Planning for Cash from Policies
It’s important to understand what is paid for out of every premium dollar the insurance industry collects. The vast majority goes to paying claims and then for salaries, commissions and overhead. The rest, and sometimes that’s a small margin, is profit.
Many people are unaware of the fact that insurance premiums cannot immediately be counted as earnings by the company that collects them. Insurance regulation requires that you actually earn the premium one day at a time. So, on an annual policy, we do not earn 100 percent of the premium on the first day, but 1/365th of it. That tiny fraction, rather than the whole sum, is all that’s available to pay claims and expenses on day one, even though we may be liable for millions of dollars worth of exposure to loss from the moment the policy becomes effective. Benefit from the free home insurance quotes from the top insurance companies.
One of the things we can do while we’re holding the money is to invest it. Here again, insurance regulation imposes restrictions on what kinds of investments are permissible and in what proportions. Regulators also take investment returns into account in determining that the rates insurers charge are adequate but not excessive. In addition, regulators, over time, have demanded that some benefit must be realized by policyholders because you are holding this money (the premium paid but not yet earned) and making money on it. We have it, but we don’t have all of it until the end of the policy’s period.
But returns are not guaranteed. Usually we make money, but sometimes we don’t. For instance, we may earn a low return on fixed rate investments, while claims inflation is two or three times more than anticipated. In that situation, the investment income doesn’t make up the shortfall.
Another reason we invest the money while we are “holding” it is to increase our ability to write more business and to deliver on our promise to be there when our customers need us, in other words, to settle claims. We have to have more money in our bank account than is needed to pay known claims and expenses. These extra funds are called “surplus.” Regulators require that insurance companies have a sufficient amount of money on hand at all times to pay for potential claims, plus a sizeable cushion for contingencies. Therefore, for every dollar you are willing to accept from a customer, you have to have a certain amount of money already sitting in your bank account that is readily available to pay claims in the future. We do everything we can to enhance the surplus through investment.
