July 30, 2010

How Insurance Companies Make Money

With the high price of auto insurance quotes, it can be easy to assume that all insurance companies are a racket designed to rip off consumers while smiling all the way to the bank. While there will always be subtle variances between the types of insurance products and how each individual insurance company manages its finances, there is a great deal of uniformity in the basic structure for how insurance companies make money and stay in business. Demystifying the process can go a long way towards reducing frustration with an auto insurance quote and obtaining an auto insurance coverage policy that is right for the individual policyholder's needs.

All insurance companies generate their income by charging premiums for the various insurance products. Premium costs will vary by age of driver, past accident and driving history, make and model of vehicle, type of vehicle, residential address, garaging situation, number of drivers on the vehicle being insured, installed safety features, and other factors. Premiums may also vary by length of coverage purchased and discounts may be available for longer policy periods. When a policyholder is involved in an auto incident and submits a claim, the dollar value of that claim is considered an expense against premiums collected. Each claim payout reduces profits to the insurance company. When claims arise as a result of a natural disaster such as a hurricane or earthquake, the insurance company may suffer huge loss of profits and may raise rates to compensate. Claim payouts do not correlate to the amount of premiums paid by the individual policyholder. An insurance company will pay the value of claims decided in favor of the other party whether or not they have collected premiums equal to the value of the claim from their policyholder.

Insurance companies attempt to leverage the potential for future losses due to auto incident payouts by investing premium funds collected in excess of claims. Insurance companies use complicated statistical models to assess risk and return for various investment opportunities, and pick and choose investment vehicles to ensure fluidity of funds against rate of return. This also factors in to the variety and type of insurance products a company may elect to offer, which is why auto insurance quotes from certain regions of the country or world may have different coverage levels and terms than in other areas of the country.

Understanding the mechanics of how an auto insurance quote is calculated and what goes into the insurance company's willingness to bear the risk of their policyholder's future involvement in auto incidents can go a long way toward assisting with locating and purchasing the best possible auto insurance coverage.