How An Insurance Company Makes Money

For the average insurance company, it is a common misconception that the goal of their business is to take in as much money as possible. In fact, for many insurance companies, this couldn't be farther from the truth. Rather than earning large sums of money themselves, it's more important for them to provide low rates for potential customers in order to make money indirectly off of these customers' own investments and life decisions.

For one thing, this means they will never get as much money upfront from a customer as they could have if they had charged higher premiums – but it also means that those same customers are unlikely to ever leave the company because its prices are too high. However, this is the only way these companies can make money.

The Rates Payable to Insurers

In order for an insurance company to be profitable, it needs to be able to charge enough money to cover the administration costs associated with insuring the riskiest customers – those who are most likely to need expensive insurance coverage because their lives are at stake. So, what exactly causes a company's profits in this situation? It's simply done by charging a certain amount for products that measure up with a certain amount of risks covered. This means that every year, insuring parts of people's lives requires them to pay premiums for coverage that may or may not ever be needed.

The Process

The process is simple. Insurance companies will pay a certain amount of money to the policyholders in the form of regular payments in order to provide them with coverage for their lives. However, they make this money back in other ways. The most common way is through investment – meaning that they invest the money that policyholders pay for insurance and use it to fund their own company as well as outside investments.

There are many different kinds of investments that insurance companies make with customers' premiums, which vary in their riskiness and profitability depending on how it's invested and who invests it. For example, some insurance companies will invest their premium payments into stocks or bonds in order to earn a higher return on investment (ROI). Others will invest it into gold, oil, or other commodities which they know are extremely profitable or at least stable.

Unfortunately for customers who pay for insurance that has been invested on their behalf and do not have the knowledge to make such decisions themselves, there is currently no direct way of knowing exactly where their premiums are invested – therefore making it difficult to invest your own money on your own terms.

Some companies are more transparent with this information than others. For example, one company that I work with had a monthly investment breakdown in its customer service e-mail newsletter, providing customers with a list of current investments with the amount of money that each investment returns. However, this is the exception rather than the rule.

Another way that insurance companies make money off their customers is through investments in the general economy. For example, if an insurance company's investment portfolio consists of stocks or bonds from other companies, they will make money off of these companies' stocks or bonds going up or down in value.

In order to limit their risks on their investments, insurance companies will only invest a certain percentage of their available capital into any one investment – further minimizing their risk while maximizing profitability. Some insurers keep a larger amount of money on hand in order to pay out higher claims, while others use this capital to invest (again) and make even more money overall.

The Investment Returns

Insurance companies make on average a very competitive return on investment (ROI). Many companies have been known to make anywhere from 8% to over 15% ROI each year, with the higher returns rivaling that of other investment options like mutual funds and savings accounts. Though this is considerable, the ROIs are often calculated over a period of years, meaning that they don't necessarily show the gains or losses immediately (though many people believe otherwise).

There are arguments for and against this, but I will leave them for another time – though you can read more on it here .

The Risks

According to the Insurance Information Institute, "premiums" are the amount of money that customers must pay each month in order to receive these benefits. The majority of insurance companies use this term; however, some companies also calculate different rates based on coverage and risk – so this review will only be covering premiums.

Insurance companies have a variety of risks they could potentially face if they were to mismanage their customers' money. These include things like outright fraud, loss of earnings due to mismanagement or error, and losses due to increased costs for other investments because of the company's mistakes.

Unfortunately, many insurance companies are not regulated as closely as they should be. Though they are required by law to disclose information about their investment strategies, these are not laws and they are not enforced. This means that people are unlikely to find out about these risks until they are already too late.

The Costs

Insurance companies often provide a different cost of coverage for insurance underwritten by private insurers versus a company's self-insurance program. If someone wants to be insured through an insurance company but is underwritten by a private insurer, the actual premiums will be higher than those if the same insurance policy were issued and underwritten by a self-insurance program (which is more of an extra burden than it sounds like).

When insurance companies charge more money for underwritten policies, they make more money. This is because the savings from reducing their losses on self-insured policies is not as substantial as the savings from reducing their losses on underwritten policies. With this in mind, insurance company employees are motivated to push for underwriting with private insurers in order to minimize their expenses and maximize their profits.

The hidden costs of unnecessary products are also a huge reason for the high costs of using private insurers – especially when it comes to life insurance. There are many life insurance options that do not truly serve the customer's needs and instead add additional pain and suffering to an already overwhelming grief process.

The Continuing Role of Insurance Companies

Since I have been a financial advisor before, I have also seen the impact insurance companies play in our society. We rely on them to take care of all the needs that come with day-to-day situations – whether it is car insurance to cover our vehicles when we're driving, homeowners' insurance to cover damage from fires and natural disasters, or life insurance to pay for our loved ones after we pass away.

Their role is so important that they make up one of the largest industries worldwide in terms of revenue and employment. According to Invesco's "Global Insurance Review" as well as their annual survey, the total world revenues are estimated at $7.7 trillion in 2013 (i.

Conclusion

In the end, what it comes down to is that insurance companies are simply businesses that make money off of spreading risk. You will do well to investigate them for yourself, but just remember that just because the company is one of many doesn't make them any less important or valid.

It's a shame that insurance has been misused in this way; however, I hope that this review will help you discover what it really is and work with your own intuition and research to find the best possible solution for yourself.