A lot of people love to beat up on insurance companies. If one were to try and find an individual not employed or invested in the insurance industry in some way who thought positively about insurance companies, they would be hard pressed to find one.
And it’s no surprise insurance companies have such a shameful reputation. If one hopes to get from an insurance company what they thought they paid for, it’s essential for them to understand how such companies work.
Understanding How Insurance Companies Make Profit
The first instance of insurance appeared in the ancient world in the form of maritime insurance (or marine insurance).
Traders used to restrict their business to their villages or societies. But in 1200 and 1300, Europeans began paving the way for international free trade, sending their tradable goods half a world away.
However, with innovations comes newfound problems, which for the traders of that time came in the form of fraudulent boat captains, crew members, pirates, sunk ships, ship fires, and ships seized by opposing countries during military campaigns.
The traders ultimately decided that the value of selling to a broader global market outweighed the risks associated with international export via ship, which was only by sea.
Traders minimized their risk by spreading their goods across numerous boats, so in the event one or two shipments were lost or damaged, they still had something left over to recover the loss.
Eventually, the introduction of hedging instruments in the form of commenda contracts and marine (Mutuum) loans became the nearest thing to marine insurance.
The Sophistication of Insurance in Enlightenment-Era Europe
As Europe entered the Enlightenment Era, various specialized versions of insurance formed. In the 17th century, other types of insurance services developed in London.
Robert Hayman took out two £100 “policies of insurance” with Arthur Duck, the diocesan Chancellor of London in those times, one intended for the safe arrival of his ship headed to Guyana, and another for life insurance.
Since then, all sorts of insurance policies have been developed as consumers began making more money, creating significant middle-class populations who could now afford to collect more things of value than centuries before.
This economic change transformed insurance from being a service for the wealthy to a service that is required by law in some cases, such as automobile and commercial insurance.
How Modern-Day Insurance Companies Ensure Profits
In theory, an insurance company would make its profit from collecting premiums from the insured in the hopes of minimizing the number of claims paid out.
Supposedly, insurance companies reduce risk by conducting risk assessments of potential customers and writing up a contract accordingly.
This is why, for example, an individual with a poor driving history will be charged a higher rate or even denied a policy in severe cases.
Additionally, insurance companies often reward good drivers for staying accident-free over a specific period, as well as avoiding traffic infractions.
For example, if an insurer makes $10 million in a year from incoming premiums and pays out $3 million in claims, it earned $7 million for that year. If it paid over $10 million, then, of course, it has lost money.
However, most if not all insurance companies don’t rely on premiums for a bulk of its profit. If it did, the companies annual income would be unpredictable and unstable. Thus, they invest specific percentages of the premiums towards investments of various kinds.
For example, life insurance companies like to invest in 30 percent of their holdings into common stocks, while five percent of their holdings go into the stock market.
Additionally, they must be reasonably sure that the investments they put the money into can absorb any unsustainable loss due to a high number of payouts or poor investment, so diversification is essential.
The Name of the Game Is to Not Lose Money, Not Help You
Though a lot of people understand the strategies used by insurance companies to increase profits inherently go against the insured, some people remain optimistic that the insurance company they chose is as nice as it seems on their website or in interactions with customer service.
However, according to Queenerlaw, a leading law firm based out of Tennessee, a lot of unwitting consumers believe a number of myths surrounding insurance companies. Some of these myths include:
- Insurance companies can accurately assess who was at fault.
- The insurance company paid my property damage so they cannot say that the car crash was partly my fault.
- The insurance company wrote a letter saying that they would pay the claim, so now they are obligated to pay for the car crash.
- The insurance company will pay my medical bills.
- Insurance companies have access to medical records and accident reports.
- Health insurance carriers and auto insurance carrier will cooperate with respect to your medical care.
No one in this world would ever get what they want out of others if they told you how they make a profit.
Anyone in business to make money understand that their business hinges on the fact that consumers either don’t know how to access something, can’t access it, or get it from them rather than put forth the energy to do it themselves.
This consumer attitude is what fuels a multi-trillion dollar services market around the globe. For instance, if an individual had the discipline and know-how to create their own investment strategy to ensure themselves, they wouldn’t need an insurance company.
Of course, this person would need to use the same if not a more stringent risk management system used by insurance companies to protect against loss. But who wants to be responsible for that, right?
Don’t fall victim to the games most insurance companies play; learn about your policy, read your contract, and, if possible, keep an attorney on retainer in case you need one.
