It might appear that insurers don’t earn much from offering insurance, but that is not the case. So how do they make profit?
The products offered by life insurance companies can be broadly divided into 4 types. They are Term Insurance, Endowment Insurance, Whole Life Insurance and Annuities. Term insurance policyholders have to make annual premium payments in exchange for their death benefits, commonly known as the sum assured. The insurer might have to pay a sum ranging up to rupees one crore against regularly collected premium from the holder, where premium depends on the age of taking the policy.
In most cases of death, the sum assured will be much greater than the premium paid and still, the insurers make profit. Similarly, for Endowment policy, policyholders pay a risk premium, also they pay a fixed amount in addition to the instalment towards systematic savings to be received as a lumpsum amount equal to the sum assured on maturity. Based on the investment income of the company, the sum assured is also supplemented by the bonus accrued to the policy every year. In a whole life insurance policy, on death of the policyholder, the insurer will pay the nominee full sum assured with or without bonus as per terms and conditions of the policy.
From the above examples, we may feel insurers can’t gain profit. The death of people are very uncertain and the insurers have to pay the sum assured any time, that they collect from shareholders. Hence the source of profit of insurers is from a different side.
If in a year one million people take insurance its certain that they won’t die in the same year or in 25 years which is considered as an average term of a policy. The insurer doesn’t need to consume the risk premium collected every year to pay the death claims as the business moves on. The prediction of death claim experience in almost all cases is better than the pricing of each product which was assumed to be easier. Considering this, insurers are characteristically conservative as they undertake the unforeseen risk. For a claim experience which is better by 0.2 to 0.5% in a year, a substantial benefit for an insurer is confirmed over a period of time. Better underwriting of risk has a major role in the generation of income. LIC’s investment income alone from equities was more than Rs 14,000 crore, During the year 2018-19. The market value of LIC’s stock market investments at the end of FY19 was more than Rs 28 lakh crore. The income gained will be again reinvested after dividends are paid to the shareholder.
The amount paid to policyholders by insurers as death claims and the accrued bonus is the sum after meeting all business procurement and management expenses.