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.



Source by Joe Folger

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