An insurer or insurance company is an entity that insures against an undesired event (hereafter "loss") taking place by paying out money in that event. To take on this risk, the insurer is paid in advance, usually in a series of payments called " premiums." The guaranty of payment in the event of loss is called an "insurance policy."
An insurer plays a valuable role in the economy by analyzing and thinning financial risks. By collecting affordable premiums from a large number of customers, the insurer is able to pay a "benefit" to any customer that suffers the loss insured against. The insurer thus minimizes and restructures the risk into an affordable payment shared by all of its customers.
Furthermore, an insurer encourages less needlessly risky behavior by charging higher premiums to customers that have higher risk factors for suffering the insured loss, or simply not insuring them at all. This is called "underwriting." Underwriting policy can include charging higher homeowners insurance premiums to homeowners living in a disaster-prone area, charging higher life insurance premiums to smokers, and charging higher auto insurance premiums for male adolescents. This effectively discourages such risky behaviors as living in the known paths of hurricanes and floods, smoking, or letting your teenage son drive.
The Business Model of Insurers
Insurers have an unusual way of making a profit, in that they handle a large amount of money with the expectation that they will have to pay some amount of it back out at a future date. In the meantime, they invest this money (called "float") in interest-bearing securities, or, if they are confident in their investing prowess and their underwriting standards (i.e. so they will not need to pay back the money soon), they may invest in equity. So an insurer can turn a profit by collecting more in premiums than it pays out in loss benefits, and can turn another profit by successfully investing its float.
Insurers are regulated at the state level, usually by a state insurance office in each state in which they write policies. The financial strength of an insurance company is rated by the AM Best Company.  Some large insurers have their own agents who sell their products directly to the public. Many sell their policies through local agents who may work for independent agencies. Increasingly like discount brokers, insurers sell their policies directly to the public via 800 numbers and the internet. The classical insurance agent could be a dying breed.
- Loss ratio is the loss benefits the insurer pays out divided by the premiums it collects. The lower the loss ratio, the better for the insurer and its investors.
- Expense ratio is the insurer's other expenses divided by the premiums collected. Again, the lower the expense ratio, the better for the insurer.
- Combined ratio is the loss ratio + the expense ratio. If the combined ratio is less than 1.00, the insurer is making a profit from policy writing alone. This is in addition to the profit its invested float earns.
Related Fool Articles
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