Revenue model of Insurance companies

Insurance company payouts! We’ve seen the dramatic presentation of these in various media where someone’s life is put in peril to release a massive payday in the form of insurance ke paise or we see the “besahara family” looking for respite in the form of insurance ke paise.

Well, these portrayals are rather single-dimensional, as a lot of insurance payouts are a lot less dramatic and do not only cover the loss of value to an unfortunate person's passing.

Another aspect that isn’t as glamorous(might explain why it’s not covered as fervently), but equally important if not more, is how insurance companies make the money to give out in these multiple cases while maintaining their businesses, preferably at a profit.

So today, we turn the spotlight on this little-known facet of the insurance industry as we find out, “How do insurance companies make money?”

The Insurance Industry

The insurance industry of India is regulated by the Insurance Regulatory Development Authority of India (IRDAI) which estimates that the market for insurance will increase exponentially over the next few years due to innovative products, well-organised growing distribution channels, and government policies like Pradhan Mantri Jeevan Jyoti Yojana, Atal Pension Plan, and Covid -19 insurance policy schemes.

The life insurance industry of India is dominated by LIC, with 66.2% of the ‘life insurance’ market in its hand. This market is expected to reach $200 billion by 2027, which is about ₹16 lakh crore.

The Indian health insurance industry reported a growth of 26.3% in FY22, making it the largest non-life insurance sub-segment with a market share of about 36%, followed by the motor segment at 32%

The share of the private and public sector in the ‘non-life insurance’ segment is in a competitive stage where the private sector enjoys 48% of the market, and the public sector has the next 38.8% of the market.

The insurance regulator IRDAI has also undertaken various initiatives towards boosting the insurance penetration, such as permitting insurers to conduct video-based KYC, launching standardised insurance products and allowing insurers to offer rewards for low-risk behaviour.

Driving Forces of the Insurance Industry:

Several factors contribute to this growth, including:

a. Expanding Economy: India's growing economy creates a larger base of potential customers with disposable income who want to invest in insurance.

b. Growing Middle Class: A rising middle class is increasingly seeking financial security, leading to a higher demand for insurance products.

c. Government Support: Regulatory reforms and government initiatives are promoting insurance penetration in India.

d. Innovation: Insurtech startups are emerging, offering new and innovative insurance products and distribution channels.

Thus, all in all, we can say that with every possible entity and policy supporting the insurance industry, it is bound to rise! And so we are here to simplify the working of the insurance industry for you. 

Interested? Hop in!

Meaning of Insurance

Starting with the basics first! 

Insurance is a legal contract between two parties which consists of the insurance company (insurer) and the individual (insured), in which the insurance company agrees to financially protect the insured individual for financial losses caused by a type of event which qualifies as the one to be insured in exchange for the premiums paid by an individual. 

To simplify, it is a risk transfer mechanism in which you transfer your risk to an insurance company in exchange for protection against financial loss caused by unforeseen events ranging from the ones in your life to the mobile phones you use and in order to avail such too-good-to-be true services; the premium is the amount you pay for this agreement. 

Finally, it's critical to safeguard what's 'vital' to you.

Let's look at the aspects which qualify as an insurable risk.

What Qualifies as an Insurable Risk?

a. Quantifiable: For an unforeseen event to be labelled as an insurable risk, it has to be one that can possibly be stated in numbers. This is an essential prerequisite as an insurance company calculates the amount of premium required based on this parameter.

b. Unintentional: 'Unforeseen’ is the word that you will come across every time you go through a write-up on insurance as it is one of the requirements for an insurable risk. Any measurable loss that occurs by chance is likely to be considered as an insurable risk. 

c. Reasonable: A measurable loss that occurs by chance now has to be reasonable in terms of money as well. The loss that occurred should not be too expensive to be covered. 

Next, let’s see exactly what can be insured as we look at the various types of insurance products

Types of Insurance Products

Insurance products can be generally classified as either Life insurance products or General Insurance products. What do they mean? Well, let’s have a brief look into them. 

a. Life insurance protects you from the likelihood of unforeseen financial loss from dying. Term plans, endowment plans, whole life insurance plans, money back plans, and unit-linked investment plans are just a few examples of life insurance policies. Many life insurance policies, which incorporate protection and savings, can be an excellent tool for long-term savings.

b. General insurance products, on the flip side, cover financial losses caused by a variety of risks other than those related to mortality. Health insurance, motor insurance, marine insurance, liability insurance, travel insurance, and commercial insurance are all examples of general insurance products that cover a wide range of risks.

Picking The Right Insurance For You

In addition to this, insurance products are highly dynamic in nature and one has to spend a lot of time analyzing whether or not the premiums are affordable and also whether the offerings and the specified terms and conditions of the insurance align with your needs or not.

There is a solution to ease this process and that’s our very own tech-driven financial planning platform, Finology Recipe. All you need to do on this platform is enter your age, your goals, the duration in which you want to achieve those goals, and your income. Following this, Finology’s Recipe will serve you with unbiased recommendations which can save and shape your future for the better! 

So, how do these companies make money? Let's find out.

Revenue Sources of Insurance companies

TAKE MORE THAN YOU NEED TO GIVE OUT! This is how an insurance company does business. Let me elaborate and simplify this process for you. 

The business model of insurance companies has mainly 2 components; Underwriting and investment income. 

Underwriting activities

Only a small part of the population that is insured ends up making a claim. These people are paid from the majority of revenue generated by premiums collected from insured individuals, what is left is used for running the business and the rest is profit.

For example, suppose there is an insurance company called XYZ and it has earned ₹5 lakh from the premiums paid to it. So, technically this becomes one of the revenue-making zones for the business. 

Now, since it is a business it might have incurred some cost for running it, as well as paid out a certain amount to its customers who have unfortunately suffered due to an unforeseen event.

Let’s assume that the expenses were equal to Rs. 1 lakh and Rs. 2 lakhs were paid out to the ones who have been insured by the company. 

Therefore, the total profit for XYZ insurance company is:

Revenue - (Operating expense + amount claimed by insured) which in our case is Rs. 2 lakhs. This is one way an insurance company makes money. 

Investment income

Now we all know that sitting on cash is the worst thing that one can do with their money as the time value or the purchasing power of it decreases with the time. The insurance industry understands it the best! 

Therefore they have constructed their business model around this concept as well. Now how does this work? See, an insurance company hardly keeps the premiums collected in their pockets. They rather invest this money in various financial markets in order to increase their income.

Now how can they do this? It’s simple, they don’t have to shell out much on creating a product unlike other industries like the automobile, FMCG or any other industry which is engaged in the creation of physical goods.

Therefore, just like any other investor, even the insurance company invests in markets and enjoys a return from it. 

Other revenue streams:

However, the revenue generation is not limited to only these two methods, there are several other like cash value cancellations wherein the insured individual chooses to close the account as a result of which the insurance company gets to keep all of the premiums that it has previously collected. 

Along with this they also make money from coverage lapses which are nothing but the penalty collected by an insurance company when an insured person defaults on payment of premium.

The Bottom Line

Premium is the major source of this industry’s income, that is its “revenue from operations”, and it invests a major part of this money as well since insurance companies don’t necessarily operate asset-heavy businesses to establish a production line for its inventory. Technical defaults and cancellations comprise the rest of the revenue source.

This is how the “Zindagi ke saath bhi, zindagi ke baad bhi” company and more like it stay zinda and functioning as well as generate enough money to be able to pay insured individuals their due amounts.

Following this information, has your outlook on the insurance industry changed? Let us know in the comments below if you learned something new, and share with a friend who you think wouldn't know these facts about insurance companies.