Insurance companies make money in two main ways: Charging premiums to the insured and investing the insurance premium payments. Sounds simple, right? It both is and isn't.
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The concepts behind how insurers generate their big bucks are straightforward. But the details of how they make money can be more involved. Here's what you need to know.
How insurance companies make money
There are several types of insurance:
- Health insurance pays for part or all of individuals' medical costs.
- Life insurance provides money to one or more designated beneficiaries when the insured person dies.
- Property and casualty insurance pays for damage to cars, homes, and business properties.
- Specialty insurance covers types of risks that other insurers don't cover and is also known as excess and surplus (E&S) insurance.
- Reinsurance provides insurance for insurance companies to cover losses above certain amounts.
Companies that provide any of these types of insurance make money in the same two ways:
1. Underwriting
Every insurer makes a significant portion of its revenue by underwriting, which is basically charging a fee (called a premium) for taking on financial risk.
Insurers employ actuaries who use statistics and mathematical models to evaluate the financial risks involved in insuring different scenarios. Once the financial risks are assessed, specific insurance plans can be created and premiums set for each type of insurance plan.
For example, actuaries for a property and casualty insurance company consider the probabilities of natural disasters in determining how much money in premiums that homeowners in different geographical regions should pay. Actuaries for life insurance companies might use age, sex, and medical histories to calculate estimated life expectancies to determine how much different customers should pay in premiums.
When a person enrolls in an insurance plan, he or she agrees to pay a set premium to the insurer in exchange for the insurer taking on a certain level of risk. With many insurance plans, the amount of liability that remains the responsibility of the individual is called the deductible amount. Your auto insurer, for example, might require you to pay the first $1,000 of any damage costs before the insurance company is willing to pay anything.
2. Investment income
All of that money in premiums generates a lot of money for insurance companies. The companies don't have to pay out any money until or unless an insurance claim is submitted, such as a claim for a hospital visit or damage to a home during a tornado.
What do insurers do with the often huge sums of cash generated by premium payments? The companies put some aside in reserve to ensure that they'll have enough to pay all claims anticipated over the near term. But then they invest the rest of the money.
Investment income tends to be a lot smaller than underwriting revenue. Many insurers invest relatively conservatively, perhaps by investing in bonds or stable blue chip stocks. However, insurance companies can still significantly pad their top and bottom lines through their investments.
Investing in insurance companies
There are two primary reasons why you might want to consider investing in insurance stocks. First, insurance companies can deliver solid long-term returns. Second, the business models of insurers tend to make them resilient during economic downturns.
Of course, some insurance companies are better than others on both of these fronts. Health insurance giant UnitedHealth Group (UNH -0.17%), for example, has handily outperformed specialty insurer Markel (MKL 0.36%) over the past 10 years. Markel also fell much more than UnitedHealth Group did during the market contraction caused by the COVID-19 pandemic.
Insurance stocks are usually seen as good picks for conservative investors. However, even aggressive growth investors might like certain insurance stocks. Trupanion (TRUP 2.11%) especially stands out as a potential choice for growth investors. The company provides medical insurance for cats and dogs. Its stock skyrocketed as the North American pet medical insurance market took off (though like many other growth stocks, has dropped in 2022).
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Investing in Insurance StocksInsurance companies can produce great returns no matter what the economy.
Investing in Health Insurance StocksHealth insurance is a necessity today, which means it's a great addition to your portfolio.
Investing in Pet Insurance StocksWe love our pets, but they can be expensive. These companies help pet owners with vet bills.
Investing in Financial StocksTake advantage of the changing finance industry, and invest in its most promising stocks. Here's what the landscape looks like. Keith Speights has positions in Trupanion. The Motley Fool has positions in and recommends Markel Group and Trupanion. The Motley Fool recommends UnitedHealth Group. The Motley Fool has a disclosure policy.
FAQs
Here's what you need to know about the two ways insurers generate revenue. Insurance companies make money in two main ways: Charging premiums to the insured and investing the insurance premium payments.
How do insurance companies have enough money? ›
Most insurance companies generate revenue in two ways: Charging premiums in exchange for insurance coverage, then reinvesting those premiums into other interest-generating assets.
How do insurance companies get so much money? ›
Insurance companies make money primarily from premium income, but they also invest the accumulated premiums in financial instruments to generate investment income. They also earn revenue from sources such as fees for policy services and commissions from partnering with agents and brokers.
Do insurance companies make money from investing? ›
Insurance companies make money primarily through the process of underwriting and investing. Let's dive into a detailed description and analysis of how insurance companies generate their revenue.
How do insurance companies make money on Quizlet? ›
They collect more in premiums than they will need to pay out in claims.
Why are insurance companies losing money? ›
The industry has seen sustained losses before, including between 2008 and 2012. But experts say the past decade is different because of climate change. As the planet warms and storms and fires grow more intense, the cost of disasters is increasing faster than insurers can afford.
What is the most profitable insurance to sell? ›
Life insurance is the most profitable—and the hardest—type of insurance to sell. With the highest premiums and the longest-running contract, it brings in cash over a long period of time. In the first year, agents make the largest annual sum on a policy, bringing in anywhere from 40–120% of the policy premium.
Do insurance companies ever lose money? ›
If too many customers die sooner than expected and the insurer needs to pay out more claims than planned, the insurer loses money. This is why the life insurance application process is so thorough, and why there are harsh penalties for concealing information on your application in an effort to lower your rates.
Do insurance companies run out of money? ›
But a large catastrophic event can cause some insurers to run out of money. In insurance lingo, this is known as “insolvent.” There are also regulations that protect the customers of an insurer that goes insolvent. Most state's have an “insolvency” fund or association that provides a safety net.
Do insurance companies make huge profits? ›
All told, America's largest health insurers raked in more than $41 billion of profits in 2022. That is a staggering sum of money. It is so much money, in fact, that you might assume that Americans are able to receive high quality, accessible care whenever they need it.
Insurance Float: This term is often used in the insurance industry to refer to the amount of money an insurance company has from premiums paid by customers that has not yet been paid out in claims. This money can be invested by the insurance company for a profit.
Is it safe to invest in insurance companies? ›
While many businesses and consumers have felt the sting of higher interest rates and inflation, Fidelity Portfolio Manager Fahim Razzaque says insurance stocks can do well in such an environment because the category is less sensitive to the health of the economy than most others.
What are the disadvantages of investing in insurance? ›
Disadvantages of buying life insurance
- It can be expensive if you're older or have health conditions.
- Whole life insurance can be unaffordable in the long run.
- Cash value can be a weak investment tool.
- Applying can be daunting.
What are Top 10 Highest Paying Cities for Insurance Ceo Jobs
| City | Annual Salary | Monthly Pay |
|---|
| Berkeley, CA | $104,058 | $8,671 |
| Renton, WA | $101,131 | $8,427 |
| Santa Monica, CA | $100,321 | $8,360 |
| Bailey's Crossroads, VA | $98,578 | $8,214 |
6 more rowsThe Top Five Highest-Paying Insurance Career Jobs In 2024
- Insurance Agent.
- Insurance Underwriter.
- Actuary.
- Personal Finance Advisors.
- Claims Adjusters, Appraisers, Examiners, and Investigators.
Big payers ranked by 2022 profit
- UnitedHealth Group: $20.6 billion. Total net earnings in 2022 were $20.6 billion, up 16.4 percent year over year. ...
- Cigna: $6.7 billion. ...
- Elevance Health: $6 billion. ...
- CVS Health: $4.2 billion. ...
- Humana: $2.8 billion. ...
- Centene: $1.2 billion.
Many insurance firms operate on low margins, such as 2% to 3%. Smaller profit margins mean even the slightest changes in an insurance company's cost structure or pricing can mean drastic changes in the company's ability to generate profit and remain solvent.
Can you make a lot of money in the insurance industry? ›
Insurance agents earn a mean annual salary of $79,650 or an hourly rate of $37, according to the latest data from the Bureau of Labor Statistics (BLS). While starting wages can be significantly lower than this number, industry veterans with an established client network can easily earn a six-figure salary.
Do insurance companies get money from the government? ›
We pay taxes to the government and the government gives our money to a middleman: for-profit insurance companies or for-profit health providers.
