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Pricing and Assuming Risk
Interest earnings and revenue, reinsurance, evaluating insurers.
- Personal Finance
How Do Insurance Companies Make Money? Business Model Explained
Insurance companies base their business models around assuming and diversifying risk. The essential insurance model involves pooling risk from individual payers and redistributing it across a larger portfolio. Most insurance companies generate revenue in two ways: Charging premiums in exchange for insurance coverage, then reinvesting those premiums into other interest-generating assets . Like all private businesses , insurance companies try to market effectively and minimize administrative costs .
Revenue model specifics vary among health insurance companies, property insurance companies, and financial guarantors . The first task of any insurer, however, is to price risk and charge a premium for assuming it.
Suppose the insurance company is offering a policy with a $100,000 conditional payout. It needs to assess how likely a prospective buyer is to trigger the conditional payment and extend that risk based on the length of the policy.
This is where insurance underwriting is critical. Without good underwriting, the insurance company would charge some customers too much and others too little for assuming risk. This could price out the least risky customers, eventually causing rates to increase even further. If a company prices its risk effectively, it should bring in more revenue in premiums than it spends on conditional payouts.
In a sense, an insurer's real product is insurance claims . When a customer files a claim, the company must process it, check it for accuracy, and submit payment. This adjusting process is necessary to filter out fraudulent claims and minimize the risk of loss to the company.
Suppose the insurance company receives $1 million in premiums for its policies. It could hold onto the money in cash or place it into a savings account , but that is not very efficient: At the very least, those savings are going to be exposed to inflation risk. Instead, the company can find safe, short-term assets to invest its funds. This generates additional interest revenue for the company while it waits for possible payouts. Common instruments of this type include Treasury bonds , high-grade corporate bonds , and interest-bearing cash equivalents .
Some companies engage in reinsurance to reduce risk. Reinsurance is insurance that insurance companies buy to protect themselves from excessive losses due to high exposure. Reinsurance is an integral component of insurance companies' efforts to keep themselves solvent and to avoid default due to payouts, and regulators mandate it for companies of a certain size and type.
For example, an insurance company may write too much hurricane insurance, based on models that show low chances of a hurricane inflicting a geographic area. If the inconceivable did happen with a hurricane hitting that region, considerable losses for the insurance company could ensue. Without reinsurance taking some of the risks off the table, insurance companies could go out of business whenever a natural disaster hits.
Regulators mandate that an insurance company must only issue a policy with a cap of 10% of its value unless it is reinsured. Thus, reinsurance allows insurance companies to be more aggressive in winning market share , as they can transfer risks. Additionally, reinsurance smooths out the natural fluctuations of insurance companies, which can see significant deviations in profits and losses.
For many insurance companies, it is like arbitrage . They charge a higher rate for insurance to individual consumers, and then they get cheaper rates reinsuring these policies on a bulk scale.
Investopedia / Hilary Allison
By smoothing out the fluctuations of the business, reinsurance makes the entire insurance sector more appropriate for investors.
Insurance sector companies, like any other non-financial service, are evaluated based on their profitability, expected growth, payout, and risk. But there are also issues specific to the sector. Since insurance companies do not make investments in fixed assets, little depreciation and very small capital expenditures are recorded. Also, calculating the insurer's working capital is a challenging exercise since there are no typical working capital accounts. Analysts do not use metrics involving firm and enterprise values ; instead, they focus on equity metrics , such as price-to-earnings (P/E) and price-to-book (P/B) ratios . Analysts perform ratio analysis by calculating insurance-specific ratios to evaluate the companies.
The P/E ratio tends to be higher for insurance companies that exhibit high expected growth, high payout, and low risk. Similarly, P/B is higher for insurance companies with high expected earnings growth, low-risk profile, high payout, and high return on equity. Holding everything constant, return on equity has the largest effect on the P/B ratio.
When comparing P/E and P/B ratios across the insurance sector, analysts have to deal with additional complicating factors. Insurance companies make estimated provisions for their future claims expenses. If the insurer is too conservative or too aggressive in estimating such provisions, the P/E and P/B ratios may be too high or too low.
The degree of diversification also hampers comparability across the insurance sector. It is common for insurers to be involved in one or more distinct insurance businesses, such as life , property, and casualty insurance. Depending on the degree of diversification , insurance companies face different risks and returns, making their P/E and P/B ratios different across the sector.
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Insurance Companies Business Model
We all are surrounded by different uncertainties and risks in our life. Whether a celebrity or a normal human being; everyone lives in the fear of losing valuables. People have different worries like health issues, financial loss in business, death loss, job insecurity, etc. Apart from these worries, another fear is related to property loss and natural calamities i.e. earthquake, floods, famine, fire, drought, etc. In organizations also, both employees and employers are worried about different risks, like employees have a risk factor of losing jobs and employers for the wellbeing and physical safety of employees. So, we can say that everybody experiences risks and uncertainties at some point in their life.
Insurance offers a way to provide protection from above different financial losses. It is considered as one of the mediums for providing not only financial security but also emotional and materialistic security. Insurance supports by protecting us from uncertain possible risks i.e. accident, fire, sudden death, major health-issues, burglary, etc. Insurance can be broadly classified as Life Insurance and General Insurance.
• Life Insurance: It is considered as a contract that provides compensation in monetary terms in case of disability or death of a person. Even a few life insurance policies are composed to provide post-retirement financial security or for a fixed period. We borrow life insurance policy by making a lump-sum payment or periodic payments i.e. Premium to an entity that provides insurance i.e. “Insurer or Insurance Company”. In lieu of the premium, the insurer or insurance company assures to compensate an assured amount to the family in case of disability or death or at a defined time. So, we can say that life insurance secures families by providing financial security even in the sudden death of a family member.
• General Insurance: It is a contract that provides financial security in the form of compensation on other losses except for death. These financial losses can be related to different liabilities like travel, health, vehicle, house, etc. Through this, insurance companies are liable to pay a sum assured of the compensation that covers vehicle damage, financial loss at the time of travel, medical expenses while taking treatment on health issues, financial loss due to fire or theft or natural disasters, etc. General Insurance is mainly of 5 types i.e., Health insurance, Vehicle insurance, Travel insurance, Home insurance, and Fire insurance.
A Brief Background
The evolution of the Insurance concept and Insurance business happened long back when businessmen throughout the world used to travel from one nation to another for business and trade purposes. The primary and cheapest way of transport was to utilize waterways. Boats and ships were the transport medium for shipping stock and inventories. But often boats containing cargo were drowned or stolen by pirates or lost. So a group of 10 merchants or businessmen looked for a solution for bearing risk due to the above loss of inventory and boats. As a solution, each of them contributed 10% worth of inventory or stocks, and the same was collected in a bag. After the contribution of each business member, the bag had enough money to compensate any ship owner who lost his ship to prevent any financial or mental loss. So, this act of these merchants is considered as commercial insurance in which they were insuring the risk on a mutual basis by money pooling (premium) and further providing that money as compensation to the merchant who suffered the loss (sum assured).
Business Model of Insurance Companies
The business model of an Insurance company involves an agreement or contract between the insurance company (insurer) and people who are insured (customer or insurance policyholder). The base of the business model of insurance companies revolves around prediction and diversification of risk. It is a risk-sharing model in which risk is pooled from individuals and redistributed among a large group of people. Before discussing the business model of Insurance companies in detail, let’s first have a look at the “Working mechanism of Insurance business”.
Business Model Canvas of Insurance Companies (Including Life Insurance Companies)
Different elements mentioned in the above business model canvas of Insurance Companies are as under:
A) Value Proposition
Following is the value proposition of insurance companies.
- Insurance companies provide different insurance policies to cover various unforeseen events to enable businesses and individuals to disburse their daily activities smoothly. These policies remove the future possibility of any big and unaffordable potential loss by providing security and mental peace. Also, losses of the few people are distributed among many.
- Different insurance policies are offered by insurance companies to cover various types of risks like home insurance, life insurance, vehicle insurance, health insurance, etc.
- Businesses and companies can also take benefits of various insurance plans like Worker’s compensation, Property insurance, Group mediclaim, Group personal accident insurance, Fire insurance, etc. to save the interest of their employees and business assets in hard times or unexpected losses.
- Insurance companies cover risks of customers against old age, death, illness, disability, etc. They provide various additional benefits or services along with core insurance products aimed at risk prevention, fast handling of claims, etc. This also includes providing health advice or cyber-security advice.
- Insurers offer various saving plans for long-term benefits, like pensions. The products offered by the insurance companies are mostly the combination of investment and protection against different risks. Thus, customers get the advantage of both returns on investment and life risk cover.
- The products of Insurance companies have guaranteed minimum returns. So, it ensures people, that their savings are safe. Even in fluctuations in stock markets, customers will still get the money as agreed at the defined time.
Value Proposition Especially Offered by Life Insurance Companies
The chart depicts the value proposition offered by life insurance companies
- Financial Security (peace of mind): – In case of death: Life insurance companies offer great peace of mind by ensuring financial safety to the family in case of demise of life insurance policyholder. – In case of health issues or major disease/illness: The major part of the income of Indians is used in healthcare and medicines. There are great chances of no earning or income during treatment in case of suffering from a critical or major illness. Life insurance companies play a significant role during this time by providing financial protection to fulfill family needs, medicine, and treatment needs. For example, ICICI Prudential life insurance has an ICICI Pru iProtect Smart Plan that includes ICICI Prudential smart health cover for the critical illness of worth Rs. 10 lakh cover and for 15 years.
- Secure future of children: Life insurance companies encourage savings or funds for the education of children. A child insurance plan is there to fulfill educational needs of children. These policies generally come under ULIP (Unit linked insurance plan) that facilitates the increase in investments and educational support. Such as, a parent at the age of 35 years takes a 15-year child insurance plan with Rs. 10 lakh sum assured and saves Rs. 1 lakh on annual basis for the purpose of higher education of a child. In case of unfortunate death of the parent at the age of 40, Rs. 10 lakh amount will be handed over to the child for fulfilling the requirement of immediate educational cost. For example, ICICI prudential life insurance has ICICI Pru Smart Life plan that gives the additional benefit of waiving off the remaining premium amount in case of death of parent that also without intact of financial protection cover.
- Avoiding loan burden by wealth creation: Life insurance companies also offer few life insurance plans that provide the medium for wealth creation. These plans or policies provide benefits of life cover and great returns by investing the premium of policyholders in various beneficial investment categories. This helps in minimizing the burden of taking and repaying loan for financial needs by encouraging savings and enhancing wealth. For example, ICICI Pru Signature which is a ULIP plan of ICICI Prudential life insurance offers such benefits.
- Retirement benefits: In the old age, everyone wants to be free from all financial burdens and work pressures to enjoy the retirement period. This can be peaceful if there is a stable monthly income or pension. As more people are working in private sectors where pension benefit is not available or very rare, so retirement seems like a burden or pressure. To avoid such worries on retirement, life insurance companies offers retirement plans through which retired people are able to get a pension and can live their life without being financially dependable on others. These retirement plans provide regular pension to a retired person and his/her spouse. For example, if a 60 years old person buys ICICI Pru retirement plan i.e. Immediate Annuity-retirement plan of Rs. 1 crore then he/she can receive Rs. 61k per month as retirement pension for the rest of the life.
- Tax benefit through tax savings: Tax benefits are also offered in Life insurance plans by insurance companies. The premium paid by the policyholder comes under the tax deduction of section 80C in the Income Tax act. So, up to Rs. 1.5 lakh annual premium is a deductible amount from gross income that lowers the tax outgo. Moreover, the maturity insurance plans are totally tax-free.
B) Customer Segments
Different customers of Insurance companies (including life insurance companies) are
- Household customer segment: This includes self-employed people, retired employees, and salaried class customers
- Trade sector: Different small and large businesses are included in this
- Industrial sector: Both public and private industries are also customers of Insurance companies
- Institutes: Various universities, schools, colleges, and institutes fall in this customer segment
- Rural sector: This segment is categorized as per age i.e. kids, youth, old age, etc. and gender-wise segment i.e. Men and Women.
C) Key Partners
The key partners of insurance companies are:
- Life Insurance and general insurance companies have network partner companies to support them in their different operational activities. The key partners of insurance companies are categorized as below: Channel and distribution partners: This includes third party intermediaries of insurance companies like agents, brokers, banks, independent consultants that work on the behalf of insurance companies in providing products and services of them and also, expand the market reach of insurance companies. Different banks and insurance companies have a partnership for selling insurance products of insurance companies to clients of banks. This partnership is termed as Bancassurance.
- Vendor and suppliers as partners: This includes suppliers of technologies, services, equipment to support the main operations of insurance companies. For example, ICICI Prudential Life Insurance has tie-up with Paytm for marketing and selling its product i.e. ICICI Pru iProtect Smart (a protection product) using the Paytm app. Similarly, the company is in partnership with Airtel Payment Bank to provide easy and fast access to savings and life insurance plans of ICICI Prudential to the customers of Airtel Payment Bank.
- Strategic and Alliance partners: This includes different companies that have a tie-up with insurance companies for projects related to the marketing and branding of insurance companies.
- Community and Social partners: Various charitable and non-profit organizations are partners of insurance companies for community and social projects.
D) Key Resources
These are the key resources of insurance of insurance companies.
- Insurance agents and brokers: The insurance agents and brokers are the main resources of Insurance companies, especially life insurance. These are the 1st point of contact for customers who are looking for insurance. These agents and brokers facilitate customers in selecting the best insurance cover by providing all necessary information. Insurance agents usually work for a particular insurance company and sell the insurance products of that company only. Wherein, insurance brokers serve customers who are looking for insurance and so these brokers are associated with multiple insurance companies to sell their products.
- Online portal or Website: Insurance companies have their own website that contains all necessary information about their products and services for different types of customers according to their needs. People can apply directly to these websites for insurance cover. Also, customers can apply through the website of Insurance agents, brokers, and third parties.
- Mobile App: Various life insurance companies have their own mobile app to facilitate customers with quick and easy apply, access for insurance, and related services. For example, ICICI Prudential Life Insurance has a mobile and tablet app i.e. ICICI PruLife for the purpose of online sourcing and servicing of life insurance policies. Customers, Advisors, Employees, and Sales Partners of the company can access and use the app.
E) Key Activities
The main activities of Insurance companies are as below:
- Marketing: This includes primarily marketing activities like advertisement and promotion of insurance-related products and services. Different agents and Brokers are the sources to sell and advertise most of life or health insurance policies. All big groups in the insurance sector have their own websites for promoting the product features of insurance companies.
- Underwriting: Insurance companies are involved in underwriting which is the process of categorizing the potential insurance policyholders into the applicable risk classification. The purpose of underwriting is to charge the appropriate price or rate.
- Administration: Insurance companies do various administrative activities once the insurance policy is sold out and underwriter approves it like establishing records, collecting premiums, answering queries of customers, and various other administrative jobs. Administration includes management of various other functions i.e. accounting, customer service, information systems, personnel management, and office administration.
- Investments: Different Insurance companies have their own investment firms (e.g. mutual funds firms) that perform tasks related to investing the premium in the capital market in order to gain the best ROI (return on investment) for providing security to policyholders.
- Reinsurance: Insurance companies are also involved in reinsurance activities through which they transfers either complete or a part of its risk to another insurance company under an insurance contract.
- Legal and Regulatory Issues: Insurance companies have lawyers who are involved in various legal activities like drafting insurance contracts, interpreting provision of contracts at the time of presenting claims, defending the insurance company in lawsuits, communication with regulators, etc.
- Claims adjustment activities: This includes activities related to providing payment to insured customers on losses.
These are the channels of insurance companies.
- Websites: Insurance companies have websites that display information related to their products, services, and other activities. The website of the insurance company provides an online medium for making online payment of premium, getting insurance proof, filing a claim and to monitor its progress, etc. It includes detail of various policies that an insurance company offers to its customers along with specific provisions.
- Mobile App: Insurance companies also have a mobile app using which customers can access the information related to their policy, file a claim, and can track their progress, etc.
- Parent company or Banks: Few of the Insurance companies have their own banks as a parent channel for initiating insurance activities like HDFC Life Insurance has its parent company i.e. HDFC Bank.
- Individual agents and brokers: Insurance companies sell and promote various insurance products and services through the channel network of brokers and agents. For this, insurance companies provide a commission to them.
- Branches: Insurance companies have different branches at different locations of the country which acts as a channel for insurance business activities. These branches also sell and promote insurance products directly other than brokers or agents.
- Social media: Social media like Facebook, Linkedin, Twitter, Whatsapp, etc. are also key channels of Insurance companies where they advertise and promote their products and services to generate sales.
- Call centres: Various insurance companies take services of call centers of BPOs for selling and promoting their insurance products.
G) Customer Relationship
The insurance companies offer the following customer services.
- Insurance companies provide a wide range of services to its customers for superior customer relations. Through the online portal or websites of these companies, customers can manage various activities like bill payments, account information, access of resources, and claim submission directly without any hassle of interacting with sales or service representatives.
- Insurance companies offer continuous support to customers by providing various online resources such as answering FAQs (frequently asked questions) and guides, direct customer support assistance through the dedicated support and service staff of the insurance companies to provide guidance and resolve queries via email or over the phone call.
H) Revenue Streams
The main resource of revenue/income of Insurance companies (including life insurance) is the premium paid by people who have purchased insurance. These premiums can be lump-sum i.e. all payment at once or in instalments or regular intervals i.e. monthly, quarterly, annually, etc.
Other than charging premiums for insurance coverage, insurance companies also reinvest these premium amounts in other assets that generate interest income.
I) Cost structure and Competitor Review
Different costs that revenue of Insurance Company (including Life Insurance Company) covers are as under:
- Losses and loss-related adjustment expenses: A life insurance company keeps a portion of its reserves for unpredictable future losses, investigation cost, and loss adjustment costs. These reserves are kept by estimating the losses an insurance company may experience in the future. Loss adjustment cost or expense is the cost bore by the insurance company during the settlement of claims. So, they have claim representatives who investigate claimed losses. As the company has to pay them for the services, so these expenses come under loss-related adjustment expenses.
- Acquisition cost: These expenses mainly include marketing-related costs, like advertisements, commissions of insurance agents and brokers, etc.
- Administrative expenses : These are considered fixed costs like office equipment and computers, etc.
- Taxes: Insurance companies are also liable to pay taxes and are considered as expenses.
- Insurance companies compete with risk retention groups, government, and also, self-insurance. The government mostly facilitates insurance cover for risks like floods, earthquakes, etc. States also provide insurance in few places like Employee state insurance (ESI), Worker’s compensation, etc.
- Different RRGs (Risk retention groups) are also competitors of Insurance companies that provide coverage for specific liability risks like malpractice in medical.
- Different large organizations or businesses that self-insure for employee benefits like health coverage; are also considered as competitors of insurance companies.
Revenue Model of Life Insurance Companies
Let’s have a look in detail that how life insurance companies generate revenue:
- Income from Underwriting: Underwriting revenues are those that are derived from subtracting the amount paid out for claims/final settlement from the actual amount that life insurance companies collect through premiums by selling insurance policies. For example, in a particular year, a life insurance company earned revenue of Rs. 1 Crore through premiums by customers for insurance policies. It further paid Rs. 50 Lakh as settlement amount or claims. So, we can say that the profit earned by the company i.e., Rs. 50 Lakh (1 crore-50 lakh) would be underwriting income for that year.
- Income from Investment: Lots of money is being earned by life insurance and general insurance companies through investment income. The premium amount paid by insurance customers is collected and invested in financial markets by insurance companies. Generally, the amount is invested in stocks, bonds, different other businesses, and in other insurance companies as well under few circumstances. So, the residual income generated from investing the premium amount in capital or financial markets is considered as income earned from investment. Life insurance companies prefer to invest the premium amount to gain the advantage of returns rather than keeping the money in idle stage until they receive actual claims for settlement. The insurance companies invest money in both low and high-risk investment mediums, like investing in securities of fixed income at lower risk and investing in equity markets to gain appropriate returns. For example, HDFC Life Insurance has various ULIP (Unit linked insurance plan) investment plans for customers for better returns like HDFC Life Click2 Wealth, HDFC Life Sanchay plus, HDFC Life Sanchay Par Advantage, etc.
- Cancellations of cash value: As life insurance companies invest the premium amount of policyholders, so the customers who have whole life insurance policy demand for the cash values or money that is earned by dividends and investment from the investment plans of life insurance companies. For this, even they also prefer to close or surrender their life insurance policy. This provides an opportunity to earn profit to the insurance companies as all the liabilities of their side ends once the cash value of money is paid to customers. By keeping the entire already paid premium amount, insurance companies provide interest income to customers on their investments and remaining cash they keep with them. So, cash value payouts are considered as a financial windfall for life insurance companies.
- Lapse of coverage: When customers are unable to pay the premium amount or miss the premium payment then it is considered a life insurance policy lapse which is a profitable part for insurance companies. In this scenario, the life insurance companies are not liable to pay any claim or death benefit or give insurance coverage to the insured customer. This is one of the jackpots for insurance companies as they keep the entire previous paid premium.
- Loss Ratio: Insurance companies use different statistical tools to take an estimate of the final claim ratio for a specific year. This ratio is termed as loss ratio which includes both reserved, paid total losses, and all operating expenses. For example, let’s say Rs. 60 is paid by a life insurance company in settlement of claims against the collected premium of every Rs. 100; the loss ratio is 60% and the profit ratio is 40%. This 40% profit ratio is included in some expenses i.e. operating costs of the company and the rest part of it will be considered as the net profit of the insurance company.
- Premium loading: Life insurance companies also make a profit or extra income through premium loading. Some Insurance policyholders are considered as high-risk customers like customers into risky work i.e. Army, Pilot, Air Force, etc. or people suffering from critical diseases or chain smokers or drinkers, etc. In such cases, insurance companies may raise the premium for policyholders, and this increased premium is considered as premium loading.
Insurance plays a significant role in the economy of India and other countries. It supports the economic activities of the country by assisting people and businesses to cope with their risks. The business model of insurance companies facilitates organizations to focus on their business functions and effective utilization of resources. Insurers earn revenue mainly through underwriting income and investment income. Most of the assets of insurance companies are financial investments, mainly listed shares, government bonds, commercial property, and corporate bonds.
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What is the Main Business Model of Insurance Companies?
June 9, 2023 | By Hitesh Bhasin | Filed Under: Business
The business model of Insurance Companies channelizes through revenue generation by putting money on risk. They bet on the risk that their policyholders will not die, or their vehicles will not entirely smash, or their property will not get scorched. All in all, Insurance Companies Business Model works around pooling risk from a payer and then redistributing that risk across a broader portfolio.
In this, the insurance company agrees to pay a specific amount of the money for the loss (mainly because of illness, damage, or death) of the assets faced by the insured individual.
In the process, they make money by charging premiums for offering insurance coverage and reinvesting those premium-amounts in many other assets that generate interest.
The process of making money varies from health insurance companies to property guarantors to property insurance companies. In this post, we will dive deep into the business model of insurance companies and try to understand how they channelize their business and make money. So, let us get started right away-
Table of Contents
Introduction to the Business Model of Insurance Companies
Insurance is not a novel concept. It has been in the commerce business for years and centuries. Insurance is a way to secure yourself or your belongings.
The company with which you have insurance takes up the responsibility of providing the compensatory amount in any damage or loss to the insured subject.
One has to deposit a specific amount in predefined intervals of time. It is called the premium. The company keeps this amount with itself, and if there is any loss of life or property, it compensates it using that money.
Major Types of Insurances offered by Insurance Company Business Model
There are several objects and subjects which can be insured. The most important types of insurances are those who are very popular and subscribed to by many people. These are of those things which are widely used or are of the utmost importance.
1. Life Insurance
What could be more important than life? Nothing is more important in life than life itself. Hence, life insurance is the most popular type of insurance. People have responsibilities for their respective families and near and dear ones.
That is why they beneficially ensure their lives to those who are left behind after their demise. The premium for this is determined according to the health condition and medical history of the person.
2. Health Insurance
Many incidents are unforeseen and come as jolts in life. Such are the health catastrophes and medical emergencies.
If a person falls ill and needs a medical procedure to be done, he/she can claim this insurance and get that reimbursed.
The bills of the procedures are paid by the insurance company using the customer’s money as the installments of the premium.
3. Auto insurance
Afterlife and illnesses, the object which is at high risk of damage is auto. One uses automobiles and vehicles almost every single day.
They get worn out easily. Hence, one needs to ensure the vehicle. It makes that if the car breaks down someday or faces an accident, the insurance company will pay for its repair.
The data like how often the vehicle will need servicing, what are the specifications of the car and what is its average performance need to be considered here before determining the premium.
How Do Insurance Companies Make Money?
Since running an insurance company is a business, everyone looks for profits. The business model for an insurance company is very different from that of other business models.
There are two basic ways of making money for insurance companies.
1. Underwriting income
This type of income is a difference in the amount of money collected as premiums from various customers and the amount of money paid to reimburse the claims. If the total amount of dividends is more than the claims reimbursed, the company has a profit.
It requires the mathematics of the business model to be accurate. If the financial adjustments are made correctly, the company will get profits; otherwise, it will have to bear losses. Here, the total amount of premiums collected is very crucial.
The premiums should be determined based on factors like the age of the person, medical history, and other physical measurements in life and health insurance and the performance and maintenance required.
The claims that are to be reimbursed depending on various factors which are known to the client.
2. Investment income
The insurance companies do not need hard cash to invest in building the company. They take money from their clients and then invest that money in other markets and businesses.
The profits gained from these investments form a source of income for the insurance companies. These companies prefer to invest in a low-risk sector where they will get certain benefits.
This means income is called investment income. It contributes mainly to the development and profitability of an insurance company.
3. Coverage lapses
If the client outlives the period for which he/she was insured or did not need to claim any reimbursement, it is called a coverage lapse. These coverage lapses work in favor of the insurer.
If the client goes on for some time without paying the premium, the policy gets inactive, and the insurer can benefit from it.
If the policy expires without any claims being made on it, the insurer gets financial profits. It is a huge source of income for insurance companies.
4. Cash value cancellations
If a client wants to take all the money back before the policy ends, this situation is beneficial to the insurers. In this case, the cash value cancellations take place.
The insurance company gives only that amount back, which is the interest they have earned on the investment made from the premium they have taken from the client.
The premiums that the client has paid stay with the insurer giving them scope for financial profits.
Benefits to Insurance Companies
Insurance companies have a lot of benefits other than financial profits. These benefits work in favor of the company and help them achieve the desired targets .
1. Reduce risks by increasing automation
Automation has paved the way for great results by reducing human intervention and human errors in many processes.
Automation has conquered the arena of insurance companies as well. Robots and technology have replaced humans. The use of SaaS (Software as a Service) has helped this industry rise to great heights.
2. Easy access to user information
The information of users and clients can be used in many forms and for many purposes. This information can fuel other businesses where this information can prove to be helpful.
It proves to be beneficial for insurance companies who would want to venture out in other business avenues.
Final Thoughts !
The business models of insurance companies are unique to every company based on various factors that ensure they do not suffer losses and always enjoy humungous profits.
As per the industry data, only 3% of consumers who pay their insurance premiums every year make a claim. So, Insurance Companies Business Model is destined to make significant profits.
They take all the premium payments and invest them continuously to multiply their profit margins.
On the concluding note, it can be said the profit-favoring meter is always going to be tilted towards the insurance companies.
What kind of insurance policies do you have?
Did this post change your perceptions about your insurance policies after knowing the revenue generation potential of the business model of insurance companies?
Liked this post? Check out the complete series on Business Models
About Hitesh Bhasin
Hitesh Bhasin is the CEO of Marketing91 and has over a decade of experience in the marketing field. He is an accomplished author of thousands of insightful articles, including in-depth analyses of brands and companies. Holding an MBA in Marketing, Hitesh manages several offline ventures, where he applies all the concepts of Marketing that he writes about.
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I wanted to see if the business model for preneed insurance companies are similar to that of insurance companies for other than preneed policies. Could you answer my question? Thank you.
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How Do Insurance Companies Make Money?
The insurance company revenue model revolves around a claimant receiving compensation in the event of an accident, illness, death, or damage to an asset resulting from theft or a natural disaster. In return for continual insurance cover, the company charges a regular fee – otherwise known as a premium. In essence, insurance companies make money by carefully considering the risk of each policy. They bet that the holder will continue to pay for insurance coverage and never be required to make a claim.
Table of Contents
Insurance company revenue generation
Most insurance companies make money via underwriting, investment income , and reinsurance.
Underwriting revenue can simply be defined as the money that is left over after the company subtracts the cash paid out in insurance claims from the cash collected via premiums.
Consider the example of a fictitious car insurance company that earned $15 million from insurance premiums in one financial year while paying out $9 million in claims over the same period. This means the company earned a profit of $6 million on its underwriting revenue .
Insurance companies devote a lot of resources to ensuring they make a profit from underwriting revenue . Applicants are vetted on a range of criteria including gender, age, medical history, claim history, and credit history. Whatever the criteria evaluated, remember that the company assesses each applicant according to the risk of them making a future claim.
If the risk level determined by an algorithm is too high, the company may raise the price of the premium or avoid doing business with the applicant altogether.
If we return the previous example of the car insurance company with $6 million in underwriting profit , one could make the argument that the cash would be underutilized sitting in the company’s bank account.
To maximize returns, insurance companies invest their profits in the financial markets. They tend to have more money to invest than companies in other industries since none has to be spent creating or manufacturing physical products. Common investments include corporate bonds, treasury bonds, and interest-bearing cash equivalents.
Some companies also sell reinsurance to other insurers. These insurers purchase reinsurance to protect themselves from excessive losses in situations where they are overly exposed to an event that could lead to insolvency.
For example, a company may run into financial difficulty if a severe hurricane causes widespread damage to infrastructure and a subsequent increase in claims over a short period of time. Indeed, reinsurance is a lucrative industry , with climate change and COVID-19 related drivers expected to grow the global reinsurance market to around $556 billion by 2025 .
- Insurance companies make money by analyzing the risk of an individual policy. Generally speaking, they bet that the policyholder will continue to pay for insurance coverage and never be required to make a claim.
- Insurance companies make a profit by collecting more in insurance premiums than they pay out in insurance claims. Strict criteria are used to determine the risk of each applicant making a claim in the future, with high-risk applicants subject to higher premiums or refused cover.
- To maximize revenue , insurance companies invest their underwriting profit in more conservative investments such as bonds and cash equivalents. Some also sell reinsurance to other insurance companies to protect them against insolvency.
Key Highlights about the Insurance Company Revenue Model:
- Revenue Generation : Insurance companies generate revenue by providing compensation to policyholders in the event of accidents, illnesses, deaths, or damages. They charge premiums in return for insurance coverage.
- Premiums and Underwriting : Premiums are the regular fees charged to policyholders. Underwriting revenue is the profit earned by subtracting claim payouts from premium collections.
- Risk Assessment : Insurance companies carefully assess the risk associated with each policyholder. Factors like age, medical history, claim history, and credit history are evaluated to determine the likelihood of future claims.
- Risk Management : High-risk applicants might face higher premiums or be denied coverage altogether to manage potential future claims.
- Investment Income : Insurance companies invest their profits in financial markets to maximize returns. Their significant capital allows for substantial investments in assets like corporate bonds, treasury bonds, and cash equivalents.
- Reinsurance : Some insurance companies also engage in reinsurance, where they sell coverage to other insurers. Reinsurance protects insurers from excessive losses in situations where they face a surge of claims that could lead to financial trouble.
- Example : For instance, if a car insurance company earned $15 million in premiums and paid out $9 million in claims, they would have $6 million in underwriting profit .
- Investment Strategy : Due to not needing to manufacture physical products, insurance companies often have substantial funds available for investment in the financial markets.
- Reinsurance Importance : Reinsurance helps insurance companies manage large-scale risks, such as those arising from catastrophic events like hurricanes, by spreading the risk across multiple entities.
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Powering new business models for life insurers through digital transformation
A life insurance buying spree fueled by the COVID-19 pandemic has ended, with sales activity falling back nearly to pre-pandemic levels, according to new data from two industry research firms. Applications for life insurance policies fell 6.5% year to date through mid-August, compared with the same period in 2021.
In light of these events, life insurers are taking a fresh look at new avenues for powering growth and exploring new business models — what if life insurers, which typically rely on intermediaries and agents for their distribution, established a direct relationship with the end consumer to acquire them? In an industry that doesn’t provide much opportunity for interactions with customers, what if they found a route to increased customer engagement that identified new ways of helping the customer and driving brand loyalty? And finally, how can they keep up with evolving expectations of millennials around when and where to engage, a cohort where only 34% own a life insurance policy?
While facing these challenges and opportunities, life insurers are embracing digital transformation initiatives as a critical enabler to power this next wave of growth. McKinsey has estimated that a 50% uplift in digitally enabled sales through investments in best–in-class digital marketing capabilities.
The Digital Strategy Group at Adobe, a team that partners with customers on their customer experience strategy to achieve their business goals, has identified three key themes to assess digital maturity and execution readiness.
1. Enhancing customer engagement and interaction data — shift from traditional products to holistic solutions and value-added services
Traditionally, insurers interacted with customers only sporadically, at the policy purchasing, policy renewal, and claim filing stages. Advisors have relatively few touchpoints with their clients — perhaps only once a year during an annual policy review. Expanding into wellness and goal-based planning or financial wellness as value-added services allows carriers to enhance customer interaction points, gather associated data, and build a data-based understanding of their needs.
For example, John Hancock Vitality, a life insurance program taps into a network of partners to reward healthy habits and offer wellness tools and resources. This lets them engage with customers on a regular basis, which can be especially key in times of crisis, like the pandemic, because it allows for a deeper understanding of the challenges customers face and how the company can alleviate them. The information collected makes it easier to direct Vitality customers toward traditional John Hancock products, such as retirement plans.
2. D2C acquisition at scale — achieve high growth and build simple products
The second challenge the industry is solving for is the issue of intermediaries between the carrier issuing the policy and the policyholder or customer. Carriers such as MetLife and Prudential are embarking on building this direct relationship with the customer through paid media or affinity partners to supplement their existing distribution network.
The starting point here is high growth, high margin, and simple products that can be sold end-to-end digitally. MetLife is focusing on pet insurance (acquired), which is expected to grow at double-digit rates CAGR compared to just 3–4% for traditional insurance products. Over time, by bringing together their customer profiles from this D2C distribution channel with profiles from traditional lines of business, MetLife can enhance their understanding of each customer’s product preferences, budget, spending habits, and more. Ultimately, this can translate into higher precision and tailored outreach around each individual’s needs.
3. Activating personalization — deliver omnichannel advice during moments that matter
Finally, when carriers develop holistic offerings and a direct relationship with the customer, they can deliver greater personalization and identify key moments that matter for their policyholders across multiple channels. Identifying and acting on these key moments requires an ability to capture “intent” data and stitch pseudonymous identities for event-based triggers. Being able to offer products to prospects or customers at key life moments has been shown to have the highest correlation with increasing sales and driving cross-sell, upsell, and retention by reinforcing the product value proposition aligned to the customer intent and need.
For example, Prudential is looking to deliver an omnichannel advisor experience for their team of 3,000 advisors who switch seamlessly among physical, digital, and hybrid channels — engaging with customers when and where they choose to be engaged. The digital experience is delivered as part of their assurance IQ platform (acquisition).
These are the key questions to think about:
- How can carriers identify the most valuable products and offerings for prospects? Are they able to generate insights based on their life stage and interests?
- How can carriers cross-sell into their existing large customer bases across their distribution channels? Is there a single view of the customer across their individual and institutional lines of business or do data siloes need to be stitched together?
- What capabilities must carriers add to develop the most promising broker and intermediary relationships?
- How can carriers enable a seamless hybrid experience to meet the customer when and where they would like to engage, switching between digital and advisor channels?
- How can carriers surface the next best action to increase advisor interaction with customers at key moments?
- How can carriers analyze their marketing campaigns performance across channels? Can the teams be more efficient to deliver campaigns to market at speed ?
Case study — transforming the customer experience at a global carrier with digital capabilities
The journey is different for each carrier. But focusing on building out a common set of foundational digital marketing capabilities will be crucial to any life insurer that wants to consider these extensions to their value propositions.
A large global carrier undertook a similar transformation and decided to pilot an initial set of MVP capabilities to accelerate growth for its retail advisory business by offering retirement solutions over a digital hybrid platform. The goal is to engage with customers on ideal retirement lifestyle with advice on how to manage money, benefits, and protection most efficiently. This life-stage focused solution requires digital capabilities around being able to identify and segment customer personas around their demographics and lifestyle needs, and then being able to personalize their initial experience on the landing page, based on their segmentation.
A/B testing for different audience segments led to higher performance of their digital sales channels. Further, personalizing offerings and home page experience based on life stage led to higher quality leads being qualified for advisor outreach. With a customer data platform (CDP), the carrier can identify their prospects needs based on first- and third-party behavioral signals and orchestrate a personalized journey with advisor touchpoints for them.
For example, if a customer navigates the site and is interested in inflation (first-party data) or their income has changed (third-party data) a message is triggered to the advisor around how messaging needs to be “inflation-friendly” and how to protect their retirement in a down year. AI-powered automation of leads allowed them to activate seven customer nurture flows that nudge customers to interact with advisors for retirement planning.
To learn more about how Adobe is helping life insurers and other organizations in the financial services and insurance industry, check out our industry solutions page .
Suhas brings extensive experience driving digital transformation, both as an external advisor to industry executives and as an operator in corporate environments — particularly in insurance. Most recently, he was at MetLife, leading global digital strategy and transformation teams, under the mandate of the chief digital officer. Prior to that, Suhas spent seven years at EY, advising global financial services clients.
Can Etili also contributed to this article.
- How Do Life Insurance Companies Make Money?
- Life Insurance Guide Updated For 2023
If you are shopping for life insurance, it might have crossed your mind how do insurance companies make their money? After all, you are paying premiums every month for coverage, so where does that money go?
Although life insurance companies provide a valuable service, they are still businesses. And like any business, their ultimate goal is to make a profit.
In this article, we will discuss how life insurance works and answer the question of how life insurance companies earn their money.
How Life Insurance Works
Before we get into how insurance companies make their money, you should first understand how life insurance works.
When you purchase a life insurance policy, you essentially enter into a contract with the insurance company. You pay premiums typically on a monthly basis, and the insurer agrees to pay a death benefit to your designated beneficiaries if you die while the policy is in force.
The payout your beneficiaries receive can be used for any purpose, including final expenses like outstanding debts and funeral costs , but also to help with other financial needs, like replacing your lost income.
There are two main types of life insurance policy – term life insurance and whole life insurance. Term life insurance provides protection for a predetermined length of time. In contrast, whole life insurance covers you for the entirety of your life. The benefit is paid out whenever you die, regardless of when.
Another option is over 50’s life insurance , which doesn’t require a medical examination and is geared towards people in, you guessed it, their fifties or older.
Now that you know how life insurance works, let’s look at how insurance companies make their money.
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The Business Models of Life Insurance Companies
The life insurance business model is based on risk assessment. Insurance companies use actuarial science to calculate the likelihood that an insured event will occur and determine the premium that should be charged to make a profit while still providing coverage. They then make strategic investments to maximise profits.
The key components of the life insurance business model are underwriting, policyholder behaviour, and investment income:
- Underwriting – is the process of determining whether or not to offer coverage and, if so, at what price.
- The actions of the insurance policyholder – refer to how often people file claims and how long they stay with the company.
- Investment income – is the return the company earns on its investments. Together, these are the primary factors determining how profitable the life insurance business model can be.
Life insurance underwriting is the process of assessing an individual’s risk to determine the coverage rate. The underwriter will consider factors such as age, health, lifestyle, and occupation to make a decision.
From Statistica’s 2021 UK mortality rates (per 1,000 people), this is how age affects your probability of dying.
How life insurance companies calculate your premium is based on the figures below and other factors
In some cases, a medical exam may be required to get an accurate picture of the applicant’s health. The underwriter will also review the applicant’s medical history and any family history of illnesses or conditions that could impact life expectancy.
These factors will determine your mortality risk, which is the risk of dying during the policy’s coverage period. The higher your mortality risk, the higher your premium will be.
For example, a heavy smoker may be charged a higher premium than someone who doesn’t smoke, as they are more likely to develop smoking-related health problems.
Or an obese person may be charged a higher premium than someone of average weight, as they are more likely to develop obesity-related health problems.
This ensures that premiums remain fair for all policyholders and mitigate risk for the insurance company. As a business, the insurance company wants to ensure that it doesn’t lose money by paying out more claims than it takes from premiums.
This is where actuarial science comes in – underwriters will use data and statistics to help them assess risk. It can be a complex process, but ultimately it boils down to ensuring people are paying the right price for their coverage.
Excellent underwriting is the key to a profitable life insurance company. If an insurance provider can accurately assess the risk of insuring an individual, they are more likely to profit from the policy.
Multiply this by thousands or even millions of policies, and it’s easy to see how lucrative the life insurance business can be.
The Actions of The Insurance Policyholder
Another important factor in the life insurance business model is policyholder behaviour. This refers to how often people file claims and how long they stay with the company.
Life insurance companies make money when policyholders pay their premiums and don’t file claims. Frequent claims will increase the company’s operating costs and can cut into profits. The companies model their premiums based on the expectation that most policyholders will not file a claim.
Insurance holders who allow their policies to lapse can also generate profits for insurance companies. They might have been paying premiums for years without ever making a claim, but as soon as they stop paying, the policy is no longer active.
While a high number of customers paying premiums is ideal, lapsed life insurance policies mean that money has been paid into the pot that will never be used to pay out claims. Essentially free money for the life insurance company.
Similarly, term policies usually end without any claims being made. This is because people often outlive the terms of their policies. A couple might take out a term policy for 10-20 years when their children are young.
But by the time the policy expires, the kids are grown and gone, and the couple is no longer in need of life insurance. The money they’ve paid into the policy over the years is pure profit for the life insurance company.
However, unless the customer takes out another policy, this is still lost future revenue for the insurance provider and can no longer be invested to generate returns.
Although insurance providers might generate revenues directly from premiums, the income they make by investing the money they receive in premiums is typically far greater. While a certain amount is set aside to cover claims and operational costs, most premiums are invested.
Life insurance companies often have extensive diversified portfolios across many different asset classes, which helps mitigate risk and protect against losses in any area. Investment income can come from a variety of sources, including stocks, bonds, real estate, and even private equity or hedge funds.
They will also earn dividends and interest from their investments, which can add to a significant amount of money over time.
Life insurance providers are conservative with their investments since they need to maintain a high level of safety and security for policyholders.
For this reason, life insurance companies typically invest in relatively safe and stable instruments. They have excellent in-house investment teams or work with external money managers to get the best returns possible without taking on too much risk.
The bottom line is that life insurance companies follow the route of many other successful businesses; they sell a service for more than it costs to provide that service. They make their money by investing in the premiums they collect and carefully underwriting the risks they take.
Life insurance companies play an important role in society by providing a safety net for families in the event of an unexpected death. And while they do make a profit, they also provide a vital service.
If you are looking for affordable life insurance, get a free, no-obligation quote from Insurance Hero today. We work with the top providers in the UK to get you the coverage you need at the best price.
Do life insurance companies make money avoiding payouts?
No, insurance companies are not in the business of avoiding payouts. On the contrary, the ABI ( Association of British Insurers ) published statistics that show that 98% of all claims were settled in 2020. The reasons for the other 2% are usually due to non-disclosure, missed payments or terms and conditions not being met.
What happens if my life insurance provider goes bankrupt?
A life insurance company filing for bankruptcy is very uncommon. In fact, the last case was during the financial crisis of 2008. Usually, if a life insurance company becomes insolvent, there are two outcomes. Another life insurance company takes them over. This way, the policyholders don’t have to worry about their coverage.
The other is that the policyholders are refunded. In the UK, the Financial Services Compensation Scheme (FSCS) protects consumers if a life insurance company goes bust. This includes compensation of up to £85,000 per person.
So while it’s never good news when a life insurance company goes bust, there are some safety nets in place to protect consumers. And if you’re worried about your own policy, you can check to see if your insurer is registered with the FSCS.
How much do life insurance companies make?
The life insurance industry is very profitable. According to Statistica, in 2019, the UK life insurance sector had written over 175 billion pounds in gross life insurance premiums. The biggest provider in the UK is Aviva , which in 2021 had an adjusted operating profit of around £2.3 billion.
Mark joined the Insurance Hero team after working in financial services for over 12 years. He brings considerable experience in giving his clients comprehensive, bespoke personal assistance, making him a valuable asset to our team. His main area of expertise is impaired life cover, where people are often seen as higher risk and therefore more challenging to insure. About the author
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How do Insurance Companies make money? Understanding their Business Model
Insurance companies operate on a business model involving a contract/agreement between the insurer (insurance company) and the insured (policyholder/customer) , wherein the former agrees to compensate the insured for any damage or loss he/she suffers on a specific asset (home, car, etc.) or on his/her life (life or term insurance ) .
This guaranteed compensation is ‘ bought ’ by the insured, by paying the insurance company a fixed amount known as the premium (renewal premium rate can change) . Policyholders have to pay premiums for their purchased policy at regular intervals, so that insurers can assume the financial responsibility to make good the losses or damages suffered by policyholders.
The income of insurance companies comes from the premiums paid by the insured. These premiums can be paid at one go that is in case of single premium policies or paid at regular intervals – monthly, quarterly, bi-annually or annually.
Business Model of Insurance Companies
Like other businesses, insurance companies also thrive on a profit, which in the particular case of insurance can be classified as follows:
1) Underwriting income : This income is earned from the difference between the amount of money the insurance company collects for all policies sold (premium) and how much they pay out in case a claim arises (final settlement) from those policies in any given time frame.
For Instance : Over a Year an insurance company collects Rs 1 Crore in revenue from premium of policies issued & the amount spent for settling claims is say Rs 50 Lakh then the underwriting income for that year is Rs 50 lakh.
2) Investment income : The premium money collected by insurance companies from policyholders is usually invested in bonds, stocks, other businesses, sometimes even in other insurance companies. Investing premium in capital markets generates a residual income which is known as investment income.
An insurance company invests the premiums to ensure that some returns are earned on the money instead of letting it sit idle, until a claim actually comes forth and has to be settled. Overall, most insurance companies have a well-diversified portfolio. They invest money their money in fixed Income securities at lower risk & also invest in equity markets at high risk to generate significant returns.
What is loss ratio?
Using various statistical tools, insurance companies can get an estimate of the ultimate claim ratio for a particular year. This ratio, referred to as the loss ratio, is the ratio of total losses (reserved and paid) incurred in claims, plus all adjustment expenses – this final sum is then divided by the grand total of all premiums earned.
For instance: If an insurance company pays Rs 60 in a claim for every Rs 100 collected as premium, the loss ratio amounts to 60% and the gross margin/profit ratio is 40%. Some part of this 40% will cover expenses incurred by the company towards its operating costs, while the rest of it will be the company’s net profit.
( Read : ‘ Best Health Insurance Cos & Latest Incurred Claims Ratio 2015 ‘)
Fixing insurance contract price and premium amount
Based on the above principle, an insurance contract’s price as well as the premium to be paid by the insured can be evaluated. While working out the contract cost and premium, the insurance company takes into account all estimated possible losses, along with the estimated management, distribution, commissions and various other costs, over and above which, a minimum margin of 2 to 5% is kept. The premium amount to a specific risk is calculated using certain statistical tools.
At the end of the year, the insurance company sets aside a certain amount to cover anticipated losses, claims and also keeps some amount as margin (more than the estimate) into an accounting reserve. Later, actual payouts are compared with the original evaluations and the account reserve is accordingly adjusted higher or lower.
Some customers may hold risky jobs (Air Force, Army, Pilot, etc.) , some may be smokers and/or drinkers, others may be obese, while some others may be suffering from pre-existing diseases. All these customers are considered ‘ high risk ’ customers for an insurance company, in case of which, the company may increase the premium for these customers. This is called ‘loading’ the premium.
Are policyholders actually paid at the time of a claim?
Genuine cases with all necessary documentation, proof and other paperwork in place definitely get paid the due amount at the time of a claim. The insurance business is based on volume. A few individuals making claims will not translate to losses for the insurance company, because claims being made are already factored in while calculating overall costs/losses. Just like a few people claim, thousands of others do not file a claim but continue paying their premiums, which collectively get carried forward and re-invested year-on-year, helping create a more-than-sufficient buffer.
How different categories of insurance companies fix premiums
Life insurance: Life insurance companies are aware about the average life span of people. If a huge number of people pay their premiums for at least a few years, the funds collected will be sufficient to cover those who actually file a claim.
Health insurance: Health insurance companies have all the necessary information about:
- The probability of people in a certain age bracket falling ill or getting hospitalized in a certain number of years.
- Present hospital charges.
- What future medical inflation is likely to be and what effect it will have on medical treatment, hospital costs, etc.
- All other related expenses.
Health insurance companies price their policies in line with the above information. While health insurance companies offer policies that benefit their clients, it is also true that they factor in their profits as well and ensure they do not make any losses.
Auto insurance: These companies are equipped with data that helps them understand that if a car is a certain number of years old, then how will it perform, what is the wear and tear, what is the likelihood of the car getting into an accident or being damaged, etc. Accordingly, companies decide the premium to make their business profitable.
Credit Card insurance: Insuring credit cards is also a kind of insurance business. These companies are aware about how many credit cards out of 100 are lost and what is the loss therein. Bearing this in mind, the insurance company fixes the premium so they are able to make profits.
This is a guest post by Tarun of Policybazaar.com.
About the Author:
He has over 15 years of experience in sales, analytics and project management and has worked in companies such as eBookers PLC and Hero ITES, bringing in his expertise to the table at PolicyBazaar.com. When not working, he loves reading and watching superheroes movies.
Kindly note that Relakhs.com is not associated with Policybazaar. This post is for information purposes only. This is a guest post and NOT a sponsored one. We have not received any monetary benefit for publishing this article.
(Image courtesy of fantasista at FreeDigitalPhotos.net) (Post Published on : 08-July-2016)
About The Author
IRDA has made Benefit Illustration Statement mandatory before logging in New Insurance Policy. But it is very difficult to read through the numbers. Please guide as to how to read it.
For example, I have one ULIP policy which I bought it for 20 years. According to 4% assumed growth rate, IRR works out to be merely 1.35% and at 8% assumed growth rate it works out to be 5.91%. So is the difference between assumed growth rate and IRR is cost of the plan? In this case it would be 2.65% and 2.09% respectively. Please guide.
Although, I could roughly be able to calculate Policy Allocation Charges, Policy Administration Charges, Mortality charges and Fund Management Charges. But IRR excluding Mortality Charges is 6.69%. Now if Fund Management Charges itself are 1.35% (excluding service tax), how could IRR be 6.69%? This is very confusing.
In case of traditional plan, IRR works out to be much lower at 4.98% at 8% assumed rate. So is the cost of this plan is 3.02%? Further there was not mention of other costs which were shown in ULIP Illustration statement.
Please guide as it is very confusing
Dear Rupali, Could you please share the illustration, will go through it and try answering your queries.
Please provide your mail id so that I can attach illustrations.
Dear Rupali ..Kindly reach me through ‘ contact ‘ page.
Sree, Which car insurance is better for any car?? Please suggest. My first insurance is near to expire at the end of August 16. Which type of car insurance & of which company’s will be better for me?? Thanks.
Dear soudagar, Suggest you to kindly compare the options by visiting online portals like coverfox.com / turtlemint.com etc.,
ReLakhs.com is a blog on personal finances. The main aim of this blog is to help you make INFORMED financial decisions by presenting the content on money matters in a simple, unbiased and easy to understand manner.
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- March 31, 2023
Explaining the LIC Business Model. How does LIC make money?
In today’s blog post, we explain the lic business model using the business model canvas and learn about how lic makes money..
Life Insurance Corporation of India (LIC) is a state-owned insurance and investment corporation founded in 1956. It is the largest insurance company in India, with a market share of over 70%. LIC’s immense success is attributed to its sound business model, which we will explore in this blog post using Alexander Osterwalder’s Business Model Canvas.
In this post, we will delve into the inception of LIC, introduce its founders, and trace the story of how and why the company was started. We will then use the Business Model Canvas to analyze LIC’s business model, discussing each of its nine building blocks, and provide relevant examples to showcase the company’s operations.
Life Insurance Corporation of India (LIC) was established on September 1, 1956, when the Indian government passed the Life Insurance of India Act. The Act led to the nationalization of 245 Indian and foreign insurers and provident societies, which were then merged to create LIC.
The goal of LIC’s formation was to ensure that the Indian population had access to affordable and comprehensive insurance coverage while also mobilizing funds for the country’s economic development. The company aimed to make insurance accessible to all, regardless of social or economic status, by offering a wide range of insurance products and services.
The Founders of LIC
The founding members of LIC were a group of distinguished individuals from various backgrounds, including the public sector, insurance, and finance. They shared a common goal of providing accessible insurance to the people of India and ensuring its long-term success.
Some notable founding members include:
- A. D. Shroff: An eminent economist and one of the architects of India’s industrial planning
- H. T. Parekh: A pioneer in housing finance and the founder of the Housing Development Finance Corporation (HDFC)
- V. K. R. V. Rao: An Indian economist and educationist who played a significant role in establishing several educational and research institutions in India
The LIC Story
The story of LIC began in the early years of independent India when the government recognized the need for a comprehensive and accessible insurance sector. Before LIC’s establishment, the Indian insurance market was fragmented, with multiple small and foreign insurance companies operating in the country.
The Indian government was concerned about the lack of regulation in the insurance sector and the potential risks this posed to policyholders. As a result, they decided to nationalize the industry, creating a single, state-owned insurance company – Life Insurance Corporation of India.
LIC was tasked with providing life insurance coverage to the Indian population and mobilizing funds for the country’s economic development. Over the years, LIC has successfully navigated numerous challenges, including competition from private insurers and economic downturns, to remain India’s largest insurer.
Using the Business Model Canvas to Analyze LIC’s Business Model
Now, let’s analyze LIC’s business model using Alexander Osterwalder’s Business Model Canvas, a strategic tool that provides a visual representation of a company’s operations. The Canvas is divided into nine building blocks, which together provide a holistic view of a business’s model.
- Customer Segments
LIC targets a broad range of customer segments, ensuring that its insurance products and services are accessible to a wide audience. These segments include:
- Individuals: LIC offers a variety of life insurance policies, such as term insurance, endowment plans, money-back plans, whole-life policies, and retirement plans, catering to the diverse needs of individual customers.
- Families: LIC provides family protection plans that offer financial security to dependents in case of the policyholder’s untimely death.
- Groups: LIC offers group insurance policies to employers, associations, and other organizations to provide life insurance coverage for their members or employees. These policies can be customized based on the group’s requirements and help attract and retain talent.
- Senior Citizens: LIC has specifically designed plans for senior citizens, such as pension plans and annuities, which ensure financial security during their retirement years.
- Value Propositions
LIC’s value propositions are the key factors that attract and retain customers. These include:
- Trust and Credibility: As a state-owned enterprise, LIC enjoys the trust and credibility that comes with government backing. Customers perceive LIC as a reliable and stable insurer, which is essential in the insurance sector.
- Wide Range of Products: LIC offers a comprehensive range of life insurance products, catering to the diverse needs of its customer segments. This variety allows customers to find a policy that suits their specific requirements.
- Extensive Distribution Network: LIC has an extensive distribution network, with over 1.2 million agents and 2,048 branches across India. This wide reach ensures that LIC’s products are easily accessible to customers.
- Customer Service: LIC is committed to providing excellent customer service, with dedicated customer support centers and grievance redressal mechanisms in place. This focus on customer satisfaction helps build long-term relationships with policyholders.
LIC employs multiple channels to distribute its products and services to its target customer segments:
- Agents: LIC’s vast network of individual agents is its primary distribution channel. These agents are responsible for selling LIC policies and providing personalized service to customers.
- Branch Offices: LIC’s branch offices serve as points of contact for customers seeking information about policies or assistance with claims processing.
- Online Sales: LIC also offers the option of purchasing policies online through its website, catering to the growing number of digitally-savvy customers.
- Bancassurance: LIC has partnerships with various banks, which sell its insurance products to their customers, leveraging their existing relationships and expanding LIC’s reach.
- Customer Relationships
LIC’s customer relationships are built on trust, personalization, and long-term engagement:
- Personal Assistance: LIC agents provide personalized assistance to customers, helping them select the most suitable policies and guiding them through the claims process.
- Customer Support: LIC has dedicated customer support centers and helpline numbers to address customer queries and grievances.
- Regular Communication: LIC maintains regular communication with its customers, providing updates on policy performance and sending reminders for premium payments.
- Revenue Streams
LIC generates revenue from the following sources:
- Premium Income: The primary revenue source for LIC is the premium income from life insurance policies.
- Investment Income: LIC invests the premium collected from policyholders in various asset classes, such as government securities, corporate bonds, and equities. The returns from these investments contribute to LIC’s revenue.
- Policy Charges: LIC also earns revenue from various charges associated with its policies, such as policy administration fees, surrender charges, and mortality charges.
- Key Resources
LIC’s key resources include:
- Human Capital: LIC’s workforce, including its agents and employees, is a critical resource that drives sales and provides customer support.
- Brand Reputation: LIC’s strong brand reputation, built over six decades, is a valuable asset that helps attract and retain customers.
- Investment Portfolio: LIC’s investment portfolio is a significant resource that generates income and helps meet policyholder obligations.
- Key Activities
LIC’s key activities revolve around providing life insurance products and services:
- Product Development: LIC continually develops new insurance products to cater to the evolving needs of its customer segments.
- Sales and Marketing: LIC’s sales and marketing activities focus on promoting its products and driving sales through various channels.
- Investment Management: LIC’s investment management activities involve making prudent investment decisions to maximize returns while ensuring the safety of policyholders’ funds.
- Customer Support: LIC’s customer support activities include addressing customer queries, processing claims, and providing post-sales assistance.
- Regulatory Compliance: As an insurance company, LIC must comply with various regulations set by the Insurance Regulatory and Development Authority of India (IRDAI). Compliance activities include meeting solvency requirements, submitting periodic reports, and adhering to guidelines on product pricing and marketing.
- Key Partners
LIC’s key partners include:
- Banks: LIC partners with banks for bancassurance, leveraging their customer base to distribute its insurance products.
- Reinsurers: LIC works with reinsurers to manage risks associated with its insurance portfolio, ensuring financial stability.
- Asset Management Companies (AMCs): LIC collaborates with AMCs to manage its investment portfolio and generate returns.
- Third-Party Administrators (TPAs): LIC partners with TPAs to streamline its claims processing, ensuring faster and more efficient claim settlements.
- Technology Providers: LIC works with technology providers to develop and maintain its IT infrastructure, including online platforms and customer support systems.
- Cost Structure
LIC’s cost structure comprises the following major components:
- Claim Payouts: Claim payouts represent the largest expense for LIC, as the company must fulfill its obligations to policyholders.
- Commissions: Commissions paid to agents and bancassurance partners form a significant part of LIC’s costs.
- Operating Expenses: LIC incurs operating expenses related to the management of its branch offices, customer support centers, and IT infrastructure.
- Employee Salaries: Salaries and benefits for LIC’s employees also contribute to the company’s cost structure.
- Investment Management: LIC incurs costs related to managing its investment portfolio, including fees paid to AMCs and other investment advisors.
Life Insurance Corporation of India (LIC) is a testament to the power of a strong business model, as demonstrated by its lasting success in the Indian insurance market. By analyzing LIC’s operations using Alexander Osterwalder’s Business Model Canvas, we can better understand the key building blocks that have contributed to its impressive market presence.
Through its wide range of products, extensive distribution network, and strong customer relationships, LIC has successfully catered to the diverse insurance needs of the Indian population. The company’s robust investment portfolio and key partnerships have further bolstered its financial stability, ensuring the long-term sustainability of its business model.
As the insurance landscape continues to evolve, LIC’s ability to adapt and innovate will be crucial in maintaining its market leadership. By understanding and learning from LIC’s business model, aspiring entrepreneurs and business professionals can gain valuable insights into the key factors that drive success in the insurance sector.
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Viridium Group acquires life insurance companies and portfolios or enters into service agreements for the management of closed life portfolios. Like any other life insurance company, the life insurance businesses acquired by Viridium operate fully consistent with all regulatory and contractual obligations. The key difference – compared to “conventional” life insurers – is that Viridium’s life insurance companies do not sell new insurance policies. They focus exclusively on the efficient management of their existing life insurance portfolios.
This business model, which is often referred to as “run-off”, is still comparatively new in Germany. Viridium’s approach is based on a simple underlying concept: The sole focus on the operational and financial requirements of existing policyholders enables life insurance policies to be managed much more efficiently.
Viridium’s consolidation platform approach is fully aligned with policyholders’ economic interests, as they benefit directly from the improved efficiencies and the associated lower administrative costs. The relevant regulatory framework, especially the regulation on profit sharing rules (“Mindestzuführungsverordnung” or “MindZV”), ensures in a transparent and reliable way that policyholders participate in the profits generated – including the cost result (as part of the so-called “other result”).
Success factors of the Viridium model
The improved management of life insurance policies is based on a combination of several success factors:
- Exclusive focus on the management of closed life insurance portfolios, combined with reduced complexity in the context of a specialised business model
- Significant investments into the migration of life insurance policies to modern and scalable IT platforms
- Comprehensive optimisation of processes and costs
- An asset management strategy designed to significantly reduce the exposure to market volatility
Having acquired and integrated four life insurance companies since 2014, Viridium benefits from significant economies of scale and in-depth specialist expertise.
Policyholders benefit directly from the Viridium model
Policyholders of Viridium’s life insurance companies benefit directly from Day 1: The costs of administrating the life insurance policies are reduced immediately after the acquisition by Viridium compared to the cost level under prior ownership.
The immediate and permanent cost reduction has as positive impact on the gross surplus of the individual life insurance company. This improves the allocation to the provision for premium refunds (“Rückstellung für Beitragsrückerstattung” or “RfB”) and thus the profit participation of policyholders from Day 1, as the profit sharing rules (MindZV) determine that policyholders participate with at least 50 percent from this profit source.
Another positive effect results from the fact that Viridium focuses exclusively on the requirements of existing policies: Marketing and sales expenses – pertaining to the origination of new life insurance policies but borne by all policyholders of the insurance company via the “other result” – are essentially eliminated within its life insurance companies. The discontinuation of these activities leads, in turn, to an increase in the gross surplus, with existing policyholders again benefiting via the profit sharing rules (MindZV).
Tangible advantages for customers
- Stable recurring returns: The success of Viridium’s efficient closed life management of life insurance companies ensures stable and recurring returns to policyholders, despite the challenging capital market and interest rate environment.
- Significantly higher profits for policyholders: Cost reductions, improvements in the investment portfolio and the stabilisation of the so-called “risk result” achieved in Viridium’s business model lead to higher gross surpluses and, therefore, higher policyholder participation via the profit sharing rules (MindZV). The increase in profit allocation to policyholders – beyond guarantees and allocations to the additional interest reserve (“Zinszusatzreserve”) – are significant:
- Special bonuses for policyholders based on successful modernisations: The execution of modernisation projects allows the release of potentially existing provisions for administrative expenses. For example, Entis Leben was able to meaningfully increase allocations to the provision for premium refunds (RfB) in 2017 and 2018. Additionally, two special bonuses were granted to customers: In 2019, a total of €37 million were credited to policyholders, followed by another €50 million in 2021. On average, policyholders at Entis Leben received an additional credit of more than €1,000 per policy.
- Increased long-term financial stability: The improved profitability and focus on a sustainably strong capital base under Solvency II are important features of Viridium’s business model. All life insurers that are part of the Viridium Group are capitalised above the level that the Federal Financial Supervisory Authority (BaFin) considers necessary for permanently stable operations even for long and sustained crisis scenarios. Viridium’s life insurance companies are financially highly resilient and operationally robust.
- Protection against cost risks: Policyholders are protected against the potential risk of rising costs per policy in a shrinking closed book, as Viridium is providing the servicing of policies at a fixed cost per policy (subject to potential index-based inflation adjustment). The risk of rising administration costs per policy is therefore borne by Viridium and not by policyholders.
- Sustainably improved operating stability : Significant investments into portfolio management systems – including portfolio migrations to modern and scalable IT platforms – and comprehensive process and cost optimisations ensure that the businesses remain stable and viable in the long term.
Low lapse ratios
Lapse ratios, i.e. early surrenders by policyholders, are an important indicator of whether policyholders believe that their policies are safe. Since becoming part of Viridium, lapse ratios have consistently declined across all companies:
The lapse ratios of Viridium’s life insurance companies also declined more than the market average in the period following the ownership change. Across Viridium, the most recent (2020) average lapse ratio of all four life entities stands at 2.4%, which is below the market average of 2.6% (source: Statista / GDV).
Policyholder rights remain unchanged
The acquisition of life insurance portfolios by Viridium – whether through legal entity sale or portfolio transfer – transfers the life insurance policies with all their associated rights and obligations. The rights of policyholders remain unchanged for the entire duration of the contracts, without any need for policyholders to act. Apart from a few exceptions, service contacts, addresses and contact details remain unchanged. Continuity combined with reliability are invaluable assets – for both sides!
Distribution partner terms remain valid
When a life insurance company is acquired by Viridium, generally all relevant agent relationships remain in place. This includes all agreed commissions for distribution partners (commissions for sales, premium increases and portfolio maintenance), which remain unaffected by the acquisition.
Detailed regulatory oversight
To date, Viridium has acquired four life insurance companies following extensive examination by BaFin: Heidelberger Leben, Skandia Leben, the portfolio of Protektor Lebensversicherungs-AG (former portfolio of Mannheimer Leben, today Entis Leben) and Generali Leben (today Proxalto Leben). A key priority for BaFin is to ensure that the rights of policyholders are fully protected and the contracts are permanently fulfilled.
The sale of a life insurance company therefore needs to pass a detailed regulatory review, which is conducted in order to safeguard the interests of policyholders.
For example, in its review of Viridium’s acquisition of Generali Leben, BaFin came to the following conclusion after completing the ownership control procedure (BaFin webpage from 9.4.2019, translated):
“ BaFin has reviewed that, for the planned acquisition of Generali Lebensversicherung AG by Viridium Group, the interests of the policyholders are adequately protected. […] In addition to the financial resources of the acquirer, the technical and operational implementation is particularly important. BaFin must be convinced that the acquirer, among others, has appropriate structures and concepts in place for continuing and developing the company.”*