WHAT DO INSURANCE COMPANIES DO?
Insurance companies assess the risk and charge premiums for various types of insurance coverage. If an insured event happens and you get hurt, the insurance company will pay you up to the agreed-upon amount of your policy. There are ways that insurance companies make money. They can pay this and still make money.
Evaluating the Risk
Because they pay premiums, businesses that buy insurance policies give up some of the risk to the insurance company in exchange for taking the risk. There must be a way for the insurance company to figure out how much risk it is taking.
It asks questions, each of which is meant to help you figure out how to deal with a certain risk. Depending on your answers to the questions, the insurance company quotes you a premium. If your risk is higher than normal, like if you don’t live near a fire hydrant, your fire insurance will be higher.
Your insurance premiums are a lot less than the possible damages, but the insurance company can afford to pay them because it gets money from a lot of people. Insurance companies work on the idea that everyone shares in the risk. All the customers pay small amounts and share the risk that way.
A fire or other covered event only happens rarely. The insurance company has to calculate the premiums so the total premiums it receives from its many customers cover the few damage claims, with some money left over for administration and profit.
Insurance companies have to consider that, if they have a lot of policies in one area and there is a natural disaster, many customers will make a claim. Because of how many claims the insurance company may not have paid, they may not have enough money to cover them. To prevent such a problem, insurance companies pass on some of the risk to other large financial firms that offer re-insurance, meaning they may be protected in a worst case scenario.
Over time, insurance companies get a lot of small fees and have to pay out a lot of money. Before they pay the damages, they may have a lot of money that they invest, says Obrella. Because they don’t want to take much further risk, they often place this money in safe assets, but it still creates a large income. This money helps insurance companies make more money, and they can use it to lower the premiums they charge or to make more money.