How Do Car Insurance Companies Make Money?
Last Updated on December 6, 2019
While car insurance is one of the wisest investments you can make (in fact, if you want to drive a car legally, you have to purchase liability coverage, at the bare minimum), you still might be wondering how your carrier is profiting off of you. After all, car insurance is a business, and nobody gets into business without the goal of making money.
So, how do car insurance companies make their money? Below, we shed some light on this frequently asked question.
How Auto Insurance Works
The goal of auto insurance is to protect you from the possibility of a monetary loss. In other words, you rely on an insurance company to safeguard you from financial disaster. This disaster can occur for any number of reasons; an accident, damage to your vehicle, theft, and so on.
Car insurance is beneficial for a number of reasons. It reimburses you when for losses that are covered, it promotes safer driving, and prevents the possibility of accidents. For example, if you are involved in an accident and damage someone else’s car and cause injuries to another driver or passenger, the insurance company that provides your liability coverage will help you pay for the cost of damages and medical care. In other words, you won’t be solely responsible for paying those fees out of your own pocket.
How Auto Insurance Premiums Work
When you purchase an auto insurance policy, you are required to pay a premium. The premium is the fee that you have to pay in return for your insurance provider offering you financial protection in the event of an accident or any other incident that your policy covers arises.
Your insurance provider uses the premiums that you pay in a number of ways:
- A part of your premium is paid out to the agent that services your auto insurance policy.
- The provider offering services in the event that you file a claim also receives a portion of the premium. For example, if you are in an accident, the insurance adjuster and the repair company that fixes your vehicle will receive a part of your premium.
- If any losses do arise, a part of the premium you pay is put on reserve to cover those losses.
How do Auto Insurance Companies Make Money?
As mentioned, you pay a premium for your auto insurance, as does every other person who holds a policy with your insurance company. All of the premiums that are collected by the auto insurance provider are pooled together. That money is then used to pay for various expenses, including claims and losses.
The pooled premiums are placed into an account, which is invested. Your insurance company makes money from the investments from that account.
It’s important to note whenever you file a claim on your car insurance, your insurance provider must dive into the money that it has put on reserve in order to pay for any losses. In order to offset the loss from the reserved funds, your auto insurance company will increase your rates. The more claims you file, the higher your premiums will be, as your insurance provider will have to pull more money out of their reserves each time you file a claim and they have to cover losses.
To further clarify, the amount of money your insurance company makes is collected from all the policies that are sold vs. how much money the company has to pay out in claims. For instance, if an insurance provider collects $2 million in premiums in one year and they pay less than $2 million in claims, the insurance company has made a profit. However, if the provider has to pay out more than $2 million in claims, they have experienced a loss. When a loss occurs, rates increase in order to offset the loss.
Other Sources of Revenue
Insurance companies can also make money on auto insurance policies that lapse. A lapse occurs when an auto insurance policy expires and a claim was never made. In this case, the insurance company will receive all of the premiums without ever having to make a payout, which means that they end up acquiring a major profit.
Regardless of how auto insurance companies make money, as a policyholder, you need to make sure that you are not being taken advantage of. If your rates increase past the going market rates, or past the point you are comfortable paying, it’s time to start looking for a new insurer.
The best way to lower your insurance premiums is to compare rates and then pick the most affordable insurer from the bunch. To start shopping around for auto insurance quotes, please scroll back up to the top of this page and enter your zip code in our quote box. After filling out our brief form, you will be presented with quotes from the top insurance providers in your locale.