How Do Life Insurance Companies Make Money? (PART 1)

 

How Do Life Insurance Company Make Money? (PART 1)

Life insurance companies make money on life insurance policies in four main ways: charging premiums, investing those premiums, cash value investments, and policy lapses.

1. Charging premiums

Paying your policy premiums keeps your policy in force so that your beneficiaries get the death benefit.

Premiums are carefully calculated by your insurer to cover your death benefit and provide profits to the company. Based on the length of your policy’s coverage and your estimated life expectancy, the premium you pay funds: 

• Your policy’s death benefit

• Cost of administering your policy

• Profit for the insurance company

If too many customers die sooner than expected and they need to pay out more claims than planned, the insurer loses money, which is why underwriting is so thorough and there are harsh penalties for concealing information on your application.

2. Investing premiums you paid

In the years before they need to pay out the death benefit, your insurer invests a portion of those payments. The insurer sets aside enough cash to pay out claims in case of a market downturn and keeps any interest gained.

3. Gains from cash value investing

An additional investment stream comes from permanent life insurance customers, whose premiums fund both their death benefit and an investment-like cash value feature. The cash value grows at a rate set by your provider.

The funds go into a larger pool of investments managed by your provider, and some of the earnings stay with the company.

4. Policy lapses and expiration

Finally, there are some insurance policies that go unclaimed. This might happen with term life insurance, which ideally expires when you’ve saved enough money to self-insure. Permanent policies, which come with high premiums, are often surrendered or lapse when owners can’t keep up with the payments.

While a policy lapse or surrender means the insurer is no longer liable for the payout on the policy, it also loses premiums that could have been invested. Most insurers charge a surrender fee to recoup some of that lost revenue. 

An expired term life policy is ideal for providers because it allows them to collect decades of premiums without paying out any claims.

These are only the ways insurers make money on life insurance policies. Most life insurance providers sell other financial products, like annuities, so they can rely on more than one product to bring in profits.

How insurer's profits affect your life policy

As long as your insurance company stays profitable, how the company makes a profit is unlikely to have a noticeable effect on your life insurance policy. If you own a policy with cash value, you may see gains based on your provider’s investments, but the guaranteed minimum interest should keep you from losing money. 

Your insurance company turns a profit through premiums and investments, but it’s in an insurer’s interest to keep premiums affordable to keep your business. And if your provider has strong finances, it can ensure your policy pays out to your loved ones when you’re gone.