How Do Auto Insurance Companies Make Money

October 25, 2006 10:28 PM

Many of you would have insured your vehicle and will be paying your premium regularly. You will also be claiming amount from the insurance company when your vehicle gets repaired or when it meets with any accident.

But how many of us know how the insurance company is benefited from this? How does it pay its employees? How does the insurance company make a profit by getting a meager amount in terms of premiums where it has to pay hefty amounts for claims? The fact is that the insurance companies are making good amount of money and are one of the profitable areas of business.

Actually the amount the company pays for its claims is very much less compared to the premium it collects from its customers and is thus benefited by the underwriting profit. It is the combined ratio of the company, which is nothing but the loss ratio added to the expenses ratio, which determines the underwriting profitability of the company.

If the combined ratio is less than 100% it indicates profit for the company and any thing above 100% is a loss. There are also other insurance companies, which make money on ‘Float’ instead of underwriting profit. This means these companies collect investment income on the money reserved for claims.

There are some insurance companies, which manage to make profit even though their combined ratio is above 100%. These companies invest the amount received as premium from the customers and are benefited from the interest they earn before they pay out claims.

Actually the return from this investment helps the company to offset any underwriting loss, which naturally results in the company’s profit. But many of these companies, depending on the laws existing in the area where they operate find it prudent to invest in government bonds and other lower risk investments, which may earn lower returns.

These companies ensure that the cost of funds i.e., the extra amount it has to pay is less than the returns received from the investments. Although insurance companies mainly depend on underwriting profit, the financial market now expects the companies to earn profit by investing the amount received by them.

The fact is that these insurance companies use a wide historical data while figuring out the losses and decide the premium based on it ensuring a certain percentage of profit for them.

Further it is always advisable to inquire about different insurance companies before taking policy because the premium rate differs from company to company. So think and ensure that you always choose the company that offers best services with low premium to get the best benefit.

Source: EZine

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