Paul Sanchez
Life insurance companies are consistently ranked among the most profitable industries globally. While they make money by charging premiums, the income from investing premium revenues is even more substantial. In 2020, investment income made up $186 billion of revenue for the life/annuity insurance industry, compared to $143.1 billion from life insurance premiums. Insurers invest premiums in very low-risk investments to maintain a reliable income stream. They also profit from policies that lapse or expire, as they get to keep the premiums without paying out a claim.
| Characteristics | Values |
|---|---|
| Premium collections | Premium collections are the biggest earner of profit sources for life insurance companies |
| Investments | Life insurance companies invest premiums into very low-risk investments to maintain a reliable income stream |
| Lapsed policies | Life insurance companies profit from policies lapsing or expiring |
| Permanent policies | Permanent policies, which come with high premiums, are often surrendered or lapse when owners can’t keep up with the payments |
| Term-based cover | When a policyholder outlives their cover, no payout will be made, and all money paid into the policy acts as profit to the insurer |
| Policy brokers | Advised life insurance brokers charge the customer for their services, while non-advised brokers collect a percentage of commission from the insurer |
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What You'll Learn
Premiums and investments
Life insurance companies make money by charging premiums and investing some of the money they collect. They can also profit from policies lapsing or expiring. The biggest earner of profit sources for life insurance companies is premium investments.
Premiums
When you sign up for life insurance, you start paying premiums to the life insurance company. Premiums are carefully calculated by insurers to cover the death benefit and provide profits to the company. They are calculated based on the length of your policy's coverage and your estimated life expectancy. If too many customers die sooner than expected and the insurer needs to pay out more claims than planned, the insurer loses money. This is why the life insurance application process is so thorough, and there are harsh penalties for concealing information on your application.
Investments
As policyholders pay their premiums, the insurer invests a portion of those payments. The insurer sets aside enough cash to pay out claims in case of a market downturn and keeps any interest gained. The income from investing premium revenues is substantial. In 2020, investment income represented $186 billion of revenue for the life/annuity insurance industry, compared to $143.1 billion from life insurance premiums.
Life insurance companies invest premiums into very low-risk investments to maintain a reliable income stream. They invest in fixed-income securities like bonds, as well as stocks, real estate holdings, and other types of investments.
Lapsed policies
When a policy lapses, it is no longer a liability for the insurance company because they don't have to pay out a death benefit. However, lapsed policies also represent lost revenue for the company because they are no longer receiving premium payments. To combat this, many agencies focus on retaining customers and renewing policies to ensure a steady income.
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Lapsed policies
Life insurance companies make money through premiums, investments, and lapsed policies. When a policy lapses, the company gets to keep the premiums without paying out a claim, which is a financial boon. This can occur when policyholders miss premium payments, or due to administrative errors or changes in financial circumstances.
To prevent lapses, policyholders can opt for automatic renewal, which ensures that premiums are deducted from their account on time each month. It is also a good idea to maintain an emergency fund to cover unexpected expenses, including overdue premiums. Policyholders should regularly monitor premium payment deadlines and keep lines of communication open with their insurance provider to respond to any notifications regarding their policy status.
In some cases, reviving a lapsed policy may be subject to underwriting review to assess insurability, which could include health-related questions, medical exams, or updated financial information. Once all requirements are met and outstanding premiums are paid, the insurance company will review the revival request and, if approved, coverage will be reinstated.
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Policy cancellations
Life insurance policy cancellations can result in a financial gain for the insurance company, as they no longer have to pay out a claim for that policy. Additionally, the company gets to retain the premiums paid by the policyholder up to that point. However, cancellations can also lead to a loss for the insurance company if the policy has accumulated a substantial cash value. In such cases, the insurance company may need to pay out the surrender value, which is the cash value minus any surrender fees.
The process of cancelling a life insurance policy can vary depending on the type of policy and how long the policyholder has had it. Term life insurance policies, which provide coverage for a specified period, are generally simpler to cancel. Policyholders can often stop paying premiums, and the policy will lapse. Permanent life insurance policies, on the other hand, may involve more steps and considerations, such as the impact on the cash value and potential surrender charges.
It is important to note that cancelling a life insurance policy can have financial implications for the policyholder as well. If they have paid premiums upfront, they may be eligible for a partial refund. Additionally, if they decide to purchase life insurance again in the future, their rates are likely to be higher due to their increased age and potential change in health status. Therefore, it is recommended to explore alternative options before cancelling a policy, such as converting a term policy into a permanent one or using the cash value to cover premiums.
Overall, policy cancellations play a crucial role in the profitability of life insurance companies. While cancellations can result in financial gains by retaining premiums and avoiding payout claims, they can also lead to losses depending on the specifics of the policy. Understanding how policy cancellations impact revenue and profit margins is essential for assessing the financial health of insurance companies.
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Term periods
Term life insurance is the most common type of life insurance, where the majority of people who buy life insurance buy policies that only last a set number of years. This is ideal for insurance companies because it often means they have collected years of premiums without paying out any claims. This is because, when a policyholder outlives their cover, no payout will be made, and all money paid into the policy becomes profit for the insurer.
When people first have children or buy their first homes, they are generally younger and in good health. This means they will most likely still be alive when their 30-year term life insurance policy expires. So, the life insurance company will likely get to collect premiums without making payouts to policyholders who outlive the policy terms. That money goes to help pay for claims in cases where the policyholder passes away during the term of the coverage.
Term-based life insurance lasts for a specified period, and if the policyholder passes away during the term of the policy, a payout will be made to their loved ones. However, if the policyholder outlives the cover, the policy expires, and no payout is made. This is why term periods are so profitable for insurance companies.
In addition to premiums, investment income from cash value policies is a major source of revenue for life insurance companies. Permanent life insurance policies, such as universal and whole life, contain a cash value account within the policy meant to offset the cost of insurance as the policyholder ages. A portion of each premium goes into this account, which is then invested.
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Permanent policies
Permanent life insurance policies contain a cash value account within the policy meant to offset the increasing cost of insurance as the policyholder ages. A portion of each premium goes into this cash-value account, which is then invested by the insurer, primarily in fixed-income securities like bonds, but also in stocks, real estate holdings, and other types of investments. The income from investing premium revenues is a significant source of revenue for life insurance companies, and the investment income from cash value policies is a major source of revenue.
While permanent policies come with high premiums, they are often surrendered or lapse when owners can no longer keep up with the payments. Surrender means the insurer is no longer liable for the payout on the policy, and they also lose premiums that could have been invested. Most insurers charge surrender fees to recoup some of that lost revenue.
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Frequently asked questions
Life insurance companies make money by charging premiums and investing some of the money they collect. They can also profit from policies that lapse or expire.
Term-based life insurance is ideal for insurance companies because it often means they can collect premiums for decades without having to pay out any claims.
Premiums are carefully calculated based on the length of the policy's coverage and the estimated life expectancy of the policyholder.
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