Insurance businesses make money in two ways: by charging premiums to their customers and by investing the premiums they receive. Isn’t it straightforward? It is and isn’t at the same time.
The principles behind how insurance make their large bucks are simple. However, the specifics of how they make money can be more complicated. Here’s everything you need to know about it.
How do insurance firms profit?
Insurance comes in a variety of forms:
- Health insurance covers a portion or all of a person’s medical expenses.
- When the insured individual dies, life insurance pays out money to one or more selected beneficiaries.
- Damage to automobiles, homes, and businesses is covered by property and casualty insurance.
- Excess and surplus (E&S) insurance is a sort of specialty insurance that covers risks that other insurers don’t.
- Reinsurance is a type of insurance that allows insurance firms to cover losses in excess of a particular level.
1. Underwriting
Underwriting, or charging a fee (called a premium) for taking on financial risk, accounts for a large amount of every insurer’s earnings.
Actuaries are employed by insurers to assess the financial risks involved in insuring various situations using statistics and mathematical models. Specific insurance plans can be designed and premiums set for each form of insurance plan once the financial risks have been assessed.
For example, actuaries for a property and casualty insurance firm analyze natural catastrophe probability when deciding how much money homeowners in various geographic regions should pay in premiums.
Actuaries for life insurance firms may compute anticipated life expectancies based on age, sex, and medical histories to decide how much different clients should pay in premiums.
When a person enrolls in an insurance plan, he or she agrees to pay the insurer a fixed premium in exchange for the insurer taking on a particular degree of risk. The amount of liability that remains the individual’s obligation is referred to as the deductible amount in many insurance programs.
For example, your motor insurer may demand you to pay the first $1,000 of any damage charges before the insurer will pay anything.
2. investments income
Insurance companies make a lot of money from all of that money in premiums. Until and unless an insurance claim is lodged, such as a claim for a hospital visit or damage to a home during a tornado, the firms are not required to pay out any money.
What happens to the often colossal quantities of money generated by premium payments? The firms set aside some money in reserve to ensure that they’ll be able to pay all of the claims that are expected in the near future. The remainder of the funds, however, is invested.
Investment income is typically much lower than underwriting income. Many insurers invest conservatively, such as in bonds or well-established blue-chip equities. Insurance businesses, on the other hand, can use their investments to considerably boost their top and bottom lines.
Purchasing insurance businesses as a long-term investment
There are two main reasons why you should think about investing in insurance stocks. First and foremost, insurance businesses can provide reliable long-term returns. Second, insurers’ business strategies tend to make them resistant to economic downturns.
On both of these fronts, some insurance firms are clearly superior to others. UnitedHealth Group (NYSE:UNH), for example, has outpaced specialty insurer Markel (NYSE:MKL) by a wide margin over the last ten years. During the market downturn induced by the COVID-19 pandemic, Markel also declined substantially more than UnitedHealth Group.
Insurance stocks are typically thought to be solid investments for conservative investors. Certain insurance stocks, on the other hand, may appeal to even the most aggressive growth investors. Trupanion (NASDAQ:TRUP) stands out as a possible growth stock for investors. Medical insurance for cats and dogs is provided by the company. Its stock has soared in tandem with the growth of the North American pet medical insurance market.