How do life insurance companies make money?
[social_share]Insurance companies offer a service. Basically the company will pool risk among a number of people, so that by everyone sharing a manageable part of it, then those who actually suffer that risk can be compensated and not be left in a catastrophic financial situation.
Life insurance companies are not all charities, although traditionally some of them have been mutually owned. They do need to cover their administrative costs, and at times to either make a profit for the shareholders who have distributed capital with them, or else to put aside a surplus so that in lean years the company does not go bankrupt. If a person who wants to buy a life insurance policy understands how the life insurance companies make their money, they will have some idea as to how to purchase less expensive life insurance.
Life insurance can be complicated in all its details, but the basic idea behind life insurance is the same as for all types of insurance: it pools the risks amongst a large number of people. This is done on two levels, within the insurance company and outside the insurance company – on the reinsurance market.
Within a life insurance company, the risks are judged by attracting the right people with the right profiles. There are a number of features life insurance companies seek amongst their customers, some of which can’t be controlled and some of which can. For example, life insurance companies like to know a person’s age as well as their previous health history. However, they also want to know the person’s current lifestyle and smoking history. Yes, sometimes it’s true that a person can reduce their life insurance premiums by living a healthier lifestyle.
Although life insurance companies use the same actuarial techniques to judge risks, they assign different weights to different risk factors, and upon occasion even ignore some risk factors. As the risk factors affect the cost of the insurance policy, a person may find that similar policies will have quite different premiums with different companies.
Life insurance companies also spend significant sums on marketing their products, and so a company may offer cheaper life insurance if they have less expensive routes to market. This can be the case when life insurance is offered in bulk to employees of a firm or members of a professional group or trade union.
