How Does Life Insurance Work?
Everyone is going to die sometime but then how do life insurance companies make money life insurance is essentially a contract between the insured and the insurance company that pays out if the policyholder the insured dies the life insurance money generally goes to a family member or beneficiary but how can this be profitable for the insurance company everyone dies after all well it all has to do with how the contracts are set up there’s generally two types of life insurance
term life and permanent life term life covers the insured for a set amount of time generally somewhere in the range of 15 to 30 year periods if you die in that period the policy pays out if you don’t then you get nothing as you’re no longer covered in this scenario life insurance makes a little bit more sense as it removes the possibility of every policyholder eventually dying since it’s only a given period of time insurance companies can run complicated and sort of morbid models to determine how many
people will die in a given group what your risk of death is and conversely this allows them to properly set your life insurance rates if 100 people pay 50 a month for 10 years the insurance company gets 600 000 then if only 25 of those people die in that term the company only pays out to 25 people that means as long as the life insurance policies only pay out less than 24k each then the insurance company still turns a profit that’s not to mention too that the insurance company can invest the premiums
that you pay in the meantime turning an even bigger profit but what about permanent life insurance in these scenarios the plan will pay out if the policyholder is still paying their premiums at the time of death companies that sell these policies make money in a few different ways they get to keep the money from people who stop paying their premiums and move on this is essentially pure profit for insurers as they never have to pay out and two they invest the money people pay over time a
term life insurance policy for a healthy 20 year old is about 70 a month for a hundred thousand dollars of coverage that means if a person lives to be 80 they’ll have paid about 50 000 in premiums over that time they would still get about 2x return on their money but if the insurance company invested that money over that time they could turn it into several hundred thousand dollars at a modest interest rate of return thanks to compounding interest but then why even get life insurance well because if
you don’t live to be 80 then you’ll still get the full payout and will have paid much less in premiums making your return even better the last minor way that companies can make money on life insurance is by sneakily putting in terms and clauses into the contracts this can get the companies out of paying out certain death benefits in fringe scenarios this helps ramp up the profit just slightly more so to summarize
life insurance companies make money by either setting term limits charging higher premiums investing the money you give them and otherwise running complicated statistical formulas about who will die and when to ensure that they keep their profits high and their payouts low.
