What Does My Insurance Company Do With My Premium?

There are some common and persistent misconceptions about what insurance companies do with the money they collect from you and every other policyholder. Some people think it sits in the bank until someone makes a claim. Not true. Others believe that premiums go to pay for claims that have already happened. Not true either.

Your premium dollar travels a long and winding road, but, in the end, most of it goes to assist consumers in one way or another. For example, if you suffer a loss, a portion of your premium dollar and those of several other policyholders finds its way back to you, to help you recover.

For the record, this is what happens to your premiums:

In the insurance system, money is always moving. On a daily basis, there are claims to be settled, taxes to be paid and other costs related to running a business (paying salaries, buying equipment, paying rent, etc.). Some money is always set aside so that the company can respond quickly to catastrophes, when a large number of claims will have to be paid in a short period of time. This is called a reserve.

Any money that is not needed for day-to-day expenses or reserves is usually invested by insurers.

Here are a few things you should know about insurers’ investments:

1. Contrary to what some people think, insurers have never had a year when they lost money on investments. Some years are better than others, but the industry has always generated positive investment returns. 
2. Insurers are among the most careful investors in the country. On average, approximately three quarters of their investments are in government bonds.
3. In order to make sure that insurers are able to pay claims, the federal government monitors the industry’s investments to make certain that they are low-risk.
4. Insurers strive to maintain a portfolio that allows for quick liquidation of investments to pay claims.

Why do insurance companies invest the money? 

The nature of insurance is such that your insurance company holds your premium until it is needed to pay claims. By investing the money in the interim and making a return, your insurance company is able to offset the cost of claims and charge you less than you would otherwise pay.

In fact, there have been years when returns on investments were so good (10% or higher) that insurers only had to collect enough premium to pay for claims and expenses, and made all of their profit from investments. Even when investment returns are much more modest, this is an excellent way to keep premiums as low as possible for consumers.