How Do Insurance Companies Make Money?
There's no need to wonder, "How do insurance companies make money?" The answer is simple—you.
Ah, insurance. There's never been a truer thing that you can't live with or live without. This is especially true when people who can't afford health insurance get hit with a tax penalty that makes them... well, even less able to afford health insurance.
But, as our grandparents once told us, it's not polite to talk about politics with people you've just met! So, dear reader, we're going to take a hard look at all types of insurance companies; auto, health, life, all of that "fun" stuff.
Speaking of fun, here's a fun fact about auto insurance statistics from the Insurance Information Institute, who has been collecting data for over 60 years.
While 77 percent of drivers in the US pay for comprehensive coverage insurance, only one to six percent of drivers actually file claims and get those claims paid out.
Pretty cold fact, isn't it? Should insurance companies really be that reluctant when it comes to paying claims? Insurance companies do make money in a variety of ways, but ultimately, you're their biggest cash cow.
It's not just a question of how do insurance companies make money—it's also a question of how they're one of the most profitable types of businesses in the world.
They make a lot more off those insurance premiums than they actually give out to customers.
Insurance companies are disgustingly rich because they're making an unholy amount of money on your insurance premiums, and making you fight to the death to actually get money back in an insurance claim.
When it comes to actually getting money out of a claim, some companies are so resistant, they find any loophole they possibly can to not pay you the money you rightfully deserve.
Let's make a case in point by looking at State Farm's 2018 financial results. For the sake of getting the point across, I'm only going to give you one company's numbers, but you can expect to see similar reports of growth, profits, and generally screwing customers over from most insurance companies.
- State Farm boasts of underwriting income gain of $1.7 billion.
- State Farm's total revenue in 2018 was $81.7 billion—this combines insurance premium revenue, earned investment income, and realized capital gains.
No insurance company is eager when it comes to paying claims.
So you might think "Oh, gee, that's not so bad! They're making money off a bunch of things!" However, let's look at their auto insurance business, which is 65 percent of their total combined net premium.
State Farm took in $42.7 billion of your dollars on auto insurance premiums.
They only paid out $31.2 billion.
That means there was more than $10 billion that just went into paying State Farm's employees, operating expenses, bolstering investments, and lining upper management's pockets.
This is the norm for most of their different types of insurance, roughly $10 billion in profit for each type.
A company needs to pay its bills and be profitable, don't get me wrong; but when a company treats its paying customers like trash after they file a claim just so that they can keep padding that profit on insurance premiums, it's a little harder to give them your undying support.
Insurance companies also make money off of their investments.
As we saw earlier, with the numbers from State Farm on their total revenue and underwriting income, insurance companies do make a lot of money off of their investments.
Investment income is definitely part of what keeps insurance companies afloat, and also helps to keep them profitable. When you have literally billions of dollars to invest, it's not too hard to make a few more billion in clear profit. Most investing insurance companies can play things pretty safe and don't need to do a lot of risk investments, they're just investing such a huge volume of money that they're going to make a lot back on it in interest (which is as good a reason why you should invest in insurance companies as any).
This definitely seems like a more wholesome method of profitability for insurance companies, but here's a little food for thought.
Where'd that money in their investments originally come from?
Well... for the most part, you! Insurance companies invest the premiums you pay. Of course, many of these companies were started on investor dollars and they needed that money to establish themselves before they could start collecting your money. Even so, any very large insurance company collects most of its investment dollars directly from their policy holders.
Life insurance is one exception—since that's pretty cut and dry with what is covered and what isn't.
It's hard for life insurance companies to really deny a lot of people their payouts. That might sound morbid, but it's true; when the insured claiming that their loved one has passed away and they are entitled to life insurance, it's pretty hard for the company to argue about coverage or weasel out of paying.
In the case of life insurance companies, the types of insurers are a little bit different. Since this is one of the cheaper forms of insurance, most companies don't see as high of a profit margin on this particular type of insurance.
Generally, the premium payments on a permanent life insurance policy partially cover the actual insurance and partially go into an investment known as an accumulation account. Life insurance companies rely more on investing for the profits than making a ton of money on insurance premiums.
Another way most companies balance out life insurance being a bit less profitable is by offering different types of insurance as well. There are definitely some dedicated life insurance companies out there, but others, such as Prudential and AIG, offer a wide variety of other services that have a solid profit margin to cover the costs for each institution.
You're not buying a service so much as you're really just buying peace of mind.
The problem with insurance is that every type of insurance—health, auto—really ends up being emergency insurance. When I had a good health insurance plan, I paid $240 per month for it. That's $2,880 per year. I went to two doctors that entire year and didn't have any covered prescriptions. Doctor visits are expensive, but two general wellness visits cos a lot less than nearly $3,000.
The case with my car is even worse; I got a cheap car who's overall value was only $14,000. I pay $2,000 a year in insurance (and yes, I know all the smart ways to reduce my insurance premium here). I have a six-year car payment, which requires me to have a loaded insurance policy on it. The result? I'll have paid my insurance company $14,000 by the time the car is seven years old. I could literally just total my car any time between now and then, and still theoretically be better off without ever having to pay for insurance.
Pretty much all insurance boils down to being accident or emergency insurance.
Because that's the only way it'll pay for itself.
Essentially, the money paid into buying insurance is just in case something happens. The majority of people pay thousands of dollars, endless sums of cash, into paying insurance premiums, and never see a penny of it back. Insurance companies take those premiums collected, invest them, and enjoy.
However, if life was any other way, the insurance industry probably wouldn't be able to survive and remain profitable. That's why there's really no winning, and literally why you can't live with or without insurance.
So, the simple answer to the question of how do insurance companies make money is you—your hard work, and your blood, sweat, and tears. Make sure to familiarize yourself with insurance lifehacks you need to know so that you can save yourself a boatload of money later.