what do these insurance companies invest my money in?

Question

Noway could they make anything on collecting my house premiums of 500 annually compared to claims that may come in for $150,000 or more. That would take 300 premiums per year. and what if there were 15 other claims for 10000 because of hail or wind? just seems like a losing business unless they take the money and use it to invest? in what? the intrest rates stink.

Answer 1

HI, your friendly insurance guy here, again! :)

Insurance companies are required to have a certain amount of money on hand to cover claims. That means they tend to invest conservatively with most of their funds. They also rely heavily on actuarial predictions of probable loss, and present value / future value computation.

Actuarial predictions: Actuaries are high-powered mathematicians who, among other things, help insurance companies figure out what the probabilities are of losses occurring. An Actuary may determine that, for example, the odds of a house burning to the ground in New Hampshire is 1 in (whatever number) per year.

They then multiply the expected number of house fires by the average cost of claim per fire to get an estimate of the expected losses due to fires that year.

Present Value / Future Value computations: Insurers tend to fund payment of claims by starting with the value from the first part of this post, for example, the expected cost of losses due to fire in a given year.

Let's say the insurer expects to have $5,000,000 in fire-related claims. The company will buy something like a $5,000,000 face value 1-year bond. Such a bond can be purchased at a discount (meaning you pay less for it than $5,000,000).

At the end of the year, the bond comes due and provides funds to recoup the cost of paid claims, or pay due claims.

That's a simplification, but it's essentially a good example.

Also, since claims for a loss are INCREDIBLY fewer in number than premium paying clients, it's actually not hard at all for an insurer to cover claims and still make a LOT of money.

Witness MassMutual, which had higher gross revenues last year than Coca-Cola. Belive it - insurers are taking in a LOT more money than they pay in claims.

The exceptions are cases like Hurricane Katrina. The only reason the home-owners insurance carriers in the area have not gone totally out of business due to claims is that they denied, and denied, and denied claims. If they paid out on all those claims they'd probably go under. that's a case where a natural disaster caused SO many claims at once there's no practical way for the carrier to cover its payouts.

Anyone reading who is an actuary can explain in more detail

Answer 2

In our community of 70,000 people, there are about 30,000 dwellings. I think we have one house fire about once a week. Not all fires are total losses.

I pay $500 per year for homeowners insurance.which comes to $15 million per year for 30,000 houses

The average house is $200,000. Times 50 equals $10 million. That leave $5 million profit or about 33% on each dollar in premiums.

Between the paying of the premium and paying claims the excess cash is invested similar to what a bank might do, but without most restrictions. I have personally sold non traditional real estate and had insurance companies bid for the mortgage because banks would not loan on it. They do charge higher rates and have higher fees.

Insurance companies can quickly raise rates such as after Katrina, if there are large losses or expenses.

The year of 2006 was the most profitable year for insurance companies that I can remember. There were no hurricanes but the premiums were still high.

Answer 3

Insurance companies have a complex algorithm to help them charge the right premium and invest and make a profit.

Answer 4

stock, bonds and t-bills