Life Insurance Companies and Profits

Factual Questions
1

I’ve been wondering about this for awhile. I must be missing something here.

Most insurance is just that, insurance for things that really don’t happen often. Automobile insurance companies make a profit by taking the money they receive from ‘good drivers’ who pay their money and never use the services of the insurance companies and subtracting the money they pay out to the unlucky car accident victims and bad drivers. If they use odds (bad drivers pay more) the auto insurance turns a profit.

But life insurance is a bit different (from what I understand.) Everyone pays money and everyone dies, and insurance is cheap compared to what you receive when you die (not ‘if’, when.) $250,000? A million? For $10 a month! Uuuh.

So then, how do life insurance companies make money?

2

A life insurance company uses standard mortality tables that are based on experience over a lot of people over a lot of years. They know that those who pass their physical exam in order to get the insurance have a life expectancy of a certain number of years. Half will die before that time and half after. Those who live past their life expectancy pay the cost to the company of those who die early. The company charges a premium that will pay for the benefit and also make them some money. In addition, they invest the premiums they collect and make additional money that way. The only thing they have to worry about, like a gambing casino, is a long run of bad luck. This isn’t very likely to happen and they add an additional premium charge to protect against it.

3

Life insurance is not necessarily cheap compared to what you receive when you die. Try buying a 20 year level premium policy at age 70.

The point is this - life insurance covers you only for a limited period of time for a set premium. (With one exception, described below.)

As you age, those premiums go up up up. And that’s how life insurance companies (generally) make money.

And the exception? “Whole life insurace” has a guaranteed death benefit, no matter how old you are when you die.

This is accomplished by charging an extra premium which is invested. After many years, the total investment is big enough to pay the death benefit.

4

Or, to put it another way, here’s the formula:

(Income from premiums) + (Income from investments) - (Payouts for deaths) = (Gross profit)

You can see how, if investments are not returning much, premiums will have to be increased to maintain the same gross profit. Conversely, with good investments, either profits go up or premiums can be reduced.

5

It’s also a loan to the company. It’s not like they put the premiums under their mattress. It’s invested. That’s led to other problems right now…

6

Ahhhhhhhh, you missed the obvious!

Life insurance salespeople hook you with the sob stories, get you to sign up…

After paying out good money for a finite period of time, you lose your job, life circumstances change, or you just get POed at paying the premiums.

So you cancel the insurance.

Voila! Profit for the company!

~VOW