I worked in the insurance business for 16 years and saw for myself how profitable it can be. I won't try to go into all the details, but I can give you a pretty good idea of how profitable an insurance company can be by giving you a general idea.
Insurance is a way to deal with risks. It is bought to protect against the possibility of a big loss in the future. The person who has insurance pays the insurance company a certain amount of money, called a "premium," to cover the risk of having to pay out money in the future. In exchange for paying the premium, the insured gets a written document called an insurance policy that explains what events are covered and how much the policyholder would get paid if those events happened.
The insurance company collects premiums from a large number of insured people to pay for the small number of claims they have to make.
They look at past losses to figure out how likely they are to happen again, and then they charge premiums to cover those losses while making a profit for themselves.
For example, let's say there were 100 homes in a certain area, and each one was worth $100,000. They would be worth $10,000,000 all together. Based on what has happened in that neighbourhood in the past, two homes are likely to burn down every year. Without insurance, each of the 100 people who live in the house would have to put away $100,000 in case it burns down and they have to rebuild it. With insurance, each homeowner would only have to pay $2,000 into an insurance pool to pay for rebuilding the two homes that are expected to burn down.
Two burned houses, each worth $100,000, cost $200,000 to rebuild. $200,000 divided by 100 homeowners gives us a premium of $2,000.
The insurance company will then have to raise that $2,000 premium a little bit to make a profit.
In addition to the profit that the insurance company builds into each premium it receives, it would also have to deal with what the insured group actually goes through. If the insurance company gets more money in premiums than it pays out in claims, this is called a "underwriting profit." On the other hand, it has an underwriting loss if it pays out more than it has taken in.
The loss ratio is one way to figure out how well an insurance company is doing. To figure out the loss ratio, you add up how much they had to pay out in losses and how much it cost them to do so.
claims and divide that number by the amount of money paid in premiums. A ratio that is less than 100% shows a profit, while a ratio that is more than 100% shows a loss.
Many times, an insurance company can still make money even if its ratio is higher than 100%. This is because there is usually a time gap between when premiums are paid and when claims are paid. During that time, the company can invest the money it has taken in and make a profit from it. This profit can be used to make up for any losses from underwriting, and the company could even end up with a net profit. For instance, if the insurance company paid out 15% more in claims and expenses than it took in in premiums, but made a 25% profit on its investments, it would have made a 10% profit.
So, as you can see, an insurance company can make money in more than one way. How well they can predict their payouts and how well they can invest the money they get are two important things to look at.
