Insurance Companies - How do they generate revenue?

In our previous blogs, we have discussed the different types of insurance which are available in the market.

To read the first Blog (Insurance - Introduction) in this Series. Click here 

For second Blog (Types of Insurance) in this Series. Click here 

Let’s understand the operations of insurance companies and their process of making money via case study, at the end of which we will have a broader picture of insurance company operations.

Mayank is a finance major student in Stanford University, Illinois. He is 26 years old and wants to work in the insurance sector. During his annual job fair, he attended a presentation of a company, majorly working in the property and casualty insurance sector. The presentation was about different sectors in which the company is operating in. He was surprised to learn that to make insurance available to the public, insurer performs a wide variety of specialized operations. The company has operations in rate making, underwriting, investment, marketing, claims, finance, information technology, accounting, legal, and other areas as well.

Now, we will be discussing the operations of insurance companies which are as follows:

  1. Ratemaking: It helps a company to calculate and set the price of insurance premium.

a) Total premiums charged to customers should be adequate for paying all the claims and expenses during the policy period.
b) Rate and premiums are decided by an actuary, by analyzing the company’s past loss experience and statistics.

2. Underwriting: It is the process of selecting, classifying and pricing applicants for insurance. Person who is involved in the acceptance and rejection of an application is called an Underwriter. The different steps in underwriting is as follows:

3. Production: It refers to the sales and marketing activities of insurance companies. Agents who sell insurance are referred to as producers. Producers is a competent professional with a high degree of technical knowledge in a particular area of insurance.

4. Claim Settlement: For adjusting claims, every insurance company has a claim settlement department, the objectives of this department include:

a) Verification of a covered loss
b) Fair and prompt payment of claims
c) Personal assistance to the insured

The claim process begins with a notice of loss followed by investigation process by claim adjustor in order to determine the amount of loss occurred on actual basis. Afterwards, the adjustor may require a proof of loss before the claim is paid fully / partially or denied.

 5. Reinsurance: Shifting of part or all of the insurance originally written by one insurer to another insurer. Reasons for Reinsurance:

a) Increase underwriting capacity
b) Stabilizations of profits

 6. Investment: Investment is one of the essential operations of insurance companies where the portion of the premiums which are paid by the insured are further invested until there is a need to pay off claims and expenses.

How Insurers make money?

Have you ever wondered, how insurance companies are able to generate income. Let’s overview the business model of the insurance sector:


Primary Sources of Income of Insurance Company

  1. Underwriting Income: It is derived from the difference in the amount of money collected in the form of premium for all the sold policies and the money paid in the claim settlement of all the policies at any given period of time.

For example, ABC Insurance Company collected Rs.1 Cr in premium for the policies issued or renewed for the given year.

If claims < Rs.1 Cr, company makes profit

If claims > Rs.1 Cr, company suffers loss

This is almost the opposite of the traditional business that buys and sells goods, where they have to pay upfront for the inventory and recover their cost via sale.

 2. Investment Income: A part of the premium collected from the insured is invested into the market to gain interest over the time. Most companies have a well-diversified portfolio and invest money either in low-risk fixed income securities or high risk - high return equity markets.

Now we have a clear understanding of working and business model of insurance companies. In the next blog we will elaborate on factors which affect the pricing of insurance premium.


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