How Do Insurance Companies Make Money?
- Uncover the three basic ways life insurers stay profitable when you discover how life insurance companies make money. Spoiler alert: It's a balancing act.
Life insurance is a multibillion-dollar industry that continues to earn profits year-over-year. According to research conducted by LIMRA, life insurance policy sales increased by double digits in the first quarter of 2021 — a number that hadn't been realized in decades.
But particularly with all the new policyholders on board, how do life insurance companies make money? The answer is threefold: premiums (direct payments), investments and lapsed policies.
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Top 3 Ways Life Insurance Companies Make Money
You might think, "Okay, if company A collects $1,000,000 in premiums, but four people collect $250,000 on each of their policies, how can life insurance companies possibly make money?!"
At first glance, it certainly seems like all life insurance companies would be bankrupt, right? But their financial reports tell a different story. Here's how they make a profit.
It's not rocket science; when people send you money, you have more money than you did before. You're in the positive. But where life insurance companies must tread carefully is the ability to make more money than they pay out. When an annual premium is $1,000 and a company is paying out $1,000,000 a week in benefits, it's hard to see where the silver lining is. That's where money-making strategy #2 comes into play: investments.
Insurance companies make investments with the premiums they take in and, because they hopefully won't need to pay out benefits for 20 years or more, can turn those premiums into long-term returns.
Even when the stock market takes a dive or a global pandemic changes the dynamic of every industry, life insurance companies have generally made decades of wise financial decisions to overcome the temporary slump.
Lapsed Policies & Cash Outs
When a policyholder decides they no longer want the policy or can no longer afford it, the policy lapses and the now-former policyholder is not eligible to collect benefits. While this may only occur in a small percentage of cases, life insurance companies reap all the rewards (previously paid premiums) without losing a dime.
Whole life insurance policies cover the policyholder for the entirety of their life span while accruing a cash value over time. The insurer generally elects to treat a portion of the premium as the actual premium and will invest the remainder in the hopes of offsetting the cost of fulfilling their contract.
A certain number of policyholders, for reasons such as financial hardship, may choose to cash out the policy and receive its cash value. In this case, the contract is considered fulfilled and the life insurance company profits from not having to cut a $250,000 check. The cash-out amount is never close to the pay-out amount.
What's the Good News for Policyholders?
Of all insurance types that will stand the test of time, life insurance companies top the list. Simply put, 100% of people die in one way or another, which means the need for life insurance — and companies to provide it — will remain. A profitable life insurer has a unique opportunity to maintain a positive customer relationship for decades.