The field of life insurance is consistently ranked among the most lucrative in the global economy. On their annual corporate tax returns, insurers typically record profits in the billions of dollars. But exactly where do all of this company's profits come from? Examining the mechanics of life insurance, in particular the process by which your premium is determined and the destinations of the funds it generates, will lead you to the solution you seek.
The Workings of a Life Insurance Policy
You have created a life insurance policy when you submit an application for life insurance, get approved for the policy, and begin paying premiums to the life insurance company. Your beneficiaries are entitled to receive the death benefit from your life insurance policy once you have passed away. How the insurance business deals with the premiums it collects between the time it receives those payments and the time it pays out a death benefit (if there is a payment) is what decides whether or not the insurer will be profitable.Making A Profit Off Of Your Premium
The primary methods through which the insurance company generates revenue are the accumulation of profits from customers' premium payments and the subsequent investment of those profits. Insurance firms have thousands of actuaries on staff who are experts in advanced statistics and probability so that they can determine what the appropriate rates should be. They make calculations to determine the financial costs of insurance companies' risks, such as whether an insured person smokes, is obese, or has one or more severe health conditions like cancer or heart disease. These factors can affect the premiums that an insurance company must charge. They make use of this information to construct and change the mortality tables that underwriters use to assess the premiums that the company should charge to a particular insured person based on that person's specific health circumstances. To calculate how much it needs to collect from its clients as premiums in order to pay off its obligations and, preferably, earn a profit for the current fiscal year, the company can use this method. The calculation of your individual mortality risk, which is the foundation of your premium, takes place during the underwriting process. This is the part of the process in which your application, health history, and any extra information are taken into consideration.Turning Your Payments Into Investment
Although insurance firms might make a profit directly from premiums, the income they make by investing the money they receive in premiums is typically far more significant. In point of fact, investment income accounts for a sizeable portion of total revenues and profits. In the life and annuity insurance industry, investment income will account for $186 billion of revenue in the year 2020, which is significantly higher than the $143.1 billion that will be generated from life insurance premiums. Consider the cash value component that is included in permanent life insurance policies in order to gain a better understanding of how this operates. Permanent life insurance products, such as universal and whole life, provide a cash value account that the company can use to offset the policy cost as the insured person ages (and insurance costs increase). A portion of each premium is deposited into the cash-value account, which is then invested through the "general account" of the insurer, typically in fixed-income securities such as bonds, but also in stocks, real estate assets, and various other sorts of investments. The insurance company retains a portion of the revenues, while the remaining portion is distributed to the policyholders. Insurers and policyholders end up financially better off due to this arrangement. The amount of interest credited to policyholders' cash-value accounts is determined not only by the money earned by the general account but also by the kind of policy and expenses incurred. The cash values of variable life insurance contracts are not contributed to the insurance company's general pool of cash reserves. Instead, these cash values are retained in a separate account. Instead, they are placed in the individual sub accounts of mutual funds that are available inside each policy.Term Policies and Those That Have Expired
Despite the fact that a considerable portion of a life insurance company's profits come from the interest and dividends earned on its cash value policies, insurers may also realize a profit on lapsed policies and term policies that are nearing the end of their terms. This is due to the fact that when an insurance policy expires, the corresponding responsibility for the insurance company disappears, and the firm is relieved of the need to pay any death benefits associated with the policy. Nevertheless, lapsed policies constitute a source of revenue that they cannot recover. There is no longer any payment being made toward the policy's premiums, and in the case of permanent insurance, the cash value is no longer eligible to be invested. The most recent statistics come from a study conducted jointly by the Society of Actuaries and a body representing the insurance industry called LIMRA. The study indicated that the overall yearly policy lapse rate was 4.0 percent between the years 2009 and 2013. The researchers found the cancellation rate for term policies to be 6.2% on an annual basis.How Life Insurance Companies Make Money - the bottom line
Analysis of mortality rates and the proportion of policies that are kept active until either their terms run out or a death benefit is paid out has consumed a significant amount of time and financial resources within the life insurance business. It is amongst some of the most profitable industries in the world since it has learned through previous experience as well as the work done both recently and in the past by thousands of actuaries what prices to charge and how to invest.