How do Insurance stocks make money? And are they a safe investment?

Insurance stocks have among the most peculiar business models of all listed companies. Consumers may only see a company that they give their money to, and may get their money back in certain circumstances – at their discretion of course. But how do they determine the criteria as to when or if cash will be paid out? And what does it do with customers’ money in the interim?

How do Insurance stocks make money?

Insurers primarily make money through a combination of underwriting profits and investment income. As we all know, Insurance companies collect premiums from policyholders in exchange for coverage against specified risks.

Some common types of insurance for consumer markets include health insurance, life insurance, property insurance, and liability insurance.

• Health Insurance: This type of insurance helps cover the cost of medical expenses for individuals and their families. It can include coverage for doctor visits, hospital stays, prescription drugs, and more.
• Life Insurance: This is a contract between an individual and an insurance company where the insurer agrees to pay a designated beneficiary a sum of money upon the death of the insured person. This provides financial support for loved ones in the event of a tragedy.
• Property Insurance: This type of insurance protects against damage to physical property, such as homes or businesses. It can cover losses due to fire, theft, natural disasters, and other events.
• Liability Insurance: Liability insurance provides coverage for legal expenses and damages in the event that an individual or business is found legally responsible for causing harm to another person or property.
• Business Insurance: Then there are several types of business insurance, ranging from providers to SMEs to large corporate providers such as QBE (ASX:QBE).

Insurers pay out claims when policyholders experience covered events (like accidents or natural disasters). The difference between the total premiums collected and the total claims paid is the underwriting profit. If premiums exceed claims, the company is profitable; if not, it can incur losses. Consider that IAG faced 15,000 claims worth A$350m after Cyclone Gabrielle back in February. In the end it was profitable, but the impact was big enough that IAG saw a need to quantify the impact prior to reporting season.

Efficient management of operational costs and claims processing can further enhance insurers’ profitability. This includes utilising technology and data analytics to streamline operations and assess risk accurately.

So what do they do with the money?

Insurers invest the premiums they collect before they need to pay claims. This includes a range of assets like stocks, bonds, and real estate. The returns generated from these investments provide additional income, which can significantly enhance overall profitability.

How do they minimise risk?

If no insured events happen, then it is great to be an insurance stock. But, not so much if insured events do happen. So how do they protect themselves?

First of all, insurance stocks carefully assessing risks and implementing strategies to minimize potential losses. This includes setting premiums at a level that is appropriate for the risk being insured, as well as establishing policies and procedures for handling claims. Insurance stocks may just opt not to insure certain events at all – for instance, some smaller companies may refuse to insure drivers with a bad record. Larger companies may for instance refuse to insure larger businesses for the risk of employee misconduct damaging the company if it cannot see there are appropriate policies in place that might stop such occurrences from happening.

And if clients keep claiming, insurance stocks may hike premiums accordingly to account for the risk. Insurance companies also use reinsurance, which is when they transfer a portion of their risk to another insurance company. This helps spread the risk and prevents one major claim from causing financial strain on a single company.

They may purchase insurance for themselves – called reinsurance.

Conclusion

Insurance companies play an important role in protecting individuals and businesses from potential financial losses. By effectively managing risks and utilising various strategies, they are able to provide a safety net for consumers and businesses who may face unexpected events.

Understanding how insurance companies operate and protect themselves can help individuals make informed decisions when it comes to purchasing insurance coverage. So, it is important to research and carefully consider the different types of insurance stocks available to investors.

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