There are hundreds of companies and new ones are coming everyday. So, you wonder how do they make money an if it is a profitable business. It is a type of business that has entry requirements. And they have to follow these requirements in every state they want to sell policies. You cannot just start a firm and sell policies of any kind. You have to submit an application to state authorities and show them that you have found and comply with other requirements as well.
It is a business of assessing risk and pricing it correctly. The problem is that they can only rely on the past information when they are setting their rates. They have no idea what can happen in the next six months to a year. We may have a very bad weather and claims may surge. This does happen at times and companies have to accept the losses.
However, there are provisions in the policies that protects companies from going under in one bad year. For example, they may be able to refuse to pay claims when it is determined a catastrophic events and act of God instead of an insurable event. For example, they exclude a few large disasters in particular in the areas they are commonly seen. As an example, policies in California may exclude earthquake as the state is known to be sitting on an earthquake zone. Otherwise, one big quake will be enough to run a few companies down to the ground.
They also exclude civil unrest and war. Terrorism may be excluded from many policies as well and this is brought in after 9/11. Companies are excluding terrorism where possible to avoid any risks of paying large sums in cases of big terrorist attacks.
They still need to employ many clever statistician, mathematicians and programmers to calculate their premiums correctly. They need to be able to charge enough to their policyholders that they will still make money after paying all the claims and their running costs. As they are not alone in the market place this may be tougher than it looks. That is why they may use smart strategies. One of the common strategy is that they can be very competitive when a good driver is concerned. When they see that the risk of insuring a vehicle is low based on driver history they can cut their prices a lot.
On the other hand, they may not want to put their hands under a stone by insuring a risky driver. They make sure that large premiums are paid before they can insure these people. That is why you won’t find many companies that are keen to insure you when you have a few claims already.
The recent reports suggest that insurance business is not as profitable as people may think. Many large companies are declaring losses on their insurance operations. However, large premium collections allow them to make money on these funds. They collect the premium at the start and they can use this money until it is require to pay a claim. This is another source of income for them.