Workflow Of Insurance Companies

Companies can plan for assuming the risks from failed business strategies, non-payment from customers or poor management decisions

, but they can't plan for assuming the costs of natural disasters, fire at their facilities or accidents resulting in liability. For that, they buy insurance. Insurance companies assess the risk and charge premiums for insurance coverage. If an insured event occurs and you suffer damages, the insurance company pays you up to the agreed amount of the insurance policy. The way insurance companies work, they can pay this and still make a profit.

Evaluating Risk

Companies that buy insurance policies transfer their risk to the insurance company in return for paying their premiums. The insurance company has to evaluate how much risk it is taking on. It asks questions, each of which is designed to evaluate a particular risk. Depending on your answers to the questions, the insurance company quotes you a premium. If your risk is higher than usual -- for example, if you are not near a fire hydrant, then your fire insurance will be higher. If you don't answer the questions honestly, the insurance company may refuse to pay if there are damages.

Shared Risk

Your premiums are much lower than the possible damages, but the insurance company can afford to pay them because it receives premiums from many customers. Insurance companies operate on the principle of shared risk. All the customers pay small amounts and share the risk that way. A fire or other covered event only happens rarely. The insurance company has to calculate the premiums so the total premiums it receives from its many customers cover the few damage claims, with some money left over for administration and profit.

Re-Insurance

Insurance companies have to consider that, if they have a lot of policies in one area and there is a natural disaster, many customers will make a claim. The insurance company may not have collected enough premiums to cover so many claims. To prevent such a problem, insurance companies pass on some of the risk to other large financial firms that offer re-insurance. The large firms take over the extra risk from the insurance company that holds the policies, and it pays for this service. For major natural disasters, the re-insurance companies pay for some of the damages through the local insurance companies that sold the policies.

Investment Income

Over time, insurance companies receive lots of small amounts in premiums and have to occasionally pay out large amounts. Before paying out the damages, they may have large surpluses, which they invest. Because they don't want to take much additional risk, they typically place this money in safe investments, but it still generates a substantial income. This income increases the revenue of the insurance companies, and they can use it to reduce the premiums they charge or to increase their profits.