Brief Summary

Simply put, insurance companies help consumers manage their risk. In exchange for a constant stream of premiums, insurance companies offer to pay consumers a sum of money upon the occurrence of a predetermined event, such as a natural catastrophe, a car crash, or a doctor's visit.

More broadly put, insurance companies create value by pooling and redistributing various types of risk. It does this by collecting liabilities (i.e. premiums) from everyone that it insures and then paying them out to the few that actually need them. The insurance company can then effectively redistribute those liabilities to entities faced with some sort of event-driven crisis, where they will ostensibly need more cash than they currently have on hand. As not everyone within the pool will actually suffer an event requiring the total use of all of their premiums, this pooling and redistribution function lowers the total cost of risk management for everyone in the pool.

Measuring performance in the Insurance industry

A key metric for insurance company performance is = "the combined ratio", which measures expenses + claims payouts  /  insurance premiums.   Most insurance companies have a combined ratio around 102%... which means that they have a 2% loss on the underwriting activities, but recover that loss later by investing the money in the market.

An Efficient Operator:  Progressive Insurance

Between 1991 and 202, Progressive grew sevenfold from $1.3 billion to almost $9.5 billion in sales.  But they did this without innovating new products, without entering growing markets, and without much advertising.

The key to Progressive's success was keeping their "combined ratio" down to approximately 96%, which means that they were profitable not only on their investments, but also on their underwriting activities.   Through excellent Operations managemnt, the company was able to improve efficiency and stay profitable when other companies were not.   How did they increase efficiency?  They cut the cycle time for people who have claims, which reduced the number of people that switched companies due to unsatisfactory service.  This cut costs.  Since they take approximately 100,000 claims per day, Progressive was saving money by cutting the cycle time (less car rentals, less unhappy customers, etc).    They also used the internet to quote competitors rates so that customers could easliy compare prices.

How insurance companies make money

Insurance companies theoretically make money in two ways:

• By charging enough premiums to cover the expected payouts that they will have to cover over the life of the policy
• By earning investment returns ("the float") using the collected premiums

In actual practice, most insurance companies pay out almost all of their premiums in order to attract larger customer volumes and liabilities. Chief earnings focus is thus placed on investment returns.

Various types of insurance companies

Property and Casualty E.g. home, auto, etc.

Generally purchased by individuals.

Health E.g. PPO, HMO, Medicare supplements, etc.

Generally purchased by employers for employees.

Life E.g. term life insurance, variable annuities, etc.

Generally purchased by individuals.

Reinsurance

Generally purchased by insurance companies.

Companies; External Links

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UnitedHealth Group - UnitedHealth Group (NYSE:UNH) is the parent company of various other health services organizations and health insurers. With 22 million enrollees and $71 billion in... read more 304 views | Related: Aging Baby Boomers, CIGNA Corporation (CI), Costco Wholesale (COST)