Many insurance companies provide insurance products that are meant to be a safety net for customers. This may include insurance policies on houses, cars, and even life insurance. However, insurance companies will not stay in business if they pay out more than they take in as revenue from customers’ insurance payments plus investment income, so how do insurance companies make money?
How Insurance Companies Make Money
Insurance can seem like an odd business model at first glance because the insurance company has to pay out money when the insured person (the policyholder) makes a claim on their insurance policy. For example, if you have homeowners insurance and your house is destroyed by fire or severe weather then the insurance company will likely need to give you enough money to replace it.
So insurance companies have to find some way to make their insurance policies pay for themselves and insurance company revenue depends on a number of different factors including the claims they receive, the insurance rates they charge, and of course how well their investments do. Not all insurance companies will invest their insurance premiums but those that do will likely invest the insurance premiums in stocks, bonds, or other kinds of securities that are expected to earn a return over years or decades. The insurance company has no legal obligation to give you back what your insurance premium was worth when you made your policy payment but most insurance companies will try to keep up with inflation because this is a good way to prevent having many customers who feel like they are getting ripped off by paying too much for their insurance policy insurance when they renew their insurance policy.
How insurance companies make money on whole life policies
Insurance companies earn a large insurance premium for whole life insurance. Since insurance premiums go up with the insured person’s age, an insurance company can collect more in insurance premiums over someone’s lifetime than they will pay out in claims. They do this because their investment income rates are higher than the return that a younger person earns on their investments like certificates of deposit and bonds.
An insurance company invests the customer’s money so it earns more interest than a CD or bond because these investments take more time to “mature.” If these investments are successful, then the cost of caring for those riskier customers becomes profitable for the insurance company, and the price insurance companies charge customers reflects how profitable insurance is to that insurance company.
An insurance company may also think that a customer who buys whole life insurance policies for many years has good credit and those insurance premiums might be relatively safe investments since the insurance company can expect these insurance premiums to be paid as long as the insured person lives. Not all insurance companies invest your insurance premium in stocks and bonds but most will if they have enough money from other customers’ insurance payments to invest. Healthy insurance companies try not to put all their eggs in one basket, so they spread their investment income out across different kinds of securities like stock mutual funds, bond mutual funds, corporate and government bonds and CDs with different maturities too which helps them earn more insurance premiums over the long term. A healthy insurance company also keeps enough insurance premiums on hand to pay out insurance claims if there is a year with more insurance claims than normal, which is why insurance companies are required to have some kind of insurance rating called an “A” rating or above by rating agencies.
How insurance companies make money on whole life policies for low-income people
Insurance companies give you a way to increase your cash value in whole life insurance policies that allow you to pay lower monthly insurance premiums as long as your investments earn less interest income over time.
This type of policy was designed for customers who could not afford the higher monthly payments required by other types of whole life insurance plans and it will require you to keep up insurance premiums for almost the entire insurance contract period that will be 25 years or more if you want to keep up your insurance coverage.
This is insurance companies’ way of being fair to low-income people who might not be able to afford the insurance premiums for whole life insurance on their own. Since insurance companies make money by investing your insurance premium, and they can’t always count on a young person’s investments to earn as much interest after just a few years so insurance companies give you the option to delay getting higher insurance rates until later in life even if this means you have less money at that time.
The insurance company lets you pay a lower insurance premium and earn less on investments because they know that low-income people can’t afford to do anything else. It is still important for these people with low incomes to keep purchasing life insurance policies so they have some cash available in case of an unexpected tragedy.
In addition, many seniors find themselves living longer than their retirement nest eggs last as we understand today and insurance companies don’t mind taking extra insurance premiums from them over time. This is because insurance companies really like growing very old customers who may not live long after making these kinds of purchases.
Insurance companies are in the business of making money. They do this by investing insurance premiums and keeping costs as low as possible for customers with lower incomes who may not be able to afford whole life insurance policies without a discount. This type of insurance policy is designed specifically for these people, allowing them to pay less upfront but have their insurance rates go up later on when they can more easily afford it. Insurance companies also like annuity contracts because they take less time than stocks or bonds to “mature”– potentially giving the company more capital over time if everything goes well.