So, where do insurance premium payments go? If a person pays a certain amount of money for insurance every month, what does the money do that makes it worthwhile for the company to insure the individual for potentially hundreds of thousands of dollars? When the decision’s made to cancel someone’s coverage, what factors into that decision?
Thanks,
–CiaTH
What does the money do? It provides for an actuarially expected profit.
IE if there is a 1% chance of you costing them $100K (and a 99% chance of you costing them $0) then if they charge you $1,500 bucks, then they will make $500 on average. That way almost all of the people will complain that they are getting nothing for their money though, which is kind of funny.
It works by using huge numbers of people. Look up law of large numbers whereby the average loss for a group approaches it’s expected loss with a larger and larger number of people.
As to when can the drop your coverage, I’m only familiar with policies which are cancellable if the entire group of those policies is cancelled, ie they can’t just cancel one person because he is sick or whatever.
To add to bri1600bv’s answer, an insurance needs money for three things:
[ol]
[li]To cover their operating costs.[/li][li]To make payments on current claims.[/li][li]To invest for future claims.[/li][/ol]
The exact breakdown varies from company to company, but that’s what your premium is doing for them. Of course, premiums are generally set so that the insurance company expects to make a bit of money.
It sounds like you may be referring to group health insurance (like an employer’s insurance), but the OP doesn’t mention what type of insurance. Health insurers cancel people all the time, usually because they claim they have non-covered pre-existing conditions.
With auto insurance, you can be cancelled (or at least refused renewal; I don’t think you can actually be cancelled) for having a terrible driving record. As described by bri600bv, insurance is a way for people to pool their risk. If I have a 1 in 1,000,000 chance of killing someone in an auto accident, that’s low odds but that occurrence could wipe me out financially. So I’ll share that risk with 999,999 other people. It spreads the risk out. Sure, it will cost me to be part of the pool, but I know how much it will cost me, and I know I can’t be wiped out. Now, if I start having an at-fault accident every week or get tickets for doing 100 in a 55, then my risk suddenly becomes much higher than the risk of the other people in the pool. Someone who is a safe driver doesn’t want to share risk with a maniac. So I won’t get renewed (some states provide a high-risk pool for those who are too high-risk for commerical insurance companies).
It is invested in a portfolio of assets with an aim to make a target return over the expected payouts. Insurance companies are enormous financial investors in effect, on the non-retail side. That is what makes it worthwhile for insurance companies as a general matter.
What **wmfellows **said. It varies from field to field, but in many forms of insurance the company will refer to “underwriting profit” and “investment profit”. The former refers to making a profit of premiums over claims. The latter refers to making a profit out of investments.
In times of good investment returns, such as we have had for many years until recently, competitive pressures had driven premiums down to the extent that underwriting profits were unusual (and indeed tended to indicate that your premiums were too high) while money was made by investment profit. I know of large insureds who received more in claims than they paid in premium for year on year on year yet their insurer did not turn away their business because the sheer bulk of premium was worth having, to invest.
Now the tables have turned and it’s the other way around, at least in my field (marine). Insurers have had to jack up premiums to create some profit to cover flat (or even negative) investment returns.
Right, I should have mentioned premium based margin.
Ideally long-term investment returns from a mix of debt securities, equity securities and fixed asset (e.g. real estate with predictable rental incomes) provides a long-run significant margin for the insurer, over predicted claims. That makes insurance cheaper than say an insurance covered only by premium (imagining a case of incoming premium merely covers current risk).
I think the responders should get credit for answering the OP’s question in a factual, GQ-type manner.
Frankly, I couldn’t come up with a damn thing to say that wouldn’t get me warned. 
With health insurance, if you become seriously ill and disabled, you end up getting pushed over to Medicare and possibly Medicaid. I’ve tried looking for exact numbers, but this info is really hard to find online.