How Do Life Insurance Companies Make Money? (PART 2)

How Do Life Insurance Companies Make Money? (PART 2)

If you have life insurance or if you’re thinking of purchasing life insurance, you might interested in learning more about the structure of the business. For example, if everyone dies, how do life insurance companies make money?

Life insurance companies make money because insurance is a business model that provides more profit than payout.

Lets go into more detail, but this is a valid question, and it is important for you to understand how life insurance works. Most likely, you will need to buy life insurance at some point. Consequently, knowing how it is profitable will give you confidence your company will be able to pay your death benefit if you should ever need it.

Types of Life Insurance Policies

There are two main types of life insurance policies that people can choose from: term life policies and permanent life policies (for example, Indexed Universal Life Insurance).

Term Life Insurance

Term life policies are paid into and provide the security of life insurance for a specific duration of time. These policies rarely pay out, instead they either expire before the person dies, or the person fails to pay. Many people choose term life policies because they want the security of life insurance for their family, but aren’t worried about needing that security when they get older.

For example, a man with 4 children and a spouse may feel it is better to have term life insurance to cover the household expenses in the event of his death. However, he also knows once his children are grown and moved out and his house is paid off, he will have enough money in savings and investment accounts to cover bills for his spouse and the cost of a funeral.

Permanent / Whole Life / Traditional

Whole life or permanent life insurance is intended to be used for the person’s life and used upon death. Permanent life insurance is a term that covers types of insurance such as whole life insurance, universal life insurance, and variable life insurance. All of these are similar types of life insurance with the primary differences being how the premiums are paid.

Many people choose permanent life because it carries a cash value. Loans can be taken out against the policy and the money can be withdrawn early, with a fee and/or cancellation of the policy of course. Permanent life, such as funeral or burial insurance might be chosen by people who don’t believe they will have the financial ability to cover the costs of a funeral and the costs of bills their family maybe left with.

How Do Insurance Companies Make Money Off Term Life Policies?

Insurance companies make money off of term policies from the premiums they collect from policy holders. If the insurance company never pays a death benefit (which 98% of them will not) then the insurance company gets to keep the premium payments. Here is how most of these polices end: expiration without payment and cancellation.

1. Expiration Without Payout

Term life policies expire after a certain amount of time. As a result, if the insured person doesn’t die in that time frame, they are no longer insured by that policy.

At the time of expiration, the person may:

• choose to get another term life policy,
• get a whole life policy,
• or just go without insurance.

The life insurance company then does not have to pay out if that person dies, which leaves them with the profit from the cost of the policy.

Take for example a 15-year term life policy. If a person pays $50 a month for that policy for 15 years, that person paid in $9,000 over the duration of the policy. They do not get that money back, and the insurance company did not have to pay out the life insurance policy.

2. Cancellation

In addition, they can also make a profit off of policy cancellation and holders’ lapses in payment. When people fail to pay their monthly premium, the policy cancels and the company does not have to payout upon the persons death.

How Do Insurance Companies Make Money Off Permanent Life Policies?

Remember, whole life insurance policies are more expensive policies that are considered permanent. As a result, one common question we hear often with permanent policies is…

How do life insurance companies make money if everyone dies?

It is a common misconception that if everyone dies, the insurance company can’t possibly make money. With permanent life policies, this is an understandable thought. Permanent life policies are likely paid out a much higher rate than term life policies, though there isn’t much information on the percentage of permanent policies that are actually paid.

Even without that information though, we do know that insurance companies still make money on permanent life policies. With permanent life policies, insurance companies make their money in a couple of ways.

1. Cancellation

First, like term life policies, payments that lapse and cause a cancellation of coverage. This allows the company to keep the profit and not have to pay out the benefit.

2. Interest from Investments

Second, for those policies that don’t lapse, the insurance company takes the monthly payments and invests the money to make a profit on the interest. Profit is also determined on a quarterly and yearly term, which allows the company to balance their profit and expenses.

In a given year, insurance companies may make more money in premiums than they have to pay out in death benefits. If they do have to pay out more in benefits than they make in premiums, they are likely making money on their investment accounts.

Where Do Life Insurance Companies Invest Their Money?

Insurance companies invest money they get from premiums and make a profit from the interest. They invest their money in conservative, interest-bearing accounts such as mutual funds, stocks and bonds.

What Happens if Insurance Companies Lose Money on Their Investments?

Being large institutions, if they lose money on their investments, they are usually able to continue paying out benefits from the premiums that are paid each month. However, if they take a large loss, the company may increase their premiums in order to make up for the losses and cover the costs of benefits they have to pay out.

What Percentage of Life Insurance Policies are Paid Out?

Unfortunately, there is little information regarding the percentage of life insurance payouts. However, there is information on how much money has been made and paid out for life insurance annuities. In 2019 insurance companies collected $922.3 billion in revenue.

Of that, $145.1 billion was from life insurance premiums and $186.6 billion was made from investment income. Insurance companies paid out $302.2 billion in benefits. That means they made $29.5 billion in revenue before taxes and other expenses of course.

How Else Do Life Insurance Companies Make Money?

In addition, most life insurance companies have many more products besides standard life insurance. Many carriers (companies) provide other types of services as well. These included long-term care insurance, annuities, accident and health insurance and more.

• For example, Medicare Supplements have been very good money makers for insurance companies.
• Recently, Medicare Advantage products have also become good ways for life and health insurance carriers to make money.

Does Life Insurance Really Pay Out?

Yes! Life insurance will pay out a benefit to your policy’s beneficiaries if you (or the policy holder) dies. Your beneficiaries will get a non-taxable, lump sum benefit. However, to receive a payout, you will need to have a life insurance policy in good standing (i.e. not lapsed).

There are sometimes clauses in life insurance policies that stipulate they will not pay out in certain events. These events usually include, fraud and suicide. Typically, these clauses last two years. Consequently, if suicide occurs after the two year mark, they would then still payout a death benefit.

In addition, sometimes actuaries develop life insurance plans to include additional payouts for certain events, such as accidental death. These are called riders, and accidental death and dismemberment is a common rider on life insurance policies.

Conclusions on How do Life Insurance Companies Make Money

In summary, if you were ever concerned that there is a catch to life insurance policies that allows those companies to make money, now you shouldn’t be. There really isn’t a catch to life insurance that allows companies to make money. Life insurance, and insurance in general, is a profitable industry. Moreover, its profitability allows us all to sleep better knowing we will be protected in the case of an emergency.