HOW INSURANCE COMPANIES MAKE MONEY
The way an Insurance Company makes money directly impacts the ability of a wrongfully injured person to obtain fair compensation for their loss.
Without a detailed understanding of the well oiled money making machine that is the insurance industry, it will not matter that you suffered a traumatic brain injury, spine injury, burn injury, fractured limb, or some other significant injury. In fact, it won’t even matter that you have been wrongfully injured in a car accident, motorcycle accident, bus accident, slip and fall, or some other incident where the other person was clearly at fault.
According to the Los Angeles Times, Insurance Companies made record profit of $44.1 Billion in 2005 and $63.7 Billion in 2006. They did this using a very simple equation:
Premiums Paid by Insureds
Interest & Investment Income
Claims Paid (fair compensation to you)
= $ PROFIT $ =
The primary thing to understand is that Insurance Companies are really banks. They borrow money from their insureds in the form of Premiums. They take the Premiums and lend them out to others in the form of mortgages, institutional investment, stock ownership, etc. The amount of interest earned on these investments is often substantial makes up a significant portion, if not the majority, of the Insurance Company profit center.
Amazingly, the Insurance Companies obtain all of this money at no cost. Insureds “lend” out their Premiums at a remarkable 0.00% interest rate. Unlike any other lending source, Insureds do not charge the Insurance Company interest for their loan in the form of a Premium payment.
The importance of this fact is highlighted particularly when you understand that even the largest of Banks have to borrow money at the Federal Funds or Discount Rate, which is now approximately 2.25% and historically around 6% or more. That means that the cash used by Insurance Companies costs them 2% to 6% less than that same cash costs a large Bank.
From the moment an Insurance Company receives a premium, it can be guaranteed that it will make more money on that cash that a Bank would. Apparently, Insurance Companies have figured out a superior money making business model than the Banks themselves!
An insurer’s underwriting performance is measured in its combined ratio. The loss ratio (incurred losses and loss-adjustment expenses divided by net earned premium) is added to the expense ratio (underwriting expenses divided by net premium written) to determine the company’s combined ratio. The combined ratio is a reflection of the company’s overall underwriting profitability. A combined ratio of less than 100 percent indicates underwriting profitability, while anything over 100 indicates an underwriting loss.
Property and casualty insurers currently make the most money from their auto insurance line of business. Generally better statistics are available on auto losses and underwriting on this line of business has benefited greatly from advances in computing.
A third key point to understand is that Insurance Companies earn investment profits on “float”. “Float,” or available reserve, is the amount of money, at hand at any given moment, that an insurer has collected in insurance premiums but has not been paid out in claims. Insurers start investing insurance premiums as soon as they are collected and continue to earn interest on them until claims are paid out. Paying out money on a claim for injuries is a “loss” to the Insurance Company because it means that the Company can no longer continue to make money on that amount of “float.”
If there is no significant threat to the Insurance Company, it will invariably choose to wait as long as possible to pay fair value on any given claim. In fact, many insurance companies implement a policy by which they “string along” an injured claimant in an attempt to lull them into believing that a settlement is “right around the corner.” Adjusters will discourage injury claimants from obtaining legal counsel, promising timely resolution for months and sometimes years.
In some of the most egregious cases, an injury claimant will be “strung along” until the statute of limitations expires, at which time, the adjuster promptly informs them that they no longer have a claim.
Until such time as the cost of paying fair compensation on a claim is less than the threat posed by a competent and aggressive attorney, an Insurance Company will be loathe to take seriously an injury claim, preferring instead to delay, delay, and delay some more. All the while, the Insurance Company continues to earn interest from lending out the same money that should rightly have already been paid to the injury claimant.