How Insurance Companies Profit: Understanding Premium Collection & Investment

Insurance company money is typically received through the premiums that are collected from policyholders. These premiums are then invested further by the company, which lead to further income for the company. A part of this money is paid out to people who make claims on the insurance.

Insurance company also receives revenue from policy dividends. A policy dividend is the unearned portion of premium that is returned to the policy owner. With a stock insurance company, these excess earnings are paid as stock dividends to shareholders of the company.

The Payment of Premiums

Insurance company’s price their premiums based on the risk associated with a potential loss. This includes loss of life, loss of earnings due to a disability, a reduction in value to a home or automobile due to theft or damage. That depends on the kind of policy. The insurance company agrees to cover those risks that it feels are predictable, accidental in nature and produce a financial hardship. The premium represents the amount of risk that the insurer is willing to take, based on the occurrence of that risk across a large population and class of insured individuals.

Net Premiums

The premiums collected by the insurer are used to pay the expense associated with the risk (“cost of insurance”) and other expenses of the insurer. The net premium amount is held in the accounts of the insurer and invested in order to cover the risk. Any amount that is earned in excess of the risks for that particular insurer in a given year represents a dividend opportunity.