Insurance companies make money in two main means: Charging premiums to the insured and investing the insurance premium payments. Sounds simple, correct? It both is and isn't.

The concepts behind how insurers generate their big bucks are straightforward. Merely the details of how they make money can exist more involved. Here's what you lot need to know.

How insurance companies make money

There are several types of insurance:

  • Health insurance pays for function or all of individuals' medical costs.
  • Life insurance provides money to one or more designated beneficiaries when the insured person dies.
  • Property and casualty insurance pays for damage to cars, homes, and business organisation properties.
  • Specialty insurance covers types of risks that other insurers don't cover and is besides known as excess and surplus (Due east&Southward) insurance.
  • Reinsurance provides insurance for insurance companies to cover losses above certain amounts.

Companies that provide whatever of these types of insurance brand money in the aforementioned two ways:

1. Underwriting

Every insurer makes a significant portion of its revenue by underwriting, which is basically charging a fee (called a premium) for taking on financial risk.

Insurers employ actuaries who use statistics and mathematical models to evaluate the financial risks involved in insuring different scenarios. Once the financial risks are assessed, specific insurance plans can be created and premiums set for each type of insurance plan.

For example, actuaries for a belongings and casualty insurance visitor consider the probabilities of natural disasters in determining how much money in premiums that homeowners in dissimilar geographical regions should pay. Actuaries for life insurance companies might use age, sex, and medical histories to summate estimated life expectancies to determine how much unlike customers should pay in premiums.

When a person enrolls in an insurance plan, he or she agrees to pay a gear up premium to the insurer in exchange for the insurer taking on a certain level of risk. With many insurance plans, the corporeality of liability that remains the responsibility of the individual is called the deductible corporeality. Your auto insurer, for example, might crave y'all to pay the start $1,000 of any impairment costs earlier the insurance visitor is willing to pay anything.

2. Investment income

All of that money in premiums generates a lot of money for insurance companies. The companies don't have to pay out any money until or unless an insurance claim is submitted, such every bit a claim for a hospital visit or impairment to a domicile during a tornado.

What exercise insurers practice with the often huge sums of cash generated by premium payments? The companies put some aside in reserve to ensure that they'll have enough to pay all claims anticipated over the nearly term. But so they invest the residue of the money.

Investment income tends to be a lot smaller than underwriting revenue. Many insurers invest relatively conservatively, perhaps by investing in bonds or stable blueish chip stocks. However, insurance companies tin can still significantly pad their top and lesser lines through their investments.

Investing in insurance companies

There are ii primary reasons why you might desire to consider investing in insurance stocks. Beginning, insurance companies can deliver solid long-term returns. Second, the business organization models of insurers tend to make them resilient during economic downturns.

Of course, some insurance companies are better than others on both of these fronts. Health insurance behemothic UnitedHealth Group (NYSE:UNH), for example, has handily outperformed specialty insurer Markel (NYSE:MKL) over the past 10 years. Markel also fell much more than UnitedHealth Group did during the marketplace wrinkle acquired past the COVID-19 pandemic.

Insurance stocks are normally seen as skillful picks for conservative investors. However, fifty-fifty aggressive growth investors might similar certain insurance stocks. Trupanion (NASDAQ:TRUP) particularly stands out equally a potential choice for growth investors. The company provides medical insurance for cats and dogs. Its stock has skyrocketed as the North American pet medical insurance marketplace has taken off.