Auto insurance companies are typically set up as for-profit corporations. As with any industry, good companies are profitable and bad ones are not.
Are auto insurance companies really that profitable? How do car insurance companies make money? Is the car insurance industry more lucrative than the life or health insurance industries? Today, we’re answering all your questions about whether or not auto insurance companies are profitable.
Good Insurance Companies Are Profitable, While Bad Insurance Companies Are Not
Generally, a good insurance company will be profitable. A bad insurance company will be unprofitable and shut down.
A good insurance company hedges its risk and diversifies its insurance pool. A good insurance company prices its policies at rates where they can be profitable and competitive.
A bad insurance company fails to diversify. Bad insurance companies go bankrupt when a hailstorm or hurricane sweeps through an area, for example. Bad insurance companies charge too much – or too little – for their insurance policies.
How Do Insurance Companies Earn Money?
The insurance company is taking on risk by agreeing to cover this loss. In order for the company to take on this risk, the policyholder must pay a fee. This is known as the premium.
In an insurance company’s ideal world, the policyholder will pay premiums for life and never make a claim.
In reality, of course, a certain percentage of policyholders will make a claim. The insurance company will need to pay out these claims. The difference between the premiums collected and the money paid out in insurance claims is known as underwriting income.
Insurance company profitability varies year by year. In some years, insurers will collect large sums of cash and have few payouts, for example. In other years, the premiums collected will not cover the cost of claims paid out.
Where Do Insurance Premiums Go?
You might think your insurance company accepts your premium as pure cash. You pay $100 per month for car insurance, and $100 gets added to the insurance company’s pool every month.
Of course, this is not the case. Studies show that approximately $0.50 of every dollar collected by insurance companies goes towards paying insurance claims. Another $0.20 goes towards operating costs, like the costs of having salaried employees handling claims or operating 24/7 insurance lines. $0.15 is paid to the state and federal government in taxes. Whatever is left over is considered profit.
Insurance Companies Invest Money to Earn Profit
Insurance companies don’t just hold money in an insurance pool and wait for claims to roll in. they invest money.
Typically, state governments regulate how insurance companies invest their money. That’s why most insurance companies put their profits into low-risk investments.
These low-risk investments allow insurance companies to diversify risk and earn a profit while still being able to easily cover their liabilities.
Which Type of Insurance is Most Profitable? Is Car Insurance More Profitable than Home, Life, or Health Insurance?
The insurance industry in the United States is very competitive. Some companies specialize in a specific aspect of insurance – like car insurance. Others offer a full spectrum of life, home, and car insurance – often through a subsidiary.
Is one type of insurance more profitable than others? Is health insurance more lucrative than car insurance?
Generally, the industry is split into two sides. Some companies offer property and casualty insurance (P&C). P&C insurance covers your property – like your cars and home – and certain liabilities caused by those properties. Other companies strictly life and health insurance.
Insurance company profitability can be traced back to the underwriting process. Insurance companies become profitable by underwriting risks that result in the following two types of claims:
1) High-frequency and low severity claims
2) Low-frequency and high severity claims
In the first category, an insurance company might be profitable by only insuring drivers with cheaper vehicles instead of high-end or exotic cars. The insurance pool has a high frequency of minor accidents, but the claims are generally not severe.
In the second category, an insurance company might be profitable by protecting policyholders against events that are unlikely to occur frequently. A home insurance company might cover earthquake damage or flood damage, for example. The company will be profitable because it can charge higher premiums (because the events are so catastrophic when they occur), but severe events are infrequent (like a 1 in 100 years flood event or perfect storm).
To enhance profitability, insurance companies will also diversify their pool. An insurance company might insure homes on the coast of Florida, for example, and have a pool of customers further inland where hurricane damage is lessened. Insurance companies can diversify risk based on geography, limits, duration, and other coverage options, hedging their profits for when a 1 in 100 year event does occur.
Overall, it’s hard to definitively state which type of insurance is most profitable because profits vary widely year by year. It’s like comparing apples to oranges.
In a year with no major hurricanes, disasters, floods, or storms, for example, home and auto insurance companies might be the most profitable companies in the nation. In disaster-prone years, however, life and health insurance companies might come out ahead.
Complicating matters even further is that many insurance companies offer multiple types of insurance policies. Few companies specialize in just one type of insurance.
Certain Types of Insurance Are Not Profitable
It’s also important to note that not all insurance is guaranteed to be profitable.
Most private insurance companies in the United States no longer offer flood insurance because it was not profitable, for example.
Similarly, health insurance companies have no financial incentive to cover high-risk patients with pre-existing conditions.
That’s why the government will occasionally step in. FEMA, for example, runs the National Flood Insurance Program, which offers flood insurance to flood-prone communities that are not served by private insurance carriers.
Insurance companies are generally set up as for-profit corporations. Like any industry, good insurance companies generate profits while bad companies do not.
Insurance companies make money from premiums paid by customers. They also generate income by investing this money. By diversifying risk and income, good insurance companies can remain profitable year after year.