How Do Insurers Make Money? – Indie Learn

You may already know how insurance works, but not many people know exactly how insurers make (and spend) their money.

For example, did you know that part of your premium pays for the costs of getting someone else to buy an insurance policy? Or that, in traditional insurance models, all the premiums you pay in your first year of being insured are paid to a financial intermediary? or even that around 50-60% of all your premiums will go to pay other people’s claims?

Reading: How do insurance companies make money

How do insurance companies make profits?

Insurance, like all good business models, has to be profitable. insurers have to cover their costs and make a profit to stay in business. if they didn’t, there would be no insurance companies to cover people’s risks.

In order to make a profit, insurance companies need to get as many policies at the lowest possible cost (acquisition) and keep those policies active as long as possible (hold).

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Insurance companies make their money from the premiums they charge people in exchange for coverage. They use these premiums to pay claims, to cover the cost of attracting new customers, to pay the cost of getting people tested as part of the underwriting process, and to your monthly expenses such as paying your staff salaries and office rent. what is left is your profit.

Because insurers rely on the fact that not all of their customers will ever claim, they try to sell as many policies as possible. they use the money they collect from most policyholders to pay the few who actually claim. this is called ‘spreading the risk’. therefore, the more clients an insurer can get, the greater its chances of making a profit.

How does traditional insurance work?

Initially, a new insurance company will take a loss because it has a lot of up-front expenses to pay before it has enough policyholders on its books to cover its costs. One of the biggest expenses in traditionally structured insurance companies is the cost of paying those people who help bring in new clients. They are called brokers and, for each policy they sell, insurers pay them a commission of approximately the value of the first year’s premiums. therefore, keeping acquisition costs low is another way to increase profit margins.

Another way for insurance companies to be profitable is by keeping their policyholders insured for as long as possible. If an insured cancels their policy after the first year, the insurer suffers a loss due to the initial costs mentioned above. but if they keep their policy for a long time, that initial loss is offset over time and can turn into a profit.

Are there other approaches to insurance?

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What we’ve discussed so far is what’s called an intermediate approach. “brokered” refers to the use of intermediaries to sell products.

If you eliminate those intermediaries and replace them with more direct ways to reach new customers, your initial acquisition costs are reduced because you don’t have to pay commissions. however, the direct expenses of the insurers will also include the marketing costs of their products. they can offer convenient ways for people to buy their products, through telesales or simple online checkout processes.

Although it may seem like they have an advantage over a middle-of-the-road approach, direct insurers often have higher churn rates (in other words, their customers tend not to stick around for very long), which lowers their profits. To address this, some insurers offer wealth-building incentives for staying on board. For an example of how this might work, see the Sanlam Indie Wealth Bonus, a rewarding investment given to clients for being insured.

Ultimately, the winning solution for an insurer is not to simply focus on making a profit, but to offer rewarding, quality products that do more than just promise to pay claims.

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