I worked in the insurance industry for 16 years and saw first
hand how profitable an insurance company can be. I will not
attempt to go into the nitty gritty details but I will give you
a pretty good idea in the form of an overview, how profitable a
venture an insurance company can be.
Insurance is a form of risk management. It is purchased to avoid
the possibility of a large , potential future loss. To
compensate the insurance company for taking on this potential
future payout, the insured pays the insurance company a certain
sum of money known as the premium. In return for the payment of
the premium the insured receives a written document, known as
the insurance policy, that lays out what events are being
insured and what the payment to the policyholder would be if
that event actually occurred.
The insurance company collects the premiums of a large group of
insureds to cover the few losses they would have to pay out
for.They use historical data to figure the probability of losses
and then charge premiums to cover them while building in a
profit for themselves.
For example,let's say there were 100 houses each worth $100,000
in a particular area. They would have a total value of
$10,000,000. According to the history of that neighborhood, two
houses are expected to burn down during any one year. Without
insurance all 100 homeowners would have to keep $100,000 in the
bank to cover the possibility of the house burning and needing
to rebuild it. With insurance, each homeowner would only need to
pay $2,000 into an insurance pool to pay for rebuilding the two
houses that are expected to burn down.
2 houses burn x $100,000 = $200,000 for rebuilding the houses
$200,000 divided by the 100 homeowners = $2,000 premium
That $2,000 premium will then have to be increased somewhat to
add a profit margin for the insurance company.
In addition to the built in profit that the insurance company
adds in to each premium it takes in, the company would also be
subject to the actual experience of the insured group. If it
takes in more money in premiums than it paid out in claims then
it receives what is known as an underwriting profit. And, on the
other hand if it pays out more than it has taken in then it has
an underwriting loss.
One way of looking at how well an insurance company is doing is
to look at their loss ratio. The loss ratio is calculated by
taking the losses they had to pay out and add to that the
expenses they incurred to actual pay out the claims and divide
that sum by the premiums taken in. A ratio of less than 100%
shows a profit and a ratio greater than 100% indicates a loss.
In many cases if an insurance company's ratio is greater than
100% they can still be profitable. That is because there is
usually a period of time between taking in premiums and paying
out claims. During that period of time the company can invest
the money taken in and they can earn a profit from that
investment to offset any underwriting loss and could actually
end up with a net profit. For example, if the insurance company
pays out 15% more in claims and expenses than premiums it took
in, but made a 25% profit from its investments, then it would
have received a 10% profit.
So, as can be seen there is more than one way to skin the
profitability cat for an insurance company to make money. Two
key factors in that regard are how well they can predict their
payouts and how well they can invest the money they take in.
About the author:
Joe Folger with his extensive experience in the insurance
industry is the go to guy for insurance questions. For more
insurance company information you can go to
http://www.insurancecompanyinfo.com
