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One major question that arises when we mention any sort of life insurance is, whether to buy it or not?

Although, this is quite a crucial question that arises in the minds of numerous policy seekers, what many of them are interested in is how do the life insurance companies actually make money and where do a policyholder’s funds go if they opt for a life insurance coverage plan.

Before getting to that point, let’s just brush up the types of life insurance policies.

Types of Life Coverage Plans

So, let’s try to further understand how life insurance companies earn a profit. The products that are generally offered by most of the insurance companies are of 4 types broadly: Term Insurance, Whole Life Insurance, Annuities, and Endowment Plans. The holder of a term insurance policy pays the premium charges periodically during the tenure chosen in exchange for a death benefit that is referred to as the sum assured. With term insurance, the policy seeker can receive a large cover at affordable premium charges. The sum assured can be higher than the premium paid in many of the death claims and still the life insurance providers end up making a profit.

Similarly, the policyholders of endowment plans but on top of this, they also pay a predefined amount with every installment towards a systematic savings system that is to be received as an accumulated payout that is equal to the sum assured on the plan’s maturity. The sum assured is further magnified by the accumulated bonus that is due on the policy annually depending on the investment income of the insurance company.

Under the traditional whole life insurance, the insurance provider covers the policyholder to pay a sum assured with or without bonus depending on the terms and conditions of the policy, on the policyholder’s demise after measuring the risk. All these might just seem simple and easy to understand, however, the mystery still remains.

Profit of Life Insurance Companies

In the instances mentioned previously, it seems next to impossible for the life insurance companies to be making money or profit always. After all, many people are faced with an unfortunate demise and it is certain for each and everyone’s life to end one day. This, therefore means, the insurance providers must be paying off more than they collect from the policyholders. The source of profit and inflow is definitely lying somewhere else.

Let’s say that one million people are insured in one year, it is certain that not all of them will die in a year or even during the next, say 25 years – which is considered as the average tenure of the policy. Though the premium of risk is collected from everyone on a yearly basis, the insurance provider is not required to actually consume all the collected premiums in settling the yearly death claims as their business moves forward. In almost all the instruments, be it term insurance, endowment plans, or any other plan, the actual experience of the death claim is better than what is actually assumed to put a price on these products. In these terms, the insurance provider is conservation in terms of characteristics and it totally justifiable as they need to be covering for the risk of something that is unforeseen.

If the claim experience gets better even by a mere 0.2% or 0.5% annually, it can lead to major savings for the insurance provider over the course of time. Such surplus along with the daily inflow is reinvested by the day to grow and to be able to fund even more going forward. Good underwriting of the existing risk plays quite a crucial role in the generation of income. At the same time, the premium that is accumulated under annuities plans or endowment plans is invested with extreme caution leaving absolutely no funds untouched for even a day.

Yearly Surplus

After paying off the dividends to the shareholders of the company, this money is again reinvested. The annual surplus is reached with the help of an actuary – someone who estimates the insurance provider’s liability, the fixed value of the business in the books, along with the funds available for the daily expenses along with the future appropriation.

The insurer’s return to the holders of the policy on the maturity of the policy or upon the holder’s demise, that is the sum assured and the bonus that has been accrued for the policies that come with profit out of the life of the fund after meeting all of the procurement of the business and the management expenses.

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