Insurance Explained - How Do Insurance Companies Make Money and How Do They Work

Summary

This episode of The Infographics Show explores the intriguing history and mechanics of insurance, from its colorful beginnings with pirates and the Great Fire of London to the complex fiscal models of today. It explains how insurance companies spread risk and profit by evaluating and pooling premiums, often investing in lucrative ventures. The show also touches on different types of insurance and the competitive nature of the modern insurance industry.

Takeaways

• 🎓 Insurance is a financial mechanism for spreading risk among a community to protect individuals from financial ruin.
• 🏴‍☠️ The concept of insurance dates back to ancient Chinese and Babylonian practices of spreading shipping risks.
• 📈 Insurance companies make money by evaluating and taking on risks, hoping that the cost of claims will be less than the collected premiums.
• 💼 The insurance process involves clients, brokers, and underwriters, each playing a specific role in assessing risk and setting policy terms.
• 🔖 The underwriter is a key figure in the insurance process, often taking the largest share of risk and making major decisions on policy acceptance and claims.
• 📝 A policy's terms are finalized when the client and broker agree, leading to the payment of the insurance premium, a portion of which goes to the broker as commission.
• 🔄 Reinsurance is a strategy used by underwriters to mitigate risk by selling part of the policy to another underwriter or firm, retaining a share of the premium.
• 🏢 Modern insurance companies operate on a competitive basis, aiming to write as many policies as possible to create a financial pool for investment.
• 💰 Insurance companies invest the collected premiums in financial products to generate income beyond the premiums, using the cash flow for more lucrative investments.
• 🏠 Property insurance became more common after the Great Fire of London in 1666, with Sir Christopher Wren including an insurance office in his redevelopment plans.
• 👨‍🏫 The script also promotes Skillshare, an online learning platform offering classes on various topics, with a special offer for new members using a promo code.

Q & A

What is the primary purpose of insurance?

Insurance is a financial vehicle that helps spread risk, allowing individuals to avoid financial ruin by distributing the risk across a community.

How do insurance companies make money?

Insurance companies make money by evaluating risk and determining whether it is worth the gamble. They collect premiums from many clients and pay out claims, often investing the premiums to generate additional income.

What is the role of an insurance broker in the insurance process?

The insurance broker assesses the client's risk, draws up an insurance policy, and negotiates with underwriters. The broker takes a commission from the premium and helps negotiate claims settlements.

Who are underwriters and what is their function?

Underwriters evaluate and assume the risk of insurance policies. They decide on the terms of the policy, including what risks to cover, and are responsible for paying out claims.

What is reinsurance and why is it used?

Reinsurance is the practice of underwriters selling a portion of their risk to other underwriters or insurance companies. This spreads the risk further and allows the original underwriter to reduce potential losses.

How did modern insurance begin?

Modern insurance began in the 17th century in London, particularly at coffee houses where merchants and traders would gather. Lloyd's of London, a key player in worldwide insurance, originated from these gatherings.

What significant historical event led to the development of property insurance?

The Great Fire of London in 1666, which devastated the city, led to the development of property insurance as part of the city's redevelopment plans.

How do insurance companies remain competitive in modern times?

Insurance companies remain competitive by pricing policies at their lowest possible point and writing as many policies as possible to create a large financial pool. They also invest the collected premiums in high-interest financial products.

What types of insurance policies are commonly held today?

Common insurance policies today include property, medical, life, travel, car, dental, and even pet insurance.

How does the insurance industry benefit from high-interest investment schemes?

Insurance companies invest the premiums collected from policyholders into high-interest investment schemes. This allows them to generate income from these investments, even if they pay out more in claims than they collect in premiums.