What is an Insurance, How Insurance Company works and How Does Insurance Company Makes Profit. Today In this Article we will understand how insurance company works with and Example. This article will help you in Upcoming Insurance Exam such as LIC AAO 2019.

What is an Insurance, How Insurance Company works and How Does Insurance Company Makes
Profit?

What is an Insurance Insurance is an arrangement where an entity (insurer) promises
to provide compensation to the insured upon the happening of a specified event
or loss. This promise can be obtained by paying a small charge upfront
(premium). 

I. The terms are decided between the insurer and insured via an
insurance contract. 

II. It is contract between Insurer and Insured for Financial
Protection.

III. Risk-transfer mechanism that ensures full or partial financial
compensation for the loss or damage caused by event(s) beyond the control.

How
Insurance Company works?

An insurance company works on building products aimed at
providing financial protection from risks. These risks include death of bread
earner (life insurance), hospitalization expenses (health insurance), damage to
assets (car insurance) etc. The insurance company’s role includes –
a) pricing of the premium
b) determining the coverage i.e. compensation
c) inking the insurance contract
d) collection of premium
e) administering the claim/promise

How does Insurance
Companies make Profit?

Profit = Premium
collected + Investment income on premium collected – Selling expenses – Claims
paid & provisioned – Operating expenses

Example – 



· Premium
collected = Rs. 10 lacs (say, 100 users on avg paid Rs. 10,000 each as premium)
· Investment
income = Rs. 80,000 (8% interest p.a. on Rs. 10 lacs)
· Selling
expenses = Rs. 1,50,000 (15% commission paid on Rs. 10 lacs)
· Claims
paid & provisioned = Rs. 6,50,000 (say, 13% of users made claims averaging
Rs. 50,000 each)
· Operating
expenses = Rs. 2,00,000 (20% of Rs. 10 lacs)

Hence, the profit earned by the insurance company is Rs. 1.8 lacs (Rs. 10
lacs + Rs. 0.8 lacs – Rs. 1.5 lacs – Rs. 6.5 lacs – Rs. 2.0 lacs).

While in the above scenario the insurer made a profit – it
would have been very different had 23% of the users made a claim instead of
only 13%. In this scenario, the insurer would have made a loss of Rs. 4.7 lacs.

Thus, the insurer too has to carry risk on its books and has to manage the
delicate balance between risk forecasting and pricing the policy.


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