How Insurance Companies Make Money

Insurance is a big business, a billion dollar industry worth every penny to the companies, executives, and those who sell insurance all day long. The principles that govern insurance are fairly simple, and they have been in use for centuries. They are so fool-proof that there's only very few cases when it can go wrong for the insurance companies. That's why they get rich quickly, and this is how insurance companies make money.

First, we need to understand that insurance is a game of risk. Everything is about assessing a risk and coming out with a monetary value. The way an insurance company works is by selling insurance policies to a very large amount of people, in order to pay for the benefits of only a few of them. If the calculations are done right, the money that comes in will be a known quantity, but the amounts that go out will be the unknown, the risky part. Any successful insurance company will bring in a lot more money than could possibly go out, and make tons of profits.

Let's say we're looking at a home insurance business. They sell policies to millions of people. Every time an insurance salesman goes to quote a price, they need to assess how much money should be paid. This is based on how likely the insurance company will be to pay a benefit, based on how old the building is, thus how likely it is to burn down, how close to a water source it is, how likely it is to get flooded, and so on. Even if the house is fairly likely to get hit by something, and thus the policy cost is quite high, it will not be high enough to cover everything the company would need to pay, but that's not the point. Since the millions other houses are evaluated the same way, the company is betting that most of them will not have a catastrophe occur, and the insurance company will remain on top.

Even if something does occur, most insurance companies are notorious in their reluctance to pay. The trick is that the requirements to buy a policy are not high, because you're basically giving the company money. But once something happens, and you file a claim, then the insurance company goes to great lengths. It sends inspectors, it goes back over the contract to see if everything was in order, and so on, in order to delay payment as much as possible. Sometimes however it's the insurance company that gets a bad surprise. For example, in the past there's been situations in the south where tornadoes would go through a community and destroy hundreds of houses all at once. This can be very bad because there's so many benefits that need to be paid all at once, although again most companies have found a way out of this as well, with clauses that say acts of nature are not covered.

The irony is that insurance is based on risk, on unknown, yet being an insurance company is a very safe business to be in. People will always need insurance, and the more catastrophes happen in the world, the more people will flock to get insurance policies. Meanwhile, these companies rack in profits.

Comments? Questions? Email Here

© HowtoAdvice.com

How to Advice .com