If you have always wanted to know how insurance companies make money, then you need not look any further beyond this article. One sure thing you must know from the outset is that insurance business is a very lucrative business; and regardless of the huge risks involved in several unforeseen circumstances, they still continue to make good money.
One thing you mustn’t forget at the core of the business is that insurance is about protecting people from serious eventualities that may likely happen, but more often than not, these eventualities remain “risks” at best and do not often occur – meaning that the frequency of occurrence is much lower since people take all precautions to prevent their occurrence, a development that gets insurance companies richer.
The main fact is that people get insured against future losses, but those losses do not often occur and they only remain risks; meaning that insurance companies make money from the risks people face in their daily lives, and only lose money when those risks become losses.
But do they really lose money? Hell, no. The money they pay out as reimbursements are actually pooled from customers or subscribers.
Let’s break this down in finer details.
Insurance premiums
Insurance companies make a larger percentage of their money from insurance premiums. This is the annual prepayments that customers pay to be protected from a particular loss. If this loss does not occur within the year under review, then the insurance company takes all the money pooled together.
For example, 1,000 customers insure their cars against theft for N500,000 but get charged N5,000 yearly as premium for the protection. It is not possible that all the 1,000 customers will have their cars stolen in one particular year, but where 100 customers suffer this eventuality, they will get compensated for their losses from the premium paid by the other 900 customers. But where no claims are filed for that year, the insurance company takes all the money as its own profit, which could be saved against future claims.
Public investments
When an insurance company makes a huge profit from premiums and unfiled claims, it does not leave the money on the table but invests it into real estate, government bonds, treasury bills, private equity, and other low-risk investments that would bring certain returns.
External reserves
If two customers out of 10 files for claims, the insurance company saves the profit earned from the other eight that did not file for claims or suffer any losses. This is kept as a future reserve and as a buffer against any future losses suffered by customers. This means insurance companies usually have more money than they need since 90% of their insured customers don’t suffer losses or file for claims.
Loss re-evaluation
An insurance company makes money by paying customers less than they expect due to changing economic levels and according to the level of usage exercised on the object of loss.
For instance, if a car is insured against theft for N1 million over a 10-year period and gets eventually stolen after 7 years, the insurance company would never pay you N1 million to get another new car because your stolen car must have depreciated in value over the 7 years you have used it. So the insurance company pays you the depreciated value of the car and keeps the rest for its own profit.
Reinsurance
You may not know this, but insurance companies also get insured themselves against your potential losses. Since the business is all about managing risks, your insurance company transfers the risks of protecting you to a reinsurance company which protects them in the event that you file for a large claim. In which case, the reinsurance company pays your insurance company to pay you and your insurer is saved a lot of money in the process.
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