Life insurance companies make money on life insurance policies in four main ways: charging premiums, investing those premiums, gaining interest from cash value investments, and benefiting from lapsed policies.
1. Charging premiums
Paying your policy premiums keeps your policy active, so that your beneficiaries get the death benefit.
Premiums are carefully calculated by your insurer to cover your death benefit and provide profits to the company. Based on the length of your policy’s coverage and your estimated life expectancy, your premiums fund:
Your policy’s death benefit
The cost of administering your policy
Profit for the insurance company
If too many customers die sooner than expected and the insurer needs to pay out more claims than planned, the insurer loses money. This is why the life insurance application process is so thorough, and why there are harsh penalties for concealing information on your application in an effort to lower your rates.
2. Investing premiums
As policyholders pay their premiums, the insurer invests a portion of those payments. The insurer sets aside enough cash to pay out claims in case of a market downturn and keeps any interest gained.
3. Gaining from cash value investing
Insurance companies have an additional investment stream that comes from servicing permanent life insurance policies. Premiums for these policies are many times more expensive than premiums for other types of coverage, such as term life insurance.
This is partially because permanent life insurance premiums fund both the death benefit and an investment-like cash value feature.
The cash value funds go into a larger pool of investments managed by the insurer, and some of the earnings stay with the company.
4. Benefiting from policy lapses and expirations
Finally, there are some insurance policies that go unclaimed, which can happen especially with term life insurance, if the policyholder outlives the term. Term life insurance is only meant to last until the insured person no longer has dependents or debts to cover with their policy — usually between 10 and 30 years.
An expired term life policy is ideal for an insurance company because it means it has collected decades of premiums without paying out any claims.
On the other hand, permanent policies, which come with high premiums, are often surrendered or lapse when owners can’t keep up with the payments.
While a policy lapse or surrender means the insurer is no longer liable for the payout on the policy, it also loses premiums that could have been invested. Most insurers charge surrender fees to recoup some of that lost revenue.
→ Learn more about how to buy life insurance
How does the insurer’s profits affect your life insurance policy?
As long as your insurance company stays profitable, how the company makes a profit is unlikely to have a noticeable effect on your life insurance policy.
If you own a policy with cash value, you may see additional gains based on your insurer’s investments, while the guaranteed minimum interest should keep you from losing money.
Your insurance company turns a profit through premiums and investments, but it’s in an insurer’s interest to keep premiums affordable to keep your business. And if your insurance company has strong finances, it can ensure that your policy pays out to your loved ones when you’re gone.
→ Learn more about how to understand your life insurance policy
More about the life insurance application process
Why do life insurance companies need my Social Security number?
Everything you need to know about the life insurance medical exam
Why does a life insurer need an attending physician statement (APS)?
What is a modified life insurance offer or approved other than applied?
Buying life insurance and disability insurance at the same time
