How Do Insurance Companies Make Money? This is the explanation!

Business is basically the fruit of speculation about the future and market conditions. No business is based on anything other than speculation. However, among all the business platforms, the insurance business is among the most attractive because it is based on a higher degree of uncertainty. Some people sneer at the practice of insurance because they see that insurance companies are trying to capitalize on life or even certain parts of the body that are insured. However, those who think hard about the cruelty of future uncertainties tend to secure themselves in insurance.

Among those who are a bit stifled by the existence of insurance are the government, not just individuals. Indeed, a number of governments consider the existence of insurance companies to be big criminals in various government budget debates. The cost of insurance continues to rise, at least to the extent that health insurance is important. It is not surprising that conditions like this make insurance companies continue to reap huge profits. But, is it always like that? Certainly not. After all, insurance is another form of business. And, business always wants profit. That means the insurance company can also lose money. The question that insurance companies rarely appear to be losing money on is another matter.

Apart from business practices, which are certainly based on uncertainty, how does the insurance business actually reap the benefits?
There are two ways an insurance company can make a profit. The first is to attract more money from customers by increasing the premium than what must be paid when claiming the insurance. However, since the insurance business market is so competitive, this practice is not preferred to take even though they, the insurance business, want a more practical way like this.

One of the ways that insurance companies look to increase their premium legally and professionally is by dividing consumers into a number of classes or categories. Top consumers who are willing to pay the premiums are given more discounts. Meanwhile, lower-class consumers whose premiums are lower are not subject to any discount at all. This practice is especially evident in health insurance where a company that employs a thousand employees may pay less for its employees’ health insurance than the health insurance policy you are currently paying for.

Abroad, such as in the United States, price disparities between large corporate health insurance plans and individual health insurance plans are leading to chaos in Washington, DC, when Republicans and Democrats argue over how to administer health coverage. Ironically, in a number of developed countries around the world – especially in the UK – no one provides health insurance as practiced by the United States.

Instead, these developed countries establish what is called a single-payer system or social health services in which the government pays for all services related to the health of its citizens. Here, a single payer system manages costs more effectively than even the most competitive insurance companies because all administrative services required are handled by a single government organization.

The second way that insurance companies reap profits is by using what is known as a ‘float’ to make an investment. An example of an individual who benefits from the existence of this ‘float’ is Warren Buffet. Berkshire Hathaway, his own company, bought GEICO Insurance and practiced this ‘float’ model and made huge profits. What exactly is an insurance float ?

Actually, the insurance float is the difference between the premiums collected by the insurance company and the claims that must be paid to the customer. To the layman this sounds like a spider – but it’s not quite similar. The difference is, the company’s profit (insurance) is calculated on an annual basis, while the float is calculated on a monthly basis. An insurance company may pay less claims in January than in June, for example, and during the months between February and May it can use the available funds – namely ‘idle’ premiums – to invest in other sectors.

For sizable bucks – generally starting in the hundreds of millions of US dollars – insurance companies can reap huge profits from investing this ‘float’ so they can still pay claims and keep the rest.

It can be concluded that the insurance company gets its profit by ‘selling’ insurance beyond the required value and by temporarily borrowing money from its consumers – namely customers, aka premium payers – for later investment. This practice of borrowing customer money is very profitable for insurance companies because they do not have to pay interest to customers. Armed with scaring prospective customers, insurance companies reap the benefits.

It’s just that, there are times when the insurance company loses money because of investing in the wrong place. Like it or not, they have to pay for this investment loss. As long as the insurance company has sufficient liquidity and sufficient long-term asset value to cover such losses and pay customer claims, it can continue to operate like any other business practice.

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