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 1.79%), for example, has handily outperformed specialty insurer Markel (MKL 2.78%) 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 4.62%) 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).
Related insurance topics
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.
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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
Insurance companies make money in two main ways: Charging premiums to the insured and investing the insurance premium payments.
How do insurance companies really make money? ›
Most insurance companies generate revenue in two ways: Charging premiums in exchange for insurance coverage and then reinvesting those premiums into interest-generating assets. Insurers also diversify risk by pooling the risk from customers and redistributing it across a larger portfolio.
How does insurance get 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.
Should you invest in insurance companies? ›
Investing in Insurance Stocks. Insurance stocks can make a great addition to any investor's stock portfolio. Not only does the insurance business have the potential to produce excellent long-term returns, but it's also a business that works in good times and bad.
How did insurance companies guarantee they would make a profit? ›
The main way that an insurance company makes a profit is by ensuring the premiums received are greater than any claims made against the policy. This is known as the underwriting profit. Insurance companies also generate additional investment income by investing in the premiums received.
What is the average profit margin for insurance companies? ›
Insurers and Profit Margins
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.
Who makes the most money in an insurance company? ›
Each one of these positions offers excellent pay and benefits, as well as job security.
- Insurance Agent. ...
- Insurance Underwriter. ...
- Actuary. ...
- Personal finance advisors. ...
- Claims adjusters, Appraisers, Examiners, and Investigators. ...
- Highest Paying Insurance Companies in 2024. ...
- Why Choose a Career in Insurance. ...
- Insider Insight.
One way companies make sure they can cover all the payouts is to charge higher premiums for these policies. Companies also use the underwriting process to determine how risky each policy applicant is based on their health, lifestyle, hobbies, and other personal traits.
Is owning an insurance agency profitable? ›
Owning an insurance agency offers unlimited income potential. Your earnings are directly tied to your sales and the performance of your agency. Insurance agencies typically earn commissions and bonuses from insurance carriers for policies sold, which means the more you sell, the more you earn.
What is the money a person pays to an insurance company? ›
What Is an Insurance Premium? An insurance premium is the amount of money an individual or business pays for an insurance policy. Insurance premiums are paid on policies that cover a variety of personal and commercial risks. If the policyowner fails to pay the premium, the insurance company may cancel the policy.
Does this mean that the insurance industry is recession-proof? No, it doesn't. Today, more than ever, insurance companies are urged to adopt new business models in order to consolidate - like banks do - and avert some of the risks. They will have to rethink their own investments and credit evaluation procedures.
Is investing in insurance better than 401k? ›
What's the best way to save for retirement? A 401(k) is always a better choice than a life insurance policy. Even if you would benefit from a LIRP, you should maximize contributions to your 401(k) and other retirement accounts before investing in life insurance alternatives.
What are the 10 best stocks to buy right now? ›
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| Company (ticker) | Analysts' consensus recommendation score | Analysts' consensus recommendation |
|---|
| ServiceNow (NOW) | 1.49 | Strong Buy |
| Assurant (AIZ) | 1.50 | Strong Buy |
| Howmet Aerospace (HWM) | 1.50 | Strong Buy |
| Insulet (PODD) | 1.50 | Strong Buy |
21 more rowsUnderwriting
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.
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 new business margin in insurance? ›
new business profit margin in Insurance
A new business profit margin is a system used by insurers to measure the cost of and profit from writing new policies. A company's new business profit margin is defined as the value of new business expressed as a percentage of the present value of future premiums.
How do insurance agencies make a profit? ›
How does an agency make money? Most insurance agency revenues come in the form of a paid commission. An agency is paid a percentage of the total cost of the policy offered. The total cost is the premium and the percentage the agency earns is typically called, agency revenue.
Do you actually make money selling insurance? ›
The commission you earn on a life insurance policy sale is not limited to the first year. Rather, you keep getting paid as long as the policy is in force. Your commission percentage on a policy drops after the first year, but you keep earning 5% to 10% as long as the policyholder pays their monthly premium.
What is the $75 payment Nelson must make each month? ›
Expert-Verified Answer
The $75 payment Nelson must make each month is called the premium. Premium is the amount of money paid to an insurance company for coverage. The premium contributes to the insurance company's fund, which is used to cover the costs of accidents like the one Nelson caused.
