How Does an Insurance Company Work?

Video Transcript

"This is John Pinelli, financial representative, talking to you today about how an insurance company works. So how does an insurance company work? Basically what an insurance company does is they take a ton of people, pool them together, have those people pay a small amount of premiums and then when the insurance company has a few claims they pay out those claims from the premiums they receive. Now the way an insurance company makes a profit is collecting more premiums than what they pay out in claims. This is sort of a simple concept and many people sort of have a negative view of insurance companies because they are making money because their people think that if they were to just save this money and not spend money on insurance they would benefit from that when this is simply not the case. Think of it like this, if you have 100 people and you pool them together now two people of those 100 need claims. This is a small percentage, 2% have a claim. Now without the insurance company, those two people would not be able to cover that loss, whichever it may be whether it be your life or your car or your home, etc., they wouldn't be able to cover that catastrophic loss but the other 98 people might be better off but what it does, the insurance company does is it pools those 100 people together so that they're all paying kind of a smaller portion of that potential expense that can arise from a loss. Now an important component of any insurance company is the underwriting. Now that underwriting department determines what levels of risk they are willing to take on and ultimately can determine what their level of claims are, like I said an insurance company makes money when the premiums exceed the number of claims so underwriting is a crucial part because underwriting can drastically influence the number of claims that come through, better underwriting typically leads to lower amounts of claims, stricter underwriting in terms means maybe less people get approved for insurance but also there is less claims and the insurance company will not have to pay out quite so much. This has been John Pinelli, financial representative talking to you today about how insurance companies work."