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How Insurance Company’s Make Money

How Insurance Company's Make Money

One wonders, how do insurance companies work and what is their business model? How do they profit from your small premium amount? We tell how all this happens.

What do you do when you go home in the wrath of nature or your belongings go missing during the journey or your car collides somewhere, or you are diagnosed with a serious illness with very expensive treatment? Sit comfortably? Of course not. You don’t do this, but you do it. In such a situation, you can be very upset because of the heavy financial burden due to this sudden incident. But if you have taken insurance, then you can save yourself from troubles in such situations.

Just imagine. If you had life insurance covering your critical illness, or home insurance covering the cost of damage to your home, wouldn’t you be sure after that?

What is Insurance?

Insurance is a complete life-saving tool for people all over the world. It is an arrangement in which the insurance company provides a guarantee or indemnity in the event of loss, damage, illness, or death of the insured, i.e. the insured in return for a fixed premium. With its help, an individual or business entity transfers its risk of economic loss to the insurance company under a contract.

To put it more simply, insurance is a great economic product that is sold by insurance companies to protect you and your property against the risk of loss, theft, or damage. It assures protection from economic losses due to accidents, fire, burglary, flood, etc.

There are two types of insurance policies available in India. They are:

  • Life insurance policy
  • General insurance policy

First, we will go through the life insurance policy in detail.

1. Life insurance policy

In a life insurance policy, a fixed sum of money is paid to the beneficiaries on the death of the policyholder. In a life insurance policy, the cover is provided for more than one year. You have to pay a premium for this monthly, quarterly, or annually. There are many types of life insurance policies available in the market. Let us know about some of them.

•Life insurance

Term life insurance is the most common and popular type of life insurance policy. Term life insurance provides insurance cover for death risk up to a specified period. In case of death, the life insurance company pays the benefits of the policy to the nominee. If you survive and exceed the policy term, no payout is made.

•Unit Linked Plan (ULIP)

unit Linked Plans (ULIPs) provide the benefits of insurance and investment in a single policy. The premium paid by you in this type of policy is used by the insurance company in two ways. Firstly, it is used to cover your risk and secondly, it is used to invest in low-risk and high return investments. You can choose a ULIP plan based on your risk appetite and investment ability.

•Endowment plan

Endowment plans offer a combination of both insurance and savings in a single life insurance plan. In this plan, a fixed amount is used to cover your life and the remaining amount is invested by the life insurance company. Some endowment plans offer a bonus over a fixed period. This plan is good for the long term.

•Refund life insurance

Money-back life insurance is a type of insurance policy in which you get a fixed percentage of the money back periodically as a survival benefit. You also get the benefit of a bonus declared by the insurance company from time to time.

•Whole life insurance

As the name suggests, whole life insurance provides insurance for the whole life. Its maturity period is up to 100 years. The sum assured in the policy is paid to the nominee along with the bonus payable at the time of death.

•Child plan

A child plan will help your children when you are not there. It helps in fund creation and income conservation. There is a provision to pay in installments or lump sum after the age of 18 years in the child plan. In case the parent of the child passes away, the insurance company will pay the child immediately.

•Retirement plan

A retirement plan helps you in building corpus after retirement. In retirement plans, you are provided with an annual or lump sum payment after the age of 60. They are best for long-term savings and retirement planning.

The above plans come under life insurance. Now we will learn and understand about general insurance.

2. General Insurance

General insurance is also known as non-life insurance. It protects you from unforeseen losses and damages that are not covered by life insurance. General insurance will cover the financial loss in respect of your car, house, bike, travel, health, etc.

Following are the popular types of general insurance available in the market.

•Health insurance

This is the most popular type of general insurance. It reimburses the expenses that you pay for the treatment of any kind of illness or injury. This type of insurance covers hospitalization expenses, treatment charges for critical illness, medical bills, operations, etc. Apart from this, you can include many add-on benefits like maternity cover, accident cover, etc.

•Vehicle insurance

Vehicle insurance provides financial protection to your vehicles against damage, accident, theft, natural calamity, or fire. There are two types of vehicle insurance; Car insurance and two-wheeler insurance.

•Travel insurance

Travel insurance covers your financial liabilities arising out of medical or non-medical emergencies during any trip. There are two types of travel insurance; Single trip policy and annual multiple trip policy. Travel insurance generally covers accidental death during travel, emergency medical expenses, loss of passport, delayed flights, hijacking, etc.

•Home insurance

Home insurance covers expenses incurred or damage caused to your home due to man-made calamities, natural calamities, etc. Some popular types of home insurance are home structure insurance, standard fire and special disaster policies, contents insurance, and public liability coverage.

•Fire insurance

Fire insurance protects you against damage caused by fire to your property or property damage caused by fire. Fire insurance covers not only the property insured but also its surroundings for reconstruction, repair, or replacement expenses. It also covers third-party damages. Some of the common types of fire insurance policies are specific policy, comprehensive policy, valued policy, and mobile policy.

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How does insurance work?

When you buy an insurance policy, you have to make regular payments to the insurance company in the form of a premium. In case of any loss or damage, you claim with your insurer and it will indemnify you for the damages covered by the policy. If you do not claim, your money gets accumulated along with the premiums of other insureds who have taken insurance from the same insurance company. If you make a claim, you are paid the claim amount from the insured’s stock of premiums.

In other words, it means that the small amount you pay as a premium gets accumulated in one place to pay for the losses of some people in times of crisis. Thus the working of insurance works on the principle of sharing of risks and expenses.

Since the premium amount you pay to the insurance company is much less than the total sum assured, you go on paying premiums year after year without hassle. But have you ever wondered how insurance companies make so much money from this small amount given by you so that they play such a huge amount in filing your claim? How do they earn a profit after taking care of all the expenses and claims? Come, let’s understand it.

How do insurance companies make profits?

The premium you pay to insurance companies is used in three ways. First, the insurance companies store the premium amount to pay for the incoming claims. Second, insurance companies keep some premium amounts for business expenses. Third, insurance companies invest the money earned from annual premiums in low-risk instruments. Now let us understand the source of income of the insurance company in detail.

Insurance companies earn income from the following two sources:

1. Underwriting Income

Insurance companies calculate the risk on each policy and fix the premium amount accordingly. The actuarial income is nothing but the difference between the amount collected as a premium from the insured and the amount paid in the insurance claims.

2. Investment income

Insurance companies invest a small part of the amount received as a premium in low-risk and assured income securities and in the equity market with high risk and high return (high risk and high return). This diversified portfolio allows insurance companies to earn great returns on their investments. The income earned in the form of interest accumulated on these investments is used by insurance companies to pay for various business expenses like salary, commission, administrative expenses, etc.

In short, insurance companies earn from two sources–premiums collected from the insured and income earned from investing in those premiums. These accruals help the insurance companies to pay their future claims, pay their expenses, and earn reasonable profits.

Conclusion

Insurance can prove to be extremely beneficial in case of unforeseen or unforeseen adversity. It not only keeps you free from stress but also provides income to the insurance companies, which in turn helps in the growth of our economy.

Insurance is available for everything in the world today, from property to life, from vehicle to travel. If you want to protect yourself from the unforeseen future, it is better to take insurance for yourself, your property, and other valuables.

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