Insurance works on the principle of Pooling of funds and thereby Sharing the risks. It is a very old idea which started back when sailing ships got destroyed or lost their cargoes. Merchants found that by dividing their cargoes among several boats, they protected themselves from total financial ruin. That way, if one of the boats was destroyed, no merchant lost everything. Each stood to lose only a small portion.
When you buy insurance, you join many others who pay money to an insurance company. The insurance company uses the money collected to pay claims that are submitted by those who have purchased insurance. The money is “pooled” and losses and expenses are shared. It sounds like a pretty simple business model. but then how does How does an insurance company make a profit?
The journey of your premium to claim payment . An insurance company can make the profit at every step. There are two basic ways to earn -.underwriting income, investment income, or both.
Underwriting income is the difference between premiums collected on insurance policies by the insurer and expenses incurred and claims paid out. The level of underwriting income is often seen as an accurate measure of the efficiency of an insurer's underwriting activities.Bajaj Allianz General Insurance has emerged as the only non-life company to make underwriting profits among the 22. Typically, companies make underwriting losses as they cut premium rates to grow business. But Bajaj Allianz has turned out to be an outlier. ( 2016, economic times article) Huge claims and disproportionate expenses may result in an underwriting loss, rather than income, for the insurer.
So insurance companies have another way to generate additional profits i.e investing a proportion of the premiums they receive.Unlike many other types of businesses, insurance companies collect huge sums of cash throughout the year and may not have to pay on claims on those policies for many years or ever.This unique situation allows insurance companies to invest that money while it’s not being used i.e reserves.Huge profits can be reaped, or lost, as a result.
In fact, insurance companies can knowingly charge too little for insurance policies and plan for an underwriting loss if they believe they can make a profit from investing the money they receive before having to pay claims. In the early 2000s, when the stock market was booming, this was a common practice.
This is the beauty of the insurance model – taking cash upfront before having to pay a claim in the future (or never) means insurers can put your money to work for them immediately, Provided they know how to use this money efficiently.
References :https://blog.ipleaders.in/insurance-companies-profit/https://economictimes.indiatimes.com/we ... 854488.cms