how-do-insurance-companies-make-money

How Do Insurance Companies Make Money?

The insurance company revenue model revolves around a claimant receiving compensation in the event of an accident, illness, death, or damage to an asset resulting from theft or a natural disaster. In return for continual insurance cover, the company charges a regular fee – otherwise known as a premium. In essence, insurance companies make money by carefully considering the risk of each policy. They bet that the holder will continue to pay for insurance coverage and never be required to make a claim.

Insurance company revenue generation

Most insurance companies make money via underwriting, investment income, and reinsurance.

Underwriting

Underwriting revenue can simply be defined as the money that is left over after the company subtracts the cash paid out in insurance claims from the cash collected via premiums.

Consider the example of a fictitious car insurance company that earned $15 million from insurance premiums in one financial year while paying out $9 million in claims over the same period. This means the company earned a profit of $6 million on its underwriting revenue.

Insurance companies devote a lot of resources to ensuring they make a profit from underwriting revenue. Applicants are vetted on a range of criteria including gender, age, medical history, claim history, and credit history. Whatever the criteria evaluated, remember that the company assesses each applicant according to the risk of them making a future claim.

If the risk level determined by an algorithm is too high, the company may raise the price of the premium or avoid doing business with the applicant altogether.

Investment income

If we return the previous example of the car insurance company with $6 million in underwriting profit, one could make the argument that the cash would be underutilized sitting in the company’s bank account.

To maximize returns, insurance companies invest their profits in the financial markets. They tend to have more money to invest than companies in other industries since none has to be spent creating or manufacturing physical products. Common investments include corporate bonds, treasury bonds, and interest-bearing cash equivalents.

Reinsurance

Some companies also sell reinsurance to other insurers. These insurers purchase reinsurance to protect themselves from excessive losses in situations where they are overly exposed to an event that could lead to insolvency.

For example, a company may run into financial difficulty if a severe hurricane causes widespread damage to infrastructure and a subsequent increase in claims over a short period of time. Indeed, reinsurance is a lucrative industry, with climate change and COVID-19 related drivers expected to grow the global reinsurance market to around $556 billion by 2025.

Key takeaways:

  • Insurance companies make money by analyzing the risk of an individual policy. Generally speaking, they bet that the policyholder will continue to pay for insurance coverage and never be required to make a claim.
  • Insurance companies make a profit by collecting more in insurance premiums than they pay out in insurance claims. Strict criteria are used to determine the risk of each applicant making a claim in the future, with high-risk applicants subject to higher premiums or refused cover.
  • To maximize revenue, insurance companies invest their underwriting profit in more conservative investments such as bonds and cash equivalents. Some also sell reinsurance to other insurance companies to protect them against insolvency. 

Related Case Studies

Insurance Companies Business Models

how-do-insurance-companies-make-money
The insurance company revenue model revolves around a claimant receiving compensation in the event of an accident, illness, death, or damage to an asset resulting from theft or a natural disaster. In return for continual insurance cover, the company charges a regular fee – otherwise known as a premium. In essence, insurance companies make money by carefully considering the risk of each policy. They bet that the holder will continue to pay for insurance coverage and never be required to make a claim.

Root Insurance Business Model

how-does-root-insurance-make-money-the-root-insurance-business-model
Root Insurance is an app-based car insurance provider founded by Alex Timm and Dan Manges in 2015. Since the age of fourteen, Timm, who has worked in insurance, wanted to streamline the insurance application process for both the consumer and the insurance company. The company makes a profit if the value of insurance premiums exceeds compensation payouts. While the company does have some overheads, its costs are much lower without the need to maintain physical branches.

Next Insurance Business Model

how-does-next-insurance-make-money-the-next-insurance-business-model
Next Insurance is an insurance technology company founded by former co-workers Guy Goldstein, Alon Huri, and Nissim Tapiro. Drawing from the popularity of so-called insurtech companies they launched a website in 2016 with $13 million in funding. Next Insurance began by offering insurance tailor-made for photographers and personal trainers. Next Insurance makes money via the premiums it charges to customers every month.

Real-Time Insurance Business Model

real-time-insurance
A real-time insurance business model enables Tesla to build its own insurance arm, by dynamically adjusting the premiums, based on real-time driving behavior. Reduced insurance premiums hooked with the leasing arm, enable Tesla to scale its demand side of the business.

Lemonade Business Model

how-does-lemonade-make-money
Lemonade is an insurance tech company using behavioral economics and artificial intelligence to process claims efficiently. The company leverages technology to streamline onboarding customers while also applying a financial model to reduce conflicts of interest with customers (perhaps by donating the variable premiums to charity). The company makes money by selling its core insurance products, and via its tech platform, it tries to enhance its sales.

Read Next: Next Insurance Business Model.

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