How do P&C insurance companies make money?

13.02.2020
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Introduction to P&C (Property and Casualty) insurance

Insurance is defined as a contract in which an individual or organization receives financial protection and reimbursement of damages from the insurer or the insurance company. On a basic level, Insurance is some form of protection from any unpredictable financial losses. We all know about life insurance, but there is another category of insurance known as P&C insurance which is quite different. Life insurance covers risks only associated with human mortality and morbidity whereas P&C insurance is focused on risks that result in a loss to property and possessions. Property and casualty insurance is actually a hypernym which includes many forms of insurance.

  • Property Insurance

    It is intended to cover property losses – the risks that we may suffer financial losses if the things we own, get damaged. Property insurance provides protection against most risks to property, such as fire, theft and some other kind of damage. Some basic types of property insurances are:
    -Loss of or damage to the article itself
    -Loss of income from the use of the thing
    -The extra costs incurred due to the loss of the article

  • Casualty Insurance

    Casualty insurance is a category of insurance that is mostly comprised of liability coverages. Property insurance comprises financial losses that result from damage to physical assets like buildings or furniture, whereas casualty insurance covers the risk of an incident after which the insured is obligated to pay losses to the third party. Some basic types of casualty insurances are:
    -General Liability Insurance
    -Workers Compensation Insurance
    -Commercial Auto Insurance

How do P&C insurance companies make money?

  • Premium Collection

    The business model of insurance companies spins around risk. Insurance companies make different kinds of policies according to the requirements of insurers. Each insurance policy is a contract or a commitment between the insurer and the insurance company. The contract specifies that whenever you suffer a significant loss; say the damage of your car or house, the insurance company will cover that loss based upon the contract terms. But in order for an insurance company to take on the risk of such losses, policyholders must pay a fee, which is known as a premium. This sum of premiums is used by insurance companies to pay the claims. For insurance companies, underwriting (the process through which an individual or institution takes on financial risks for a fee) revenues come from the money collected on these insurance policy premiums minus money paid out for claims and for operating the business.

    Let us take the case of home insurance that pays for the damages due to an earthquake, tsunami or some other natural disasters.
    Assume that in a year, one in 1000 people counter the damage of home due to a natural disaster. If a person meets with an accident, the insurance company has to pay $100,000 in damages and if he/she doesn’t get into such an accident the insurance company doesn’t pay anything.

    Nobody can be sure whether he/she will be the one who encounters such a disaster in the given year. To mitigate the risk, the insurance company starts pooling the money of those 1000 people. Each of them pays $200 annually as a premium. The pool now has 1000 * 200 = 200,000$. As per the assumption, one of 1000 will lose a home or the home might get damaged due to disaster and whoever encounters this situation will get money from this pool. After the claim, the company has still remained with 100,000$ left in its pocket. Out of this, the company spends 60,000$ to run its business. The rest 40,000$ is a profit for the company.

  • Investment Income

    In addition to policy premiums, insurance companies make money from investment profits. This situation allows insurance companies to invest the money while it’s not being used. When insurers receive premiums they put that money into an investment pool. They use the collected premiums as investment funds usually in guaranteed or low-risk securities such as bonds, real estate, and money market funds. When a claim is made, money is taken from that pool and is put into a cash account to pay the claim. The insurers make their money from the interest and return on investment earned from the premiums while those premiums are in the investment pool. Huge profits can be reaped by insurance companies with this method.

Insurers’ business model allows the company to focus its activity and make the most effective use of its resources. In response, insurance companies will continue to develop and revise their business models, bringing both beneficial innovation and a new set of insurance of risks. There are two basic methods that an insurance company can make money; by underwriting income, investment income, or by both. The assets generated by investment returns are chosen carefully to reflect the nature and timing of the insurance liabilities that may need to be paid.

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