One of the most common misconceptions is that insurance companies collect premiums and just spend all of the money. They must have pretty high profit margins, right? All they do is take peoples’ money and they almost never pay out a dime. Well, you might be surprised to learn that insurance companies have razor-thin profit margins. Most of the money they collect goes right back out the door. What do they do with all that money?
Taxes and Overhead
Insurance companies pay taxes just like everyone else. Of course, they only pay tax on profits – which are surprisingly small. Still, it’s a cost that insurers bear every year.
Another expense is overhead. You would think that insurers would be raking in the dough and cutting employees fat pay checks. While some executives do make a lot of money, most people working for the insurer are paid a modest salary. This salary is part of the overhead expenses of the company.
Other overhead expenses include utility bills and company benefits like retirement and health insurance plans.
Homeowner’s insurance companies make a lot of investments. That’s how they’re able to pay insurance claims. In fact, this is where most of the money goes. Insurance companies have to conservatively manage the money they collect and protect it for the benefit of policyholders.
A substantial portion of the investments in an insurer’s portfolio include government bonds, but they also invest in corporate bonds, high-value common stock, real estate, precious metals, and even some speculative investments (though these represent a very small portion of the insurer’s portfolio).
They’re so good at managing risk that there hasn’t ever been a single year when an insurer has lost money. There may be years when they don’t make a lot, but they always profit. They are considered by some to be the best investors in the world because of this.
When you have to file a claim with your Calgary home insurance company, the money has to come from somewhere – the insurer’s cash reserves. This is where a good chunk of money goes that the insurer takes in. While insurance companies try to be conservative in their claim payments, they still have to abide by the contracts that they issue.
Most people pay their premiums faithfully every month, and then forget about the money. Some people pay in for 10, 20, even 30 years and never collect. Sometimes, these same people feel that it’s unfair that they never receive any money from the insurer.
However, this is the nature of insurance – it gathers together a large group of people with the explicit goal of spreading out the risk of financial loss associated with a house fire, theft, or act of God. It’s explicit in every contract that you may never get a return on your premiums. The only way to collect is to hae something catastrophic happen to your home.
But then, that’s why we buy insurance – not because it’s an investment for us, but because we want to be protected from the “what if’s” in life.