as high risk in the underwriting process. The higher the payout for the claim and the more claims you make, the higher the insurance company may raise your policy premium. This ensures the company continues to make a profit, even if you report additional insurance claims in your next policy term.

Investment Income and Interest Earnings

Insurance companies don’t just make their money from policy premiums. They also earn income by investing this money in financial markets instead of simply sitting on it and waiting to pay out for claims. 

Insurance policyholders pay the insurer to keep a promise that they’ll provide compensation if a loss occurs. There’s no product or tangible asset involved. Since insurance companies don’t need to use the money they make from customers to produce a product, they invest this excess money to grow their profit. 

When insurance companies invest in financial markets, they earn interest on the money they keep invested over time. This allows their money (and profit) to grow as it’s invested. If their investments aren’t earning enough interest or the financial markets decline and they start to lose profit, insurance companies recover by increasing their customers’ premiums. This ensures they still make a profit, even if their investments can’t help keep them afloat.

Insurance Companies and Their Customers

In some cases, insurance companies need to work with customers on what they pay for claims. Since medical treatments are expensive and insurance doesn’t always cover all of these expenses, policyholders may need to contact insurance companies for assistance. These companies are concerned with making a profit and in order to do so, they need to pay out as little for claims as possible.

If you’re involved in a car accident, you may be facing expensive hospital or medical treatment bills that could easily put you into medical debt. Ongoing occupational therapy or chiropractor visits add up fast. Your health insurance company may not cover medical expenses related to a car accident and your auto insurance company may only offer you the lowest claim payout possible. 

Insurance claims money is usually not enough to cover all the medical treatment you need, leaving you stuck with the bill. You may need to enlist the help of a car accident lawyer to assist you in negotiating with your insurance company so you don’t go into debt paying off these bills. Experienced legal representation helps motivate insurance companies to cover insurance claims more generously. 

Whether you’re obtaining quotes for a new insurance policy, renewing your policy term, or negotiating a claim payout, it’s important to remember that insurance companies are focused on making a profit. They’re only profitable if the premiums they collect are higher than the claim money they payout. If you’re not sure about your rights or you’re facing debt because your insurance company won’t cover your expenses, you may need the assistance of an injury attorney.