How do Insurance Companies Make Money?
Insurance companies make money…and a lot of it. For the most part though; many people do not really understand how the money is made. That is what we are going to take a little look at on this page.
The money for the insurance company will mostly come from insurance company premiums. This basically means the money that you are paying for your insurance on a weekly, monthly, or even a yearly basis. There may be a few additional income sources to the premiums (i.e. some insurance companies will engage in a few investments), but for the most part the money that the insurance company takes will come from the money that you give them.
The main method for making money for the insurance company will all be about shared risk. This basically means that everybody’s premiums will go into a big pot. The premiums will then be used to make a payout whenever a claim is made. So basically; at the end of the day, any of the money that is left in that ‘big pot’ is a profit for the company. Sure; some pretty big claims are probably going to have to be made through the insurance company, but if the insurance company knows how to manage the shared risk well then they will end up making a profit. This means that the insurance company will need to analyze the amount of claims that they get, and the likelihood of certain people making claims. The insurance premiums will then be adjusted as a result of this research. The more insurance policies that the insurance company represents, the more accurate the statistics for insurance premiums seem to be as there is a bigger sample.
Insurance companies will go to a lot of effort to reduce the risk of them having to make a pay out on the insurance policy. After all; if they have to make a payout then they are basically going to be throwing away money. For this reason; many insurance companies will completely turn down people who are likely to be of a high risk, or perhaps charge premiums so high that nobody in their right mind will want to take out the insurance policy. This means that they are mostly taking money from people who are unlikely to make a claim on the insurance policy. The premiums of many cover the risks of a few. What this means is the amount of premiums collected will always be more than the claims. This is an ethical way of generating income. Without insurance, many people would have been in serious trouble. Imagine getting into an accident the day you buy your brand new car. Insurance can help protect your assets.
As I mentioned previously; insurance companies will also invest the cash that they take. This should generate a rather healthy return for them (sometimes over an additional 10%). This money will then be used as profit, or in some cases it will be used to reduce risk. Some of the biggest investors in the world are insurance companies as they have a rather large sum of cash coming in and most of the time they really do not have all that much to do with it. Take a look at most large projects out there and you will find an insurance company is behind it at some time or another!
Insurance companies are not evil capitalists. They help you manage your risks better. Insurance companies will always have some form of exclusions. This can come forth as being dishonest. In most cases, this is not the case. Insurance companies understand risk better than most of us. They know how create mutually beneficial products.
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