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How does a car insurance company make money?

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The lowdown...
  • Car insurance companies make money by collecting premiums and placing the collecting money into reliable investment vehicles
  • Customers who add significantly more coverage to their policies and never file any claims further assist the insurer’s bottom line
  • Mandatory coverage requirements on drivers combined with insurance companies’ ability to deny high-risk customer further supports solvency

A car insurance company can be a rather quizzical business to those not involved with the industry. The company seemingly exists to pay out money to those who file claims.

Yes, an auto insurance policy costs money to purchase. Regardless, someone who pays $1,200 per year for $500,000 in liability coverage would be getting a huge benefit if such a massive payout was issued. The insurance provider, it appears, is stuck with a massive loss.

The mere fact that insurance companies remain operational clearly indicates means the enterprises are solvent.

Solvency is based on the ability of the company to earn money. All of this is interesting considering the way car insurance providers pay out on claims is rather straight forward.

So, how is it that car insurance companies are able to make money? The answer is rooted in a combination of simple economics and viable business practices.

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How the Insurance Business Model Works

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Insurance companies charge a fee for a policy. Money collected by policyholders is used to pay out on claims.

Policyholders who do not file a claim are a net positive. They pay in and never take out. If their numbers are significant, the money they pay covers the money distributed to those with a valid claim.

That said, the money paid into “the system” does need to be effectively managed. Insurance companies rely on customer premium payments to cover overhead, which can be significant.

Curtailing unnecessary spending keeps waste to a minimum. Bottom lines are protected thanks to this approach.

Insurance companies also invest their capital. The interest and gains procured from these investments further add to the liquidity necessary to pay on claims. The investments are not likely going to be anything high in risk.

Putting millions of dollars into treasury bonds or procuring commercial real estate properties might be safe investments to boost net worth.

Tens of millions of dollars invested into a vehicle paying 1.5 percent interest yields a huge sum of money over the course of a decade.

Insurance companies also direct money wisely into smart advertising strategies. There is competition in this industry. A great advertising campaign firmly establishes a particular insurance provider in the eyes of an audience.

The audience then takes its business to the insurance company.

And there is another item that assists the insurance companies to attract customers.

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Mandated Liability Coverage

Simply put, due to legal requirements in 48 states, anyone who owns a car must purchase car insurance. Even if the car is not being used, to maintain registration, the vehicle does need to be insured.

This law creates a massive pool of customers who are required to purchase insurance.

Specifically, various laws mandate the purchase of liability insurance. Liability covered injury and death to persons and damage to property. The minimum amounts of liability required do vary among all the different states.

A low amount of insurance is not going to come with a heavy premium amount. Still, there is money paid into the insurance company’s account.

Adding to the Policy

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A basic policy is not something many drivers would wish to base their financial health and wellness. $25,000 in bodily injury coverage does little help when a person is being held responsible for $200,000 in damages.

So, a decision may be made to greatly maximize liability coverage. Costs rise here on the premium and many are willing to pay.

Liability is not the only type of coverage someone can purchase to cover a car. Three other types of insurance can be procured:

These various coverage categories add protections that cover damage to a vehicle in the event of an accident with another vehicle or an object or structure of some sort. Uninsured motorist coverage defines itself.

Of course, the obvious question here is “How can the insurance company make money if it has to pay out on so many different types of claims?”

As previously noted, the insurance company does not need to pay when no one files a claim.

Drivers and Claims

In order for a driver to file a claim on an insurance policy, there needs to be an incident of some kind. Millions of drivers carry at-fault liability coverage to pay for costs associated with causing an accident.

Only a small percentage of drivers are ever at fault for an accident.

The same is true of the uninsured motorist, collision, and comprehensive policies. If nothing happens to the car, then no claim is filed.

Most costs associated with driving a car are connected to routine maintenance or the lack thereof. Insurance does not cover these types of costs.

Screening Applicants

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Insurance companies also look very closely at an applicant’s background prior to coming up with a quote. Someone who has a terrible driving record is going to pay enormously high fees.

In some cases, the insurance company may choose to not accept the applicant as a customer. Similarly, those current policyholders who are constantly filing claims or getting into trouble with the traffic court and the law may be dropped.

The insurance company reduces its risks in doing so.

Finding the Best Policy

Those who are good drivers who have never found themselves in an accident nor have filed any claims on previous policies would make very much sought after customers to an insurance company.

The ability to locate a good deal on a policy increases immensely for drivers who haven’t filed claims. A wider search is going to lead to discovering better offers.

Reviewing a vast pool of quotes would be extremely beneficial to someone hoping to save money and save the insurance companies a bit of trouble.

Compare car insurance options today by using our free rate comparison tool.

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