How do insurance companies profit?
In: 2
Statistics and laws.
There is probably no greater repository of statistical data than what is held by the insurance companies. So using those statistics, they figure out the likelihood of various events, how much it would cost to recover from those events, divide that by the number of policy holders they have, and set their rates and policies accordingly to ensure that they make a profit on whatever they insure. Additionally, most jurisdictions require people to hold an insurance policy on certain types of property (cars and homes, for example), so insurance companies are guaranteed customers.
To give a concrete example with made up numbers:
The data they have tells them that an auto accident will cost them, on average, about $25,000 to cover. They have 3 million auto insurance customers. Of those, 1% will be involved in a qualified accident. So they will have expenses of $750,000,000 every year to cover those accidents. So to break even on covering their insurance customers every year, they need to charge each of them *at least* $250/year. They decide that they would like to make a 50% profit margin, so they charge each customer $500/year and take $750 million in profits.
In reality it’s more complicated than that, and many jurisdictions specify by law how much profit they’re allowed to take. But that’s the basic rundown: Figure out how much it costs you to service your policies, and then charge enough to make sure you always make a profit.
Latest Answers