How Does Life Insurance Work

Because they are commercial ventures, insurance companies work just like any other firm. You can describe the business model of an insurance company like this:

(Premium they collect + Making Profit from the investments they make with those premiums) – ( Cost to administer the funds + Costs of investments + insurance claims payouts)

If they want to make it in the market this is what insurance companies need to do:

1. Look for a big number of people that can be insured.

2. Most of them should be able to pay the premium.

3. The potential loss that the group can suffer because of contingencies that can appear need to be huge when you compare it to the premiums that are paid.

If the risk is within the normal limits, insurance firms will make a profit by respecting the planned action.

Another type of insurance business is the indemnity. To understand this, take into consideration the risks in case of an accident that you need to pay damages to a third party. If the accident doesn’t happen, the insurer doesn’t have to pay so the premium is considered profit.

After they recover the premiums, insurance firms invest the money in markets that will bring them a nice profit (government debt instruments, equity) and allow them to keep a good liquidity base.

There are people employed at all these companies, working to find the best options for the company to invest in, and to calculate what the risks are in each situation for insured people. The premium is calculated based on actuarial calculations.

Underwriting the risk is something that companies also do, to make sure that the chances of a huge loss is reduced.

While they make sure that people are protected and covered, insurance firms also make sure that they have a profit, so everyone wins.

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