Question

How do insurance companies earn and gain profits if they are paying people for their losses?

I just don't understand how they work, because I have never really taken any interest in it. But my dad recently hit a cop-car, and both the cars were badly damaged, and the insurance paid for the damage.
That was certainly not a cheap amount, so how do they earn if they are spending on people?
Do they take money from people when they sign up for an insurance?
I'm sure my dad did not pay THAT much for his insurance, so how do the insurance companies manage and run their buisness?
Or are they payed by the government?
Also, what are policies and claims?

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LB Centaur, could you please clarify?

5 years ago - 9 answers

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Insurance companies simply play the odds and base their rates upon that. For example: the odds of getting in a total loss accident are roughly 1 in 240. That means for every one accident, there are 240 people paying insurance premiums to cover that one accident, and those insurance premiums are invested for a return. They also factor in the odds of a person cancelling their policy without ever making a claim against it.

In cases like life insurance, the company collects insurance premiums from people for decades and invests the money for a higher return that what the pay out will be when the person dies (IE: If a 20 year old buys $100,000, the insurance company is taking in $40 a month for the next 50-70 years in some cases...that adds up quick when you figure the returns...the client still only pays $20,000 or so total, so the return on investment is great for them and it's profitable for the insurance company as well...especially for companies that sell term insurance where sometimes people pay into it for decades then it expires or client cancels it becuase it get so expensive and they ge tno money back and the insurance company doesn't end up paying out anything at all...clear profit on those ones.

Policy = the insurance contract basically
Claims = you file the paper work for an eligible occurance that should result in a payout (IE: If you have auto insurance and you get in an accidient, a 'claim' is when you send in the paperwork for get money from your insurance...you are basically "claiming" that the insurance company owes you money)

Source(s):

5 years ago

Other Answers

they are insured them selves for loss of profits.

by Shane Burke - 5 years ago

Insurance companies make money by investing premium dollars before those premiums are needed to pay claims.

Customers pay monthly or semi-annual premiums. Insurance company invests premiums in the stock market or other investments. By the time customer files a claim, the insurance company has made a large profit off their investment.

This is based on the fact that the AVERAGE customer doesn't file a claim right away.

by LB Centaur - 5 years ago

As you know every vehicle should be insured before they can hit the road. the basic principal behind insurance is to divide few claims between so many other participants. even though the damage of your father's vehicle was a big amount insurance co. collect huge amounts as premium. and not every car owner is going to claim insurance every year. How many vehicles do you think are out there ? and how many vehicles crash?
Insurance companies also invest the premium they collect in various markets and they gain profits from those investments.
maybe one of the most profitable businesses on this planet.
you know, life is the only insurable item that has a definite danger. Death. Insurance co has to pay life insurance benefits whether the assuared is dead or alive.

by xcaliber - 5 years ago

Good question!
Here's a brief description on how it works:
The insurance company asks it's customers many questions when signing them up. This helps the insurance company place them in a group with other similar drivers. The insurance company knows that within that group of people a certain percentage are likely to have an accident. They also have an idea of how much that will cost them. The larger the group, the more accurate their estimates are. So they charge everyone in the group enough to cover for the estimated costs of the accidents.
Insurance companies are also regulated by the states, so if they made too much profit (usually anything above 12% of annual premium) than the state will make them charge less the following year or make them send out refund checks. That keeps them from charging whatever they want.

Source(s)

by Nate W - 5 years ago

An insurance company is required to put millions of dollars "in reserve" to pay future claims, before they can sell policies. These reserves are invested - primarily in guaranteed bonds and money markets - very, very safe. They make their profits, off of the interest income from their investments.

That's how they can afford to, for example, pay out $1.17 in claims, for every $1 they take in, in auto insurance premiums.

When the market tanks, the premiums go up, because the investment income isn't there any more, to subsidize the claims. Or not there so much.

A policy, is a contract between the insurance company and the insured. A claim, is a demand from the insured, for the insurance company to pay.

by mbrcatz - 5 years ago

Automobile insurance companies -- and most insurance companies are in business to make a profit.

For example, let's say that an insurance company brings in a total amount of car premium payments of a million dollars - $1,000,000. That would happen if 1,000 households paid $1,000 each for a year - or $500 for each of 2 cars the household owns.

Then, let's say that the drivers have accidents and the insurance company has to pay out $250,000 in claims for accidents that year -- that still leaves them with $750,000. In fact most big insurance companies have premiums in the hundreds of millions or even billions of dollars and they don't just insure cars, but homes and businesses also.

They would pay some of that towards running their business such as wages and expenses, but they would also make a hefty profit. And, of course, they charge more and insure hundreds of thousands of drivers each year.

And, that example doesn't even touch on the fact that they will be investing most of the money that they have coming in. They need to have a certain amount of "capital" available for payments but the remainder can be invested.

Many insurance companies buy insurance to cover themselves if they run into a situation with a more losses than they had counted on. The insurance that insurance companies buy for themselves is called "reinsurance." This way they carry less risks to their own company because someone else will help them out if they need more money to pay claims.

You know how some of your friends' parents may pay much more for car insurance than other people do --- and some people pay a lot less?

That is because each insurance company hires people called "underwriters." They look at all kinds of factors to figure out who is most likely to get in a car crash and who is less likely to get into a crash.

If there are teenagers in the family that will usually cost more. If the teens are on honor role and took a safe drivers course, they may charge less.

If the drivers in the family have speeding tickets or other moving violations that they've gotten tickets for - the insurance company will charge them more or not insure them at all.

If the driver is married and has a record of no accidents for a period of years, and own their own home, they will tend to be charged much less than drivers who don't.

Even the type of car that you drive -- and the color -- can cause you to be charged more money because statistics used by the underwriters show that more of those models of cars get in accidents or get stolen!

Although it may seem as though they paid a lot for your Dad's accident, think about how many years he's been paying insurance premiums. If he's been paying $900 a year for 20 years, he's paid the insurance company $18,000. If he paid $1,200 a year for 20 years, he's paid the insurance company $24,000.

Take 10 neighbors all paying $1,200 a year for 20 years - and the insurance company had $240,000 in premiums-- or close to a quarter of a million dollars just from those 10 neighbors! Take 40 neighbors on a street paying that same amount and that totals close to $1,000,000 - a Million Dollars paid to the insurance companies just from that neighborhood on that one street. How much do you think that they paid out in claims and how much was profit?

It might be worthwhile and helpful to you in the future to ask your Dad just how much insurance costs him. Ask him also about what he has included -- will they fix the car if it slides off the road on ice into a tree if no other cars are involved? What if there is another car and your Dad's not at fault? Does he have a high "deductible" where he pays the first $1,000 of his own car's repair bill?

Ask these questions and if he's willing to share the answers, you'll be getting pretty smart about insurance and in a much better position for when you go out on your own! Plus, you can educate your friends about it!

Insurance is a VERY profitable business. They try to make sure that they will continue to raise their rates and/or remove drivers who are more likely to have claims such as accidents or stolen cars which will cost them money to be sure that they make a very lucrative profit!

by Friend - 5 years ago

Insurance companies themselves pay nothing: insured persons do: You must have a huge amount of people paying for insurance coverage (home car etc..) and seldom if ever having to make a claim, and that money (a good part of it will go to pay to those who have had fires or theft or accidents etc). That's also why insurance companies are reluctant to pay sometimes, because of fraudulent claims etc. So. as with any other company, if it pay out too much, it goes belly up. So they use tons of statistics and probabilities (what's the probability that "X" number of men who take life insurance will die of this or that by the time they're 50 or 60 ...)

by robert43041 - 5 years ago

Insurance companies make their profit by charging insurance policy premiums. You have to understand that insurance companies have access to numerical statistics. They know how much money it will cost for health care money to cover x people between the ages of 30 and 40. They know how many dollars in auto accident repairs they will need to spend over so many months, etc. There are statistical variations to this of course, but in general they know. So from this data, they can develop a premium to charge all customers in the "risk pool", and that is how they generally make their profits.

by mkjammin - 5 years ago