How Life Insurance Companies Make Money
It’s not a bad idea to know how insurance providers make money, especially when you are paying them for a service. When it comes to buying a gallon of milk, it’s pretty straight forward. You give someone a few bucks, they give you milk.
When it comes to life insurance, it’s not that simple. We’re going to break it down for you in hopes that it makes the process a bit easier.
A life insurance company is basically the same as any other insurance company: it transfers risk from one party to another. Whereas a grocery store sells your milk in exchange for money, a life insurance company sells you risk protection in exchange for money.
Income Statement Example
In an over-simplified example, this is what a basic income statement from a life insurance company would look like:
| Revenues from premiums: |
5,000,000 |
| Claims paid out: |
-4,000,000 |
| Payroll and office expense: |
-1,000,000 |
| Revenues from investing: |
1,000,000 |
| Net Profit: |
1,000,000 |
Cash inflow comes from premiums. That’s what you, the customer, pays for the life insurance. The premiums usually are paid in monthly or yearly installments. Life insurance companies must pay for any claims. They must keep their end of the bargain to pay out a certain amount of money when the insured dies. Then, they pay for operational expenses, such as payroll, buildings, and office supplies.
The thing you probably didn’t know about life insurance companies until right now is their other source of income: investing. They are very similar to banks in this way. They collect all their premiums but don’t have to pay out as much as they take in. Are they going to put all that cash under their mattress? Probably not. They will lend out the money they don’t need right now to other institutions, such as banks, for a rate of return.
After all is said and done, the life insurance company ends up with a net profit, which is retained into the company for growth, lent out to other entities for a rate of return, or paid to the insured in the form of a dividend.
How do life insurance companies know how much money to charge? Check out Life Insurance Actuaries for more information.
Tags: Life Insurance Basics
January 23rd, 2008 at 4:34 pm
[…] discussed in the article “How Life Insurance Companies Make Money,” insurance companies collect revenue from their premiums that the policy owner pays. How do they […]
January 23rd, 2008 at 6:56 pm
[…] The one-stop source for life insurance information. Wednesday, January 23, 2008 « How Life Insurance Companies Make Money Term Life Insurance - What Should I Know? […]