Insurance works on the best commercial principles like any other commercial venture. The basic business model of an insurance firm can be described thus:
(Premium collected + Profit on investments made from the premium collected) - (Administrative costs + Investment costs + Payout on insurance claims)
Insurance companies should have the following traits to succeed:
1. To find a large number of homogeneous group of people who can be insured
2. The premium payable should be affordable to the large group.
3. The loss to the group insuring on account of the contingency occurring should be definitely huge compared to the premium payable, capable of exact calculations.
If the risk covered conforms to the above norms, insurance companies will be able to make profit by taking proper planned action.
There is another kind of insurance business - indemnity. For example, consider the risk of paying damages to a third party if an accident occurs. If no accident, no payment and premium is profit for the insurer.
The insurance company recovers premium and invests them in markets getting good return (like equity, government debt instruments) with adequate liquidity base. They employ actuaries who work out the investment angle as well as calculate the probabilities of occurring of the risks covered. Actuaries work out and calculate the probability of risk and the appropriate premium for covering the risk. Based on the actuarial calculations, premium is fixed. These are all revised constantly in accordance with the actual reality. Insurance companies will also underwrite their risk. Underwriting reduces the probability of huge loss occurring to the particular company.
(Premium collected + Profit on investments made from the premium collected) - (Administrative costs + Investment costs + Payout on insurance claims)
Insurance companies should have the following traits to succeed:
1. To find a large number of homogeneous group of people who can be insured
2. The premium payable should be affordable to the large group.
3. The loss to the group insuring on account of the contingency occurring should be definitely huge compared to the premium payable, capable of exact calculations.
If the risk covered conforms to the above norms, insurance companies will be able to make profit by taking proper planned action.
There is another kind of insurance business - indemnity. For example, consider the risk of paying damages to a third party if an accident occurs. If no accident, no payment and premium is profit for the insurer.
The insurance company recovers premium and invests them in markets getting good return (like equity, government debt instruments) with adequate liquidity base. They employ actuaries who work out the investment angle as well as calculate the probabilities of occurring of the risks covered. Actuaries work out and calculate the probability of risk and the appropriate premium for covering the risk. Based on the actuarial calculations, premium is fixed. These are all revised constantly in accordance with the actual reality. Insurance companies will also underwrite their risk. Underwriting reduces the probability of huge loss occurring to the particular company.
