subject: How Do Life Insurance Companies Make Money? [print this page] Everyone may have thought about this question at least once while shopping for or dealing with insurance of any kind. Its always good for customers to ask this question to get a complete picture of how their money works for both parties involved. And its always good practice for businesses to reveal where they get their money from and how profits are made to ensure transparency, cogency and customer trust.
Type
How a life insuranceproduct is priced depends on its type. The two main types of life insurance policies sold in the United States are term life insurance and permanent life insurance. Term life insurance is a temporary policy that provides coverage for a limited number of years. Once the coverage period ends and you stop making premium payments, you are not protected under the policy. Permanent life insurance is longer-lasting, effectually permanently until you die no matter at what age that occurs. It usually has a death benefit amount as well a cash surrender value that can be dipped into for emergencies. The investment component or cash value of your permanent policy grows slowly but surely on the side, usually requiring up to 15 years at least to show sizable growth. Technically, permanent life insurance policies must be paid into every year, but because these policies also have a cash build-up, the interest earned on the cash-value is often put back into the policy to cover premium payment charges.
Calculations
Essentially, the life insurance industry deals with the mathematics of life expectancy and the probability of death occurring in a large collective pool of people. This is calculated by an astute group of people known as actuaries. Actuaries closely study closely trends in longevity of life and help to formulate structures that mitigate risk and loss for the insuring company. Actuaries also advise life insurance companies how to invest their monies to gain maximum returns. Actuaries are in the business of reducing costs for their employer, and therefore calculate how habits like drinking and smoking can negatively affect longevity, and convert that cost into a higher priced premium for the person seeking insurance.
Term Life
This is especially necessary with term life insurance that usually promises a walloping payout for relatively small yearly payments by the insured. Informal understanding of payout likelihood for term life insurance puts the percentage at 1% - 3% of all policies owned. This may seem like close to nothing, but when the numbers are added up, this too is a significant amount of money for life insurance companies. This is why the government puts strict regulations on insurers to demonstrate sufficient cash holding capacity (or reserves) if they want to sell term life products. These reserves may be invested conservatively in super-low risk portfolios like government bonds.
Term life policies have been selling at near-historically low rates in the past couple decades. This is because much progress has been made in ensuring that man lives a longer, healthier life. It is not uncommon anymore to see people living up to the age of 90 in many households. This means that the likelihood of payout on even a 30-year term policy bought at age 40 is still lower than youd expect. If you smoke, have a serious illness or engage in risky hobbies like professional scuba diving, the risk of paying out your policy over the others in the collective pool dramatically increases. This is why people applying for insurance coverage are underwritten first to determine what ratings class they fit in. If youre unhealthy, 40 years old and older, or exceedingly adventurous with your spare time, the onus of shouldering the risk of higher probability of death must also be borne by you.
Permanent Life
With permanent life insurance, the idea is to help the insured come as close to being self-insured as possible. Since your money in being grown within the policy via steady interest returns, you can monitor this growth and see for yourself how long it will take to reach fully-paid up status. Accuquote Term life insurance policies vary greatly which in turn changes the nature of this interest-based growth.
The Big Picture
Overall, life insurance companies invest the premiums paid into policies in the stock market, real estate, bonds and other financial instruments that promise lucrative growth. It is entirely possible for insurance companies to lose money because payouts on policies greatly surpassed their calculations. For instance, in the long term insurance industry (a relatively new field of insurance), policies sold a couple decades ago promised amazing benefits for long term care (LTC). As statistics have been pouring in about the actual cost of long term care and colossal losses by LTC companies, many insurers are pulling out of this market or hiking premiums on newer policies by a large percentage.
This is how your insurer makes enough money to bail your loved ones out of financial ruin should something happen to you. Its a simple formula on the outset, but one that takes millions of hours in research and study to ensure that the system works like clockwork for both you and your insurer. Always choose a company thats financially stable and rated A- at the very least by ratings agency AM Best (or its S&P equivalent). Good luck on your search for the best life insurance policies
by: Pat Cassidy
welcome to Insurances.net (https://www.insurances.net)
