In the end, the price of insurance depends on the risk the insurance company takes on for the customer. This will depend on how likely it is that the insured event will happen and how much it is likely to cost if it does. Actuarial science is what insurers use to figure out how much the premium should be based on how much risk there is. Using certain probability and statistical math models, the insurance company can estimate the cost of future claims with a fair amount of accuracy.
For example, say someone wants to make sure their $100,000 home is covered in case of fire. Let's say that every year, 1 out of every 1000 homes in this area burns down. Based on the math model, this would mean that the insurance company would have to charge $100 a year for the premium just to break even. In reality, the insurance company will charge more than $100, like $120. This extra $20 will pay for the costs of running the insurance company. It will also pay an amount for the insurance company to make money. The only other way for an insurance company to make money is to invest all of the policy premiums it receives. This way, while the money is in the hands of the insurance company, all of the premiums earn interest or investment returns. Even though this is a big source of income for the insurance company, most of its money comes from premiums.
People who pay premiums but don't have to make a claim have been said to lose out because they waste their unused premiums. In this way, you can't say that the insurance industry does anything good for society as a whole, so their huge profits aren't fair. Those who defend insurance companies, on the other hand, say that the peace of mind they give to all of their customers is a big benefit to society. Even if a disaster never happens, it's worth something to people to know that they will be paid if something bad happens.
The insurance company's float is the money it has from premiums that haven't been used yet. Even just the float can bring in a lot of money. Even though it is possible to lose money on any investment, insurance company floats made $68.4 billion over the five years ending in 2003. During the same time period, insurance companies paid out a total of $142.3 billion in claims. Some people think that the insurance industry won't be able to keep going as long as the float keeps making money, so they think that premiums will go up a lot in the future.
