Understanding How Health Insurance Companies Make MoneyWednesday, December 1st, 2010 by admin
The health insurance industry is unique in many ways and, according to some; health insurance companies are similar in some respects to the gambling casinos in Las Vegas or Reno. The reason this comparison is made is because of the risk factor involved in writing an insurance policy and, with the way insurance is written, the odds are always in favor of 'the house'.
Insurance companies, including health insurance companies but also life, automobile, mortgage, long term, homeowners, disability and accidental death and dismemberment insurance companies can make money in two ways. If they're fortunate, they will earn money in both ways, however, they can still remain profitable if they only make it in one of the two areas. If they remain unprofitable in both areas, however, they will surely be unable to stay in business.
The first way money is made is by the accumulation of premium dollars paid in by policyholders. Whether it's the health insurance industry or any of the numerous other types of insurance marketed to consumers, an insurance policy is a contract between two entities, the insurer and the insured. The insurer assumes a risk of financial loss on the part of the insured that, in exchange for this assumption of risk, pays a specific amount of money for a specified period of time. This money is known as the premium.
When a covered policyholder makes a claim against his policy this represents a loss for the insurer. Health insurance companies are insuring their customers against medical expenses resulting from injury or illness. If a policyholder faithfully pays his or her premium payments regularly and makes claims against the policy that equal less than the amount of premium paid in, the insurer profits from that policy. By insuring large numbers of people, some of whom will make claims and some who won't, the insurer is betting that more money will be received in the form of premium than will be paid out in the form of claims.
The second way companies in the health insurance industry make money is on the 'float'. Premiums are taken in regularly but claims are not paid out on any predetermined basis. Health insurance companies are required by law to pay out a certain percentage of premium dollars taken in, the percentage being dictated by the particular state in which they are operating. They are also required to have a certain amount held in reserve, ready and waiting for payment of future claims.
The money held in reserve is typically invested in either the stock market or some other investment vehicle. An insurer that's good in investing can profit greatly with these reserve funds.