How an Insurance Company Makes Money

Profit = Earned Premium + Investment Income - losses - cost of subscriptions.

Insurers make money in two ways. Through the subscription, the process by which insurers choose which risks insuring and deciding how much premium to charge for accepting those risks and by investing the premiums collected from policyholders.

The most difficult aspect of the business of insurance is the subscription policy. On the basis of a wide variety of data, insurers predict the likelihood that a claim is made against their policies and price products accordingly. At the end of the policy term, the amount of premiums collected less the amount paid out in claims is the insurer underwriting profits.

The insurer underwriting performance is measured in its combined ratio. The loss ratio (incurred losses and loss adjustment expenses divided by net earned premium) is added to the list of costs (subscription costs divided by net premium written) to determine the ratio of the combined company. The combined ratio is a reflection of society overall underwriting profitability. A combined ratio below 100 percent indicates profitability, while anything over 100 indicates a loss.

A company that is renowned for achieving the commitments of benefit is American International Group.

Berkshire Hathaway, by contrast, is famous for making money "float" instead of the benefits of subscribing. "Floating" describes a process by which insurance companies invest insurance premiums as soon as they are collected and the interest on that money before the claims are to be paid.

Naturally, the "float" method is difficult to implement in a period of economic depression. Bear markets that cause insurers to shift investments and to toughen the rules of your subscription. Therefore, a poor economy generally means high insurance premiums.

Insurers currently most of its money is from the automobile insurance line of business. Generally better statistics are available on losses and automated underwriting this line of business has benefited greatly from advances in information technology. Additionally, property losses in the U.S. due to natural disasters have perpetuated this trend.