Insurance is a way to protect yourself from risk. You pay a premium, and in exchange, the insurance company guarantees that they’ll pay for any covered losses up to your policy limits. But if insurance companies are paying out thousands of dollars in claims, how do they turn a profit?

The answer lies in careful risk assessment and money management. This graphic shows a typical insurance company’s business model:

Infographic depicting the insurance business model in which the customer pays their insurance premium, the insurance company invests some of that premium, the investments earn interest for the insurance company, and the insurance company pays for covered insurance claims for the customer.

In many cases, insurers will work with a trusted third party to obtain new business. Brokers like

Jerry

work with dozens of insurance companies, earning a small commission in exchange for helping bring customers and insurance companies together.

Customer premiums are an insurance company’s primary income

When you purchase an insurance policy, the amount you’re charged is called a premium. You can usually choose between paying your whole premium at the start of each policy term or breaking it up into monthly payments.

You might pay for insurance coverage for years and never need it, or you may have to file a claim for a total loss right after your first premium payment. But regardless of how long you’ve had your policy, if it’s a covered loss, the insurance company will have to pay for it.

Most customers won’t file a claim in any given year—according to the

Insurance Information Institute (III)

, about 5.3% of insured homeowners filed a claim in 2021, for instance.1 Still, insurance claims can be very expensive—those 2021 homeowners claims averaged over $16,000 each.

But insurance companies can’t just charge high premiums to cover their losses and turn a premium. In fact, insurance rates are highly regulated at the state level—insurers are prohibited from setting rates that are unfairly high or unreasonably low.

If an insurer charges rates that are too high, people won’t be able to afford coverage, but if their rates are too low, the insurance company won’t be able to pay valid claims to policyholders.

To protect themselves against big losses, insurance companies use risk assessment to set customers’ premiums.

Underwriters evaluate applicants to determine their premiums

Insurance companies have two departments that help determine rates for applicants:

Actuaries: The actuarial department helps determine insurance rates for different categories of risks

Underwriters: Underwriters evaluate individual applications to determine each person’s risk and assign the appropriate premium

When you apply for insurance, the company uses underwriters to determine how likely you are to file a claim. If they believe you’re at a lower risk of filing a claim—like drivers who have a spotless record—they’ll charge you a lower premium.

On the other hand, if you seem to be at a higher risk of filing a claim—like you’re a new driver or you have a history of traffic violations—you’ll pay significantly higher insurance premiums.

Josh Damico

VP Insurance Operations, 18+ Years Experience in Insurance

Insurance companies define a high-risk driver as someone who is more likely to file a claim.

Shop smart:

To save on your insurance costs, use

Jerry

to help you find a company that offers low rates to customers who fit your risk profile. For instance, you might save the most with a company that offers low rates to new drivers, one that forgives minor traffic violations, or one that has steep discounts for good drivers.

But while the underwriting process can help balance the cost of paying claims, it doesn’t necessarily lead to a profit for the insurance company. And, like all companies, insurers need to turn a profit.

That’s where investing comes in.

Providers invest some of the premiums they bring in

Instead of relying on premiums to cover all claims and administrative costs and still create a profit for the company, insurers invest a percentage of those premiums in things like corporate bonds and treasury bonds.

Over time, those investment accounts accrue interest, creating additional income for the insurer.

This investment income helps protect the insurance company from big cash-flow fluctuations caused by things like inflation and claims payments.

Insurers also use careful claims evaluation to monitor payouts

Bringing in money isn’t the only way insurance companies protect their bottom line. They also use insurance adjusters to carefully examine each claim to ensure that they’re not paying out for fraudulent claims or un-covered losses.

To ensure that your claims will be paid, it helps to carefully read your insurance agreement at the start of your policy and anytime you need to make a claim. That way, you can be sure you’re in compliance with all of the policy terms before you file.

What insurance companies offer the lowest rates?

Every insurance company uses its own calculations to assess customers’ rates and set premiums, so there’s no single insurer that always offers the lowest rates to everyone. Still, some insurance companies seem to put a stronger emphasis on making premiums affordable.

At Jerry, we’ve found that these insurers offer some of the lowest average rates for minimum liability and full coverage car insurance:

Insurer	Average cost of minimum liability	Average cost of full coverage
Kemper	$56	$154
State Auto	$58	$161
Travelers	$59	$140
Nationwide	$61	$155
Clearcover	$66	$130

FAQ

How do insurance brokers make a profit?

Insurance brokers like Jerry earn a small commission when they sell a policy. This commission is typically paid by the insurance company, not the customer.

Do insurance companies make or lose money?

While insurance companies can sometimes lose money by paying big claims, they typically manage their risks, premiums, and investments in such a way that they can turn a profit. They may also purchase reinsurance, which is a type of insurance for insurers to help protect against losses.

Who is the richest insurance company?

According to the III, State Farm and Berkshire Hathaway are the largest property & casualty insurers in the United States, writing a combined $134.5 million in premiums in 2022. For health insurance, the top two are MetLife and Equitable Holdings, with a combined $186 million in premiums for 2022.

Why are insurance companies so profitable?

Insurers use a combination of risk assessment and strategic investments to ensure that they remain profitable even despite claims payouts. Still, profit margins for insurers are relatively low, which is why risk management and smart investing are so important.

What type of insurance is most profitable?

Life insurance policies are generally considered the most profitable because of the lengthy policy durations, which give life insurance companies many years to earn interest on paid premiums.

Do insurance companies make a lot of profit?

According to Investopedia, most insurance companies only have profit margins of about 2–3%. That’s why it’s common to see insurers investing premiums in financial markets.

Meet our experts

Amy Bobinger

Licensed Insurance Agent — Expert Insurance Editor

Expert insurance writer and editor Amy Bobinger specializes in car repair, car maintenance, and car insurance. Amy is passionate about creating content that helps consumers navigate challenges related to car ownership and achieve financial success in areas relating to cars.

Amy has over 10 years of writing and editing experience. After several years as a freelance writer, Amy spent four years as an editing fellow at WikiHow, where she co-authored over 600 articles on topics including car maintenance and home ownership. Since joining Jerry’s editorial team in 2022, Amy has edited over 2,500 articles on car insurance, state driving laws, and car repair and maintenance.

Sarah Gray

Licensed Insurance Agent — Expert Insurance Writer and Editor

Sarah Gray is an insurance writer with nearly a decade of experience in publishing and writing. Sarah specializes in writing articles that educate car owners and buyers on the full scope of car ownership—from shopping for and buying a new car to scrapping one that’s breathed its last and everything in between. Sarah has authored over 1,500 articles for Jerry on topics ranging from first-time buyer programs to how to get a salvage title for a totaled car.

Prior to joining Jerry, Sarah was a full-time professor of English literature and composition with multiple academic writing publications.

SOURCES

https://www.iii.org/fact-statistic/facts-statistics-homeowners-and-renters-insurance#:~:text=Source%3A%20ISO%C2%AE%2C%20a%20Verisk%20Analytics%C2%AE%20business.&text=In%202021%2C%205.3%20percent%20of%20insured%20homes%20experienced%20a%20claim,with%206.3%20percent%20in%202020