What Is an Insurance Company, and How Does It Make Money?

The insurance company provides hedging services against the happening of some adverse event. In other words, the insurance company presumes the risk against some premium. Usually, insurance is carried for the loss/damage of the property, illness, death, or any other adverse event you can think about.

The business model of an insurance company

The insurance company promises the policyholder to compensate for the loss in case of some specific event. In other words, the insurance company provides coverage for the loss if some adverse event takes place. However, the insurance company only provides coverage for the assets that have been covered in the policy, and payment for the premium has been maintained.

Let’s discuss in depth that how the business model of the insurance company works.

Policy write off

This is the first stage of the business model for the insurance company. In this stage, the company markets their insurance policies and attracts customers. So, the write off is the process of registration for the insurance policy. In this stage, the risk to be covered is assessed by the company, and the probability of the loss is assessed. Then, based on the assessed risk by the company, the premium to be charged is calculated.

Multiple factors are considered in the premium calculation, including the volume of the risk, probability of happening, exposure of assets with the risk of occurrence, and many other factors. Most of the insurance companies collect premium from the customers annually while some may collect monthly. The premium is paid in advance as a claim for damages can only be filed if the policyholder is good in standing.

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Once the premium is received and details are documented, the policy becomes active, and if the loss occurs for the covered asset, an insurance company has to satisfy the claim. It’s important to note that the receipt of the premium is revenue, and payment of the claims is the expense of the company.

Survey for the incident

Suppose the policyholder reports some adverse event or incident for the covered asset. The insurance company appoints the surveyor that visits the site and collects the evidence regarding the event’s happening. Once the survey is completed, the report is presented to the claims department for further proceedings. The expense of the survey is bear by the insurance company.

Payment of the claims

Once the survey report is reviewed and the nature of the incident is presented in the survey report, the facts are assessed against the covered insurance policy to ensure the incident is covered in the policy. After an assessment of the facts and figures, the survey department approves the claim for the payment.

How an insurance company makes a profit?

The premium is received for all the insurance policies written off, and the premium is continued to be received for all the active periods of the insurance policies. However, the insurance company has to only pay the claim if the adverse event takes place. Therefore, all the policyholders do not report the damage as there is a risk of the damage, not certainty. In other words, if there is no damage to the covered asset, the premium increase profitability of the company. Only three out of the hundred policies report the claim for the damages. It means the premium collected for other policies is the premium earned after accounting for all the expenses and charges for the claims.

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Another way for the insurance company to earn is that the company’s premium is invested in interest-generating instruments. These companies do not need massive working capital to build some product or perform the services. Hence, they prefer to invest in some financial markets and earn money for them with the money collected from the policyholders. The investment income helps the company to meet the expenses or if there is any claim on any of the active policies issued by the insurance company.

So, the insurance company earns with write off for the insurance policy, regular receipt of the premium against active insurance policies, and generation of the interest income by the investment of the received premium.

Coverage lapses

Sometimes, the policyholder does not continue to pay the insurance premium; this situation turns out to be favorable for the insurance company as per terms of the policy they are not liable to pay any arising claim on the policy for which premium has not been received regularly. So, in simple words, if the policyholder does not maintain the premium payments, the status of the policy is converted to inactive, and all the premium received is kept by the insurance company. This expiry of the policy is called coverage lapses.

The policy also gets expired after some agreed and mentioned time and coverage of the asset damage lapses. To obtain further coverage for additional time, the new policy is written off against the new policy premium payment.

Chances of the loss

The loss for the insurance companies is possible if the income earned with the write-off, collection of the premiums, and the investment do not exceed the payments made under the head of the claims. However, it’s a rare situation as most of the insurance companies generate profits from period to period.

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The insurance companies provide coverage of the risk for certain damages. The damages may be for the assets, group of assets, the life of the human, or any other adverse event you can think about. The policyholders and insurance companies agree on the coverage of the risks and the premium to be paid. The premium collected by the insurance companies is invested in the interest-generating instruments as insurance companies do not need massive working capital other than to support some basic expenses. So, the insurance companies earn by writing off the insurance policy, periodic receipt of the insurance premium, and the investment of the amount collected under the head of the premium.

If any claim arises on any of the active insurance policies, the facts are assessed by appointment of the surveyor, and payment is made. However, very few policies get a valid claim. If no claim arises and the policy is expired, it’s a beneficial situation for the insurance company and termed coverage lapses.