How life insurance companies make money
Most life insurance covers a limited time period
Unlike payouts from automobile insurance, life insurance payouts can sometimes be very large—in the hundreds of thousands of dollars. That’s a lot of money for a company to pay out. However, it’s important to remember that most people who hold active life insurance policies only have them for a limited time period. This is because the majority of people who buy life insurance buy “term” life insurance, which only lasts a set number of years. Term life could help protect dependent children while they are young or help pay a serious financial obligation like a mortgage. So, many people buy term life plans that last 20 or 30 years, just long enough for children to grow up and a mortgage to be paid off.
Keep in mind that when people first have children or buy their first homes, they are generally younger and in good health. That means they most likely will still be alive when their 30-year term life insurance policy expires. The percentage of term life insurance holders who actually die is typically small.
So, the life insurance company will likely get to collect premiums without making payouts to policy holders who outlive the policy terms. That money goes to help pay for claims in cases where the policy holder passes away during the term of the policy coverage.
But how do companies make money on whole life insurance?
Of course, not everyone purchases term life insurance. Some people want policies that last their entire lives because they want to know their loved ones will receive a payout. That is why they purchase whole or guaranteed life insurance policies.
These types of life insurance policies are designed to pay beneficiaries a death benefit no matter how long the policyholder lives. One way companies make sure they can cover all the payouts is to charge higher premiums for these policies. Companies also use the underwriting process to determine how risky each policy applicant is based on their health, lifestyle, hobbies, and other personal traits. The risk level associated with each policy holder may further impact how much the policy costs.
For example, a 50-year-old male smoker seeking a policy worth $50,000 might have to pay a much higher premium than a 25-year-old female non-smoker seeking the same policy. This is because, statistically speaking, the 25-year-old is likely to pay into a whole life policy for a longer period of time.
Insurance companies: part of the lifeblood of our economy
So, what does an insurance company do with years of collected premiums once they make sure they have enough money for their annual death payouts and operating expenses? They invest the money in very stable options like bonds or blue-chip stocks. This money generally grows by a percentage over time, helping the insurance provider remain profitable and stable.
In fact, insurance companies are among the biggest investors in our economy. The corporate and government bonds they purchase fund many long-term projects such as apartment buildings and roads, as well as personal and business loans. These investments help make the total economy more stable.
And then there’s reinsurance
There’s yet another way insurance companies give policyholders confidence that the company will pay their claims. This is called “reinsurance.” It is a type of insurance that insurance companies buy from another insurer to help assure that they can meet their expenses in good economic times and bad.
As you can see, life insurance companies actually have a very strong business model that works for both the business and its customers. This is why so many people continue to trust life insurance companies to help protect their loved ones with policy benefits if they pass away.