How do insurance companies work?

Answer 1

Insurance companies take money from people and pool it together. That pooled money is held in reserve and some invested to grow the pot. The idea is that by spreading out the money across geography and risk levels you can make a profit and pay out claims. Simple Sample (Per month lets say) * Joe: $100 * Jane: $100 * Jack: $200 * Bob: $200 These 4 pay each month for $10000 worth of insurance for their car lets say. If no one ever made a claim it's pure profit. Each month if the insurance company can invest the money and make 10% they would clear $60 a month of invested return. Over time this can be substantial. But lets say Bob's car blows up after beind hit with a supervillians death ray. Bob makes a claim and the insurance company doles out $10,000 dollars. As you can see, as long as they don't have to pay out more then comes in, they can make a profit. Last I heard State Farm has well over 20 billion in assets in their pot. By controlling and keeping a close eye on claims made they can ensure that there is plenty of cash in the pot. But sometimes natural disasters can drastically deplete the pot and require time to replenish. If it goes too low, the insurance company can go bankrupt.

Answer 2

They take the premium from a large number of people and use the money in three ways: 1 To pay the claims a small number of people make 2 To cover administration costs of processing and assessing policies, premium and claims (wages, electricity, rent, equipment, reinsurance, commission) 3 The invest as much premium as they can. This is the main way insurers make money. This is because traditionally gross loss ratios (claims paid divided by premium) run at around 50%- 70%, then you add 20% for costs to acheive premium (commission etc), then 10% for costs of doing business (wages etc). So you see in a good year the business could return 20% profit but in a bad year it could be 0% or negative profit. This is where the premium investment becomes so important. A 5% return on investments can turn a profit loss into a profit gain for the company. Because most insurers average a 5% profit, investments are very important.