Are you curious if how do insurance companies work? Generally, insurance companies are organized into broad departments, including underwriting, marketing, legal, finance, and claims. Underwriting and marketing are known as “yes” departments, while finance and claims are “no” departments.
To balance out the competing interest between those two, insurance companies have a legal department. The underwriters are the ones who formulate insurance products to be sold to the customers at a given price in which they can earn profit.
Although there are standard policies already, many underwriting departments create their endorsements and forms so that the marketing department will be able to convince both the existing and potential customers.
While the marketing and underwriting departments desire to have many insured sign up as possible so that the company will collect higher and greater premiums, the claims department, on the other hand, manages claims in instances where the insured is seeking to recovers its covered assets.
How do Insurance Companies operate?
How do insurance companies work? The underwriting department claims that paying a claim cannot affect a decision, but this is not always the case. For example, if a good customer requested an accommodation for a claim, the claims department is sometimes intervened by marketing and underwriting departments.
The same is true if a broker that has brought many clients to the business is the one that filed a claim. Both the underwriting and marketing departments are assessed based on their retention ratios and premium collections. For instance, the departments can judge them based on the percentages of the insured entities who renewed their policies.
Other the other hand, the claims department is assessed based on resolving claims. Therefore, the lesser the cost that the company will incur, the better the claims department’s performance. As such, these departments are usually experiencing tension between them. The aforementioned financial measures are the ones that drive the profit and management of the company.
This is also the basis for the bonus paid to each department.
Individuals and companies can plan by assuming risks that may arise in case of a failure in business strategies, a poor management decision, or nonpayment of customers.
However, they cannot plan for the costs incurred due to fire, accidents, or natural disasters that resulted in liability. For that reason, they purchase insurance. The insurance companies are assessing the risk and will charge a premium to different kinds of insurance coverage.
If an event covered by an insurance policy occurs and damages are suffered, the insurance provider will be paying the insured up to the agreed amount when the policy is purchased. Therefore, although an insurance company is paying for this, they are still making a profit.
How Insurance Companies Work
In this section, we will be talking about how insurance companies work in detail by looking at the different aspects related to their operations to earn profit.
#1. Risk evaluation
The entities that are buying an insurance policy are essentially transferring the risk towards the insurance provider. In return, they will have to pay for the premiums. Before acquiring the insurance policy, the insurer will define the risk that they are about to take on the particular insurance policy first.
They will be asking several questions that are designed in evaluating risk. The premiums that will be charged to you will depend on how you answer those questions.
For instance, if you are not close to the fire hydrant, you will be assigned higher fire insurance. In case you failed to answer the questions, in all honesty, then the insurer may choose to refuse the payment for any damages that will occur.
#2. Shared risk
The premiums that you pay are generally lower than the possible damages that the insurance company will have to pay, but they are still making a profit since many customers are paying for the premiums.
In essence, the insurance companies are operating on the principle of what we call a shared risk. All the clients are paying small amounts as a way to share risk. Furthermore, an event such as a fire, for example, only takes place rarely.
Insurance companies are calculating the premiums so that their total will be able to cover up for the claims of damages that the customers made while still retaining a portion of it for profit and administration costs. Here is the concept of shared risk to understand further.
The insurance companies consider that if multiple policies are placed in the same area, many customers will be claiming in case of a natural disaster. If that happens, they might not have enough premiums collected to cover plenty of claims.
To avoid that, the insurance companies are passing some of the risks to the big financial firms offering reinsurance. Meaning to say, they are getting themselves protected or covered. Those bigger firms are taking over some risks from the insurer that is holding those policies. The insurer is paying them for this service.
It’s A Wrap!
Since you have read until the end of this post, you have known how do insurance companies work. It is good to be enlightened on how those companies operate to profit and pay for the claims. Here is an article that talks about the face amount of life insurance if you want to read more.