How Do Life Insurance Companies Make Money? A Comprehensive Guide To Life Insurance
It’s no secret that life insurance companies make money. Insurers make millions of profits on their corporate tax returns year after year. The profitability of life insurance companies often leaves people wondering how they make their money, and the answer to that can be found by examining how life insurance works.
Topics included in this article:
- How life insurance companies make money.
- How life insurance works.
- Types of life insurance.
- Common life insurance scams.
- How to prevent life insurance scams.
In this article, we will cover how insurance companies make money, and what that means for you as an insurance policyholder.
How do life insurance companies make money?
There is much debate about how life insurance companies make money. As this article highlights, there is no one way, but overall, they primarily make money in two ways: strategically priced premiums and smart investments. Insurance companies profit from premium payments and from investing in those premiums.
Insurance companies employ actuaries who specialized in advanced statistics and probability to determine what premiums should be.
Actuaries perform calculations to determine the financial risks that insurance companies face. The insured’s medical conditions will be taken into account, for example.
They use this information to modify the statistics that underwriters use to charge an insured person with their specific health concerns.
The company then knows how much it needs to charge its customers in premiums to cover its liabilities and make money.
Further to this, life insurance companies invest policyholders’ money in life insurance premiums, intending to make more money than the value they have to pay out in claims. Let’s look at this business model in more depth.
What is the source of income for a life insurance company?
Profiting from your premiums
First and foremost, one of the ways that life insurance companies make money is through premiums.
Policyholders who have life insurance pay premiums, which are usually paid monthly, quarterly, or annually. The insurance company invests in these premiums collected from policyholders, and this money collected in premiums has many years to grow through investment.
A large percentage of life insurance policies are paid out as death benefits, which is the payout money for policyholders’ beneficiaries when the policyholder dies.
Actuaries who specialize in advanced statistics are employed to determine what premiums should be. In this case, expenses are carefully managed, which minimizes loss. All of this ensures that life insurance companies generate a large profit each year.
Reinvesting your premium payments
As mentioned above, while insurers benefit directly from premiums, the income from investing in premium funds is even more profitable and makes the insurance companies more money than premiums alone. As a result, investment income accounts for a substantial percentage of an insurance company’s profit.
To understand this in-depth, take, for example, permanent life insurance policies, such as universal and whole life policies. They each contain a cash value account within the policy meant to offset the cost of insurance as you age and as the cost of insurance increases.
A portion of each premium goes into its cash-value account, which is then invested in various ways, such as bonds, stocks, or real estate. The insurance company makes income, and some of this is paid to its policyholders.
Interest and dividends
Insurance companies also make a profit from the interest and dividends earned on the investments made with premiums.
Dividends are income payments to shareholders whereas interest is income paid to company bond holders.
Life insurance policies have what’s known as cash value. A policy’s value grows over time, and permanent life insurance policies have cash value accounts. These accounts help to offset the cost of insurance as the insurer ages.
The cash value of a policy can be borrowed against or withdrawn, which will, in turn, affect the policy’s value. For example, if the policyholder doesn’t repay a loan, the death benefit will be reduced by the amount of any interest owed plus the amount of the outstanding loan.
Some life insurance policies have options to participate in shares, also known as participating. Participating allows policyholders to receive a share of the company’s profits every year.
Any profits owed to the policyholder are typically paid out in the form of dividends.
These dividends can be paid to the participating policyholders in cash, or the dividends can be used to purchase additional coverage, reduce their premiums, or pay the premiums in full.
Life Insurance Cancellations, Lapses, And Term Policies
Insurance companies also make a small portion of their profits from policies that have lapsed and those which are expiring.
When a policy lapses, it is no longer a liability for the insurance company. Therefore, the company doesn’t pay out a death benefit. However, policies that lapse also represent losses. Its cash value can no longer be invested in that policy, in the case of permanent insurance, as premiums are no longer being paid.
The life insurance industry has years of experience and has spent billions analyzing the factors above which make their money. Life insurance companies have the advantage of being able to analyze the history of past life insurance details, mortality rates, and the percentage of policies that expire or a death benefit is paid.
The life insurance industry capitalizes on the knowledge of thousands of actuaries and years of experience to know what to charge and how to invest, to be one of the most profitable industries worldwide.
How do insurance companies make their profit?
When it comes to life insurance and profitability, it’s largely a numbers game that comes down to statistics and probability. This numbers game is what makes life insurance profitable.
One way to consider what that means is to look at life insurance as a betting game or roulette of probability and statistics.
Overall, life insurance companies are usually guaranteed to make a profit, or to win the game, so to speak. Their profitability is due to the number of people that play. The policyholders either pay more than their benefit or reach the point that they don’t need life insurance anymore. In such cases as this, the premiums are converted into profit.
As mentioned throughout this article, this precision of methods and techniques is one of the reasons life insurance companies employ actuaries and data scientists. Every risk is taken into account, which works in the company’s favor. This is one way the insurance companies maintain a profitable running of their business while also providing a beneficial service to their customers.
Despite being seemingly complex, understanding how life insurance companies make money doesn’t have to be complicated. While searching for the best possible life insurance, it will help you to understand how life insurance works and which type of life insurance is right for you.
To make this easier to understand, here’s an example of how life insurance works.
There are no tricks involved in how life insurance companies make money, but there is a lot of advanced mathematics. As mentioned, insurance companies require precision when it comes to running their business and balancing risk.
Here’s an example from Statistics Canada of how age impacts the likelihood of death, based on the 2020 mortality rates (per population of 1,000 people):
|Age||Mortality rate (male)||Mortality rate (female)|
Based on statistics like these, life insurance companies work out a premium to charge the prospective policyholder. The more likely the person is to die within the term of coverage (e.g., the next 25 years), the higher the cost of life insurance.
That also means a longer term will attract higher premiums, increasing the likelihood that the policy will pay out. For permanent life insurance, which covers someone for life, the premiums are significantly higher, as the policy is guaranteed to pay out one day.
However, if there is unexpected death and the death benefit is paid out, this could be much higher than the paid premiums. In this case, the insurance company makes a significant loss.
Life insurance companies’ model for running their business doesn’t mean they make profits at the expense of their customers. The motives of life insurance companies are closely aligned with those of customers.
Insurers make more money and profit the longer a customer lives, and most customers want longer lives. Insurance companies offer peace of mind to their customers by providing them with a service that matches their needs.
How Life Insurance Works
A life insurance policy is made when you are approved and start paying premiums to your life insurance company of choice.
The life insurance company agrees to pay out a death benefit to your beneficiaries if you die. How the insurance company handles those premiums is what determines how profitable that insurer will be.
Essentially, a life insurance policy is a contractual agreement to provide financial protection to your loved ones. The agreement and policy are defined by a few key features, such as the death benefit, the beneficiaries, the policy term length, the premium, and the cash value.
Types of Life insurance
There are different types of life insurance, but they typically fall into two main categories: term and permanent.
Whichever type of insurance you choose will help to protect your family.
With a term life policy, you get coverage for a defined period, for example, 20 years. If you die during that period, money is paid to your beneficiaries, but when the term is over, you will need to get new coverage.
Permanent life insurance, also known as whole life and universal life insurance, provides life-long coverage with a “cash value” component. This type of insurance helps with many needs, like building your retirement figures and other financial benefits.
Here are some of the life insurances being offered today:
- Term life insurance.
- Whole life insurance.
- Universal life insurance.
- Final expense insurance.
- Group life insurance.
Common life insurance scams
Life insurance can offer peace of mind. However, shopping for a policy at affordable prices can be stressful, especially when we consider that scammers often target the market.
By learning about various scams, you can avoid becoming a victim of one of them. This guide will help you identify some of the most common life insurance scams.
Overselling a Policy
Life insurance agents most commonly work on commission, which means they are incentivized to sell you a higher-priced policy. While upselling isn’t necessarily a scam, it can lead to prospective policyholders paying more than they should.
Insurance Agent Fraud
There are cases when a premium is quoted to a customer for a policy that is never set up. Unless the victim tries to verify the policy, the fact it was never put in place likely won’t be discovered until years later or when a claim needs to be made.
As long as the changes benefit the insured, this is within legal rights to change an insurance plan. However, when a customer is misled into switching to a less valuable policy, the practice is illegal. When an agent pushes to make unnecessary changes, the customer should make necessary checks and should be suspicious of this activity.
Identity Theft Scams
Almost half of all scams relate to some form of stolen identity. With identity theft scams involving life insurance, the customer’s information can be used to open new accounts. The criminal may use the credit card number to make purchases. A victim of this scam will receive false information and may be asked to provide their identity information. You normally won’t be asked to provide your details, but always ensure who you are speaking to.
How to Prevent Life Insurance Scams
There are ways customers can protect themselves from fraudulent scams. When looking for life insurance, it’s wise to be knowledgeable about the possible life insurance scams and how to prevent them.
Here are some tips to help you prevent life insurance scams:
Independent brokers shop around with multiple insurance providers to provide the best price to meet a customer’s needs. Consider an independent broker to help you avoid scams.
Contact the agency
Contact the agent’s insurance company if you’re working directly with an agent. If you’re dealing with a trustworthy agency that can verify the agent’s reputation, you will have peace of mind to continue working with them.
Research the agency
A well-known agency doesn’t guarantee its services are good. You can verify its reputation simply by reading reviews and learning more about them.
Research the agent
Researching the agent will often help you to identify any past problems. Check that the agent has an active license with a reputable status.
Do your research while you shop
There is no shortage of agents who are willing to give out quotes which can be a blessing, but of course, that means there are a lot of choices to scan through. It’s worthwhile to compare multiple life insurance policies, and by doing so, you will get to avoid fraudulent claims.
Ask around for referrals
You might ask for referrals online or from friends and family. These referrals can take the weight off your shoulders in identifying a trustworthy agent. Good referrals take the stress out of research and verify experiences that have been recommendable.
Read before you sign
Before signing with an insurer, read the documentation carefully and question any terms that might cause issues. Make sure the policy details your coverage for your premiums.
Take advantage of cancellation periods
Many policies come with a free trial period known as a look period, so in that time, you can cancel the policy if you need to. You should receive a full refund if you cancel during this time, and you can cancel if there are any mistakes or if you have changed your mind.
Once your insurance policy is secured, you’ll still need to ask questions. If your agent starts upselling, you might need to get a second opinion from another life insurance agent to avoid possible scams.
Safeguard your information
If you receive communications about your policy, contact your life insurance agency or agents to discuss it. Do not give out any information unless you’re absolutely sure you’re speaking to a representative from a service you use.
If you’re a victim of fraud
If you realize you’ve been scammed, taking action is important. For life insurance fraud, you’ll need to seek legal assistance. You may also require help from an insurance fraud bureau where you can file a report and potentially stop the agent from scamming anyone else.
Life insurance cost
The following factors define the cost of life insurance:
- The required insured amount.
- Personal details: age, gender (commonly, men are charged more).
- Medical history (such as pre-existing conditions, previous medical operations, whether the applicant is taking medication at the moment of the application).
The failure to have comprehensive life insurance can cause unnecessary financial suffering to those left behind. Pitsas Insurances offer competitive life insurance packages for those wanting to protect their family or loved ones in the event of death.
Life insurance quote
Why choose life insurance with Pitsas Insurances
- Considerable financial income for family members.
- Coverage of expenses for your children’s education.
- Immediate mortgage payment cover.
- Tax benefits and deductions.
- Connect the policy with your medical insurance and save up to 25%.
For more information about Pitsas Insurances life insurance plans, you can visit our site.
To get a quote you can complete the questionnaire.