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How does a life insurance company make money?

Here's what you need to know...
  • Insurance companies invest in actuarial research to compile together mortality tables that will help predict when an insured will pass away
  • Once an insurance company accepts an application, the underwriter will review the personal factors and assign the insured to a rating class so that the company can collect reasonable premiums
  • The company’s goal is to ultimately collect more in premiums over the life of the policy than they pay out when and if a death benefit is paid
  • While it’s hard to predict if the company will have a loss or profit with one client, when looking at an entire pool of people it’s statistically easier to estimate if there will be profits
  • Many companies remain profitable because life insurance policies lapse and they are no longer obligated to pay the death benefit

It’s only natural to wonder how a life insurance provider that offers its clients hundreds of thousands of dollars in coverage could profit by charging their clients $20 or less each month. At face value, it might appear as if life insurance companies would be on the losing end in the marketplace. Just remember, not everything is what it seems. Enter your zip code in our FREE tool above to compare life insurance rates!

While the casual observer who’s looking at the industry from the outside might think this, when you start to learn about the inside workings of the industry, you’ll quickly discover that there are several opportunities for carriers to end up in the black. There’s a very complex science that keeps the life insurance industry running. It’s this science that ensures that the profitability rates in the sector remains at 3% today. If you’d like to learn how experienced and young carriers make money, read this guide so that you know what happens behind the scenes.

How Risk Affects Profit Margins

No matter what part of the insurance industry a company operates in, one of the biggest focuses of the company will be managing risk. It’s the companies goal to collect as much as possible and pay as little as possible. Since there’s no way for this to happen naturally, the companies manage risk by assessing an application and predicting who will and who won’t file a claim.

In the life sector, the company is concerned with who will and who won’t outlive their policy.

Since risk and profit go hand-in-hand, a huge focus is placed on actuarial statistics and research so that markets that are least likely to file a claim will be targeted.

Managing Mortality Rates Among Named Insureds

One way the company decides which risks to take on and which risks to pass on to a competitor is by managing the mortality rate of the clients that they have on their books. In the world of insurance, a mortality rate is the number of insured deaths reported in that year. Since the higher the mortality rate the more the company is required to pay out, it’s the companies goal to weed out the risky insureds in the beginning.

Assessing Personal Factors to Calculate Life Expectancy

While it’s important to look at the entire pool of customers to project liabilities and how much money should be paid out in claims, the company also needs to look at each client’s risk profile to charge the right personalized rate.

If the company doesn’t charge the right rate for each individual, it’s very hard for the company to maintain profits over time.

Mortality rates may use data from a large group of people in a risk pool, but companies must predict an applicant’s life expectancy so that they can pinpoint when the person might pass away based on their health, lifestyle and other demographic factors. Statistics are very useful in choosing a target market and in pricing individual policies. Here are some factors that can affect an applicant’s life expectancy and their rates:

Insurance Companies Benefit When You Let Your Policy Lapse

Insurance companies aren’t going to admit it, but it actually benefits them when your policy lapses years and years after you’ve taken it out. Companies do profit from using actuarial tables and collecting more in premiums than they will later payout as a benefit, but this is a rare occurrence. The reason this is such a rare occurrence is because of lapse rates. One of the life insurance industry’s biggest secrets is that insurance companies make massive amounts on premiums for coverage that eventually lapses.

While there are regulations around the notice providers must give a client before a policy will lapse, when a company has significantly high lapse rates they typically will have higher profitability rates than the average in the industry. Whether or not this is a good business tactic depends on what side you’re on.

Increasing Profits By Investing Excess Premiums

The department of insurance requires all life insurance companies to have a reserve account in a place where they keep enough funds to pay out projected claims and some. The company also must project administrative costs and pay them with the premiums collected.

Anything that’s left over is considered to be an excess premium, and how the excess premiums are used by the carrier will dictate profitability.

Excess premiums are often invested so that the company can boost their profits above and beyond what they earn by selling insurance products. How the money is invested depends on the carrier, but it’s most common for the company to take a conservative approach by investing in bonds and sometimes in stocks. If you were to look at a financial statement, you would see that this source of income is labeled ‘Investment Income’.

Companies Are Offering Products to Company with Financial Firms

In the past, insurance companies placed a lot of focus on selling term life insurance. Now that life expectancy rates are higher and the rates are calculated out to an age of 120, the rates for term insurance have gone down. With the rates for term insurance going down, many companies have started to push permanent life products that come with an investment component.

By pushing these investment-type of products, the company is able to compete with banks and other financial firms.

Now that you take a look at how the industry works, you can see why life insurance companies stay in business. Not only does the company earn premium income, there’s also opportunities to profit when there’s lapses and when the company invests excess premium wisely. Even so, it’s very important that a company charges fair and competitive premiums to even earn market share.

If you’re interested in pricing the cost of insurance to find competitive premiums, it’s time to start comparison shopping. Use an online rate comparison tool, get your personalized quotes instantly, and choose which company you trust to provide you with coverage. Compare life insurance rates now by using our FREE tool below!