Before purchasing insurance, you need to understand how insurance companies work. To help understand we have provided a detailed explanation of insurance company business model based on internet research and conversations with some friends who are experts working in the insurance field. Let’s split the model into components:
- Underwriting and investing
Underwriting and investing
Roughly, we can say that the business model of insurance companies is to pool more value in premium and investment income than the value spent on losses while offering a reasonable price that the customers will accept.
The revenue can be described with the following formula:
Income = earned premium + investment income – incurred loss – underwriting costs.
Insurance companies acquire their assets using these two methods:
- Underwriting is the process that insurance companies use to select the risk to underwrite and choose the value of the premiums charged for accepting those risks.
- Investing the received value on premiums.
There is a complex ancillary aspect to the insurance company business model, which is the actuarial science of pricing, based on statistics and probability to estimate the value of future claims within a given risk. After pricing, the insurance company will approve or deny the risks through the underwriting process.
Looking at the frequency and severity of the insured liabilities and the estimated payment average is what simple level pricing is all about. What companies do is check all that historical data on losses they’ve had and update it based on current values and then compare it to the premiums earned for an assessment of rate adequacy. Companies also use cost tax and loss ratios. Simply put, we can say that the comparison of losses with loss relativities is the way different risk characteristics are assessed. For example, a policy with the double losses would have to charge a premium with double the value. Of course, there is room for more complex calculations with multivariable analysis and parametric calculation, always using data history as input to assess the probability of future losses.
The companies’ insurance profit is the amount of premium value collected when the policy terminates minus the amount of value paid on claims. We also have the underwriting performance, also known as the combined ratio. This is measured by dividing the losses and costs by the premium values. If it is more than 100%, we call it underwriting loss and if it is less than 100%, we call it underwriting profit. Remember that as part of the business model of Companies, there is the investment part, which means that the companies can make a profit even if there are underwriting losses.
The Float is how insurance companies earn their investment profits. It is an amount of value that has been collected in premium within a specified time and has not been paid out to claims. The float investment begins when the insurance companies receive the premium payments and ends when the claims are paid out. As it is, this time frame is the duration from which the interest is earned.
United States insurance companies operating in casualty and property insurance had an insurance loss of $142 billion in the five years ended 2003, and had total profits of $68 billion for the same period as a result of the float. Many industry professionals believe it is possible to always get a profit from the float, without necessarily having an underwriting profit. Of course, there are many streams of thought on this issue.
Finally, an important thought to keep in mind when purchasing a new insurance policy is that in tough economic times, the markets have bearish trends and the insurance companies move away from float investments, requiring a reassessment of the value of the premiums, which means higher prices. This is therefore not a good time to register or renew your insurance policies.
The switching of profit and non-profit times is called acceptance cycles.
The actual “product” that is paid for in the insurance companies is the claims and loss handling as we can call it the materialized utility of insurance companies. The representatives or negotiators of the insurance companies can assist the customers in filling the claims or they can be filled directly by the companies.
The vast amount of claims is used by the claims adjusters and supported by the records management staff and data entry clerks within the companies claims department. The classification of the clams is made based on severity criteria and assigned to the loss adjusters. The loss adjusters have variable resolution authority based on each person’s experience and knowledge. After the assignment, the investigation follows with the cooperation of the customer to determine whether this is covered by the contract. The inquiry provides the value and payment approval to the customer.
Sometimes a public expert can be hired by the customer to negotiate an agreement with the insurance companies on their behalf. On more complex policies where claims are difficult to manage, the customer can normally use a separate policy add-on to cover the costs of the public assessor, known as damage recovery insurance.
When managing claims handling functions, the companies try to stabilize requirements for customer satisfaction, administrative costs, and payment leaks. Bad faith in insurance usually stems from this balancing act that creates fraudulent insurance practices that are high risk and managed and overcome by the companies. The dispute between clients and insurance companies often leads to lawsuits. The claims handling procedures and the validity of claims are the escalating issues.
Insurance companies use negotiators and representatives to initiate the market and insure their customers. These negotiators are either tied to a sole proprietorship or they are freelancers, which means they may have rules and conditions from many other insurance companies. It has been proven that the achievement of the objectives of insurance companies is due to dedicated and customized services provided by the representatives.