Almost every responsible working adult longs for a life insurance policy that will allow him or her to have a certain sense of comfort in case something bad happens. Insurance companies can help you feel secure and comfortable for a reasonable monthly fee, depending on your necessities.
From health insurance policies to life insurances or damage insurances, there is an entire industry revolved around companies wanting your money and offering nothing but a sense of security in return. But how do life insurance companies actually make money if they have to pay big policies on the due date?
There are multiple answers to this question and, even though you would be inclined to think they use complicated risk and forecast algorithms and formulas, it is not the case.
Forecasting costs according to age and health
Insurance companies don’t sell their products and services for a fixed cost, but it varies depending on your age, gender or health condition. The costs of having life insurance while you’re in your 20s are significantly lower than what a person who is over 50 years old would have to pay.
The older you are, the more you’ll have to pay to be insured. In some cases, the company may even refuse to insure you because of your health condition or age or because it sees you as a high-risk person.
Also, due to the higher life expectancy of women, some companies even calculate their insurance costs according to gender. So chances are that you will pay up to 10-15% less for your life insurance if you are a woman, simply because you are expected to live longer.
They reinvest your money
Life insurance companies don’t just take your money and put it in a safe deposit for a small interest rate, but they invest it further in stocks or bonds. In fact, only a small amount of money is used as a safe deposit, and the rest of it is invested in the stock market or in other financial mechanisms using premiums that create profitable returns.
Insurance companies act similarly to commercial banks, and this is why some of them end up becoming internationally renowned. Sure, there are also certain financial risks involved in any investment operation, but most insurance companies have enough reserves not to be affected when the stock market does poorly.
Another reason why insurance companies earn money is that they often deal with a phenomenon called “lapsing.”
A lapse means that the policy expires without a death benefit being paid. In other words, a person agrees for a 20-year life insurance and, at the end of those two decades, he or she is still alive. In this case, the insurance company doesn’t have to pay back a single cent to the client, meaning all premiums can be further reinvested.
Lapsing also occurs when people can no longer afford to pay the monthly or annual premiums, and they simply give up on their life insurance. This also means that they won’t end up with any of the money they invested so far and that the insurance company takes it all.
And, let’s face it – many things can go wrong during your life. Important decisions like buying a new house, having a baby or paying for your child’s tuition come with substantial monthly costs that are not sustainable in the long run.
After all, having to pay up to several thousands of dollars per month just for your insurance is a more significant commitment than just investing the money in a bigger TV or a brand new laptop with an optical drive.
In fact, many of these insurance firms rely on clients not being able to finish paying their policies and giving up on their contracts before the due date.
They don’t pay back as much as they earn
The key for an insurance firm to be profitable is always to pay back less than it collects. And this is, in fact, very easy, since not all payees pass away in the same year. Out of all the insurance carriers, only a few will actually have their money claimed by relatives after their death.