Insurers' Business Model 1

Underwriting and investing

The business model can be reduced to a simple equation: Profit = earned premium + investment income - incurred loss - underwriting expenses.

Insurers make money in two ways:

1. Through underwriting, the process by which insurers select the risks to insure and decide how much in premiums to charge for accepting those risks;
2. By investing the premiums they collect from insured parties.

The most complicated aspect of the insurance business is the underwriting of policies. Using a wide assortment of data, insurers predict the likelihood that a claim will be made against their policies and price products accordingly. To this end, insurers use actuarial science to quantify the risks they are willing to assume and the premium they will charge to assume them. Data is analyzed to fairly accurately project the rate of future claims based on a given risk. Actuarial science uses statistics and probability to analyze the risks associated with the range of perils covered, and these scientific principles are used to determine an insurer's overall exposure. Upon termination of a given policy, the amount of premium collected and the investment gains thereon minus the amount paid out in claims is the insurer's underwriting profit on that policy. Of course, from the insurer's perspective, some policies are "winners" (i.e., the insurer pays out less in claims and expenses than it receives in premiums and investment income) and some are "losers" (i.e., the insurer pays out more in claims and expenses than it receives in premiums and investment income); insurance companies essentially use actuarial science to attempt to underwrite enough "winning" policies to pay out on the "losers" while still maintaining profitability.

Principles of insurance

The six principles of insurance are:

1. Indemnity – Insurance is a contract of indemnity where the insurance company indemnifies the insured against certain risks for a consideration known as premium.
2. Insurable interest – means the loss of which will directly affect the insured.
3. Utmost good faith – means that the insured and the insurance company will not willfully hide anything from each other.
4. Mitigation – means the insured will not behave irresponsibly and will take due care so that the risk of loss or the loss is minimized.
5. Subrogation – means the insurance company acquires legal rights to act on behalf of the insured i.e. the insurance company steps into the shoes of the insured.
6. Causa Proxima or Proximate Cause – means the proximate cause of loss to ascertain whether the loss is covered under the policy.

Insurance

Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium, and can be thought of as a guaranteed and known small loss to prevent a large, possibly devastating loss. An insurer is a company selling the insurance; an insured or policyholder is the person or entity buying the insurance. The insurance rate is a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the premium. Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice.