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Insurance Explained: How Do Insurance Companies Make Money?Video DescriptionSummaryEver wondered how insurance companies pay out massive claims and still pocket billions in profit? It seems like a mystery, but the business model is actually straightforward. In this video, we break down the economics of the insurance industry in simple, easy-to-understand terms.
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00:06While some of us may think that there's nothing more boring than attending an insurance conference
00:11on a wet Tuesday night in Boston, and we may well be right, but if we look back to see
00:15how the industry began, it isn't as dull as it might first appear.
00:19From swashbuckling pirates to a ferocious fire that ravaged the world's greatest city,
00:23insurance has had a colorful past.
00:25But how do those grey suits who sell insurance really make money, and how do the inner work
00:29ings of one of the most complicated fiscal models really work?
00:32If these questions whet your curiosity, then stay tuned to today's episode of the Infographics
00:37Show, why do insurance companies make money, and how do they work?
00:41What is insurance?
00:42Well, insurance is a financial vehicle that helps spread risk.
00:46By taking a risk from an individual, and spreading that risk around the community, the individual
00:50is able to go about their personal or business level, and spreading that risk from financial
00:55ruin.
00:55In the simplest terms, let's look at two people.
00:58One is named Bob, and the other Jim.
01:00Bob says to Jim, I'll give you $10, but if I lose my cell phone, you'll have to buy
01:05me a new one.
01:06If Jim agrees, then that's insurance right there.
01:09Insurance companies make money because they evaluate the risk and decide whether it is worth
01:13the gamble.
01:14Jim believes that Bob probably won't lose his phone, and he'll therefore be $10 richer.
01:19If Jim finds 100 more people who are willing to give him $10 each to cover their phones,
01:24he has $1,000.
01:26If one of those 100 people loses their phone, and Jim pays $100 as compensation, he still
01:32has $900.
01:33The insurance idea has been floating around since the ancient Chinese and the Babylonians
01:38spreading their shipping risks.
01:39But it wasn't until around the 17th century in London that modern insurance really took off.
01:44Merchant marine men and traders often hung out in coffee shops in the Business District
01:49of London, and while drinking copious amounts of coffee, the idea of modern-day insurance
01:54was born.
01:55Lloyd's of London, the heart of worldwide insurance, was developed inside one of these
01:59coffee houses, and here's how it worked.
02:01First, you have the client.
02:03Say the client has a ship that he is nervous about losing to pirates offshore, or perhaps
02:07the vessel will be destroyed in bad weather.
02:09The client approaches an insurance broker.
02:11The broker looks at the ship, or pays someone to look at the ship, and they decide how much
02:16the total value of that ship is worth.
02:18The broker then assesses the risk.
02:20He asks the client where he is traveling to and what cargo he will be carrying.
02:25With all this information, he draws up an insurance policy which he shows to the third
02:29person in the chain, the underwriter.
02:31For a cheaper premium, the underwriter may exclude a few risks.
02:35And for a few more bugs, he may include some extra risks.
02:38Now, there are normally lots of underwriters approached, but one will be the lead, and
02:42the lead underwriter, like Jim, will normally take the largest proportion of the risk and
02:47sign his name first on the policy document.
02:50He is known as the underwriter as he writes his name under the risk on the insurance policy.
02:55The lead underwriter makes the major decisions when it comes to accepting the policy, and
02:59will be the main man to agree to any claims on the policy.
03:02Once the terms of the policy are agreed to, it is made legal, and the client is happy and
03:07the ship sets sails, but not before paying the insurance premium to the broker, who will
03:11take about 10% and pass the rest on to the underwriter.
03:15But what should happen if pirates board the ship, steal the cargo, and burn it at sea?
03:19Well, the client, if he is still alive, if not a representative of the client, will speak
03:24to the insurance broker, and the broker will visit with the lead underwriter and tell him
03:28the bad news.
03:29The rest of the underwriters, there may well be as many as 20 on a big policy, are told
03:33the news, and then the broker must negotiate the best claim settlement for the client or
03:37his or her representatives.
03:39The underwriters pay the money to the broker, who passes it on to the client, without deducting
03:44any cut.
03:45The broker makes his money once the premium is paid, and will help negotiate the best claims
03:49for his clients through gentlemanly honor and the prospect of future business.
03:53Now it may not be all bad news for the underwriter.
03:55If he is wise and not greedy, he may have re-insured the policy.
04:00Re-insurance puts the underwriter in the position of the client.
04:03The underwriter sells the policy onto another underwriter, or firm of underwriters, while
04:08retaining a share of the premium.
04:10Confused yet?
04:11Think back to Jim and his phone insurance.
04:13If Jim resold his $10 phone policy for $9, rather than the $10 he received, then he gets
04:19to keep a dollar each for each of his 100 clients, meaning he has $100 completely risk-free.
04:25Similarly, much of the modern-day insurance that flows through Lloyds of London is re-insured
04:30out of the building to smaller insurance companies all across the world.
04:33So what starts as a simple agreement between the client and the broker, or Jim and Bob,
04:38is spread across a business community who each stand to profit from the premium or take
04:42a cut of any losses.
04:44This is how insurance works, by the spreading of risk over communities.
04:48So that is how maritime insurance was born.
04:50It was developed through the need of ship owners to carry on in business should they lose everything
04:54whilst at sea.
04:55But what about property insurance?
04:57Well, around the same time, 1666, the Great Fire of London devastated the city where modern-day
05:03insurance was born.
05:04And famous architect Sir Christopher Wren, in his Great London Redevelopment Project in
05:091667, made sure to include an insurance office in his new plan.
05:13Now, property insurance is commonplace with most homeowners having a policy in place.
05:17Also, medical, life, travel, car, and dental insurance are all commonly held policies.
05:23Even pet insurance is a major insurance business nowadays.
05:26Over time, the business model has evolved.
05:28Modern-day insurance companies are fiercely competitive, which is good for you, the client,
05:33as policies are priced at their lowest possible point.
05:35Companies now look to write as many policies as possible to create a financial pool.
05:40They take the premium from thousands of policies and invest that money in other financial products.
05:45So the insurance underwriter may pay out more claims than they make in policy premiums.
05:49But they have invested all those premiums in a high-interest investment scheme, so they
05:54make their money outside of the original insurance product.
05:57Insurance in this example is a way of creating cash flow to be used in more lucrative investments.
06:02And if you're wondering what other creative and lucrative ways there are to make more
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06:36description and start learning today.
06:37So, what do you think?
06:39Do you have insurance to protect against the unexpected?
06:41Do insurance companies charge too much?
06:43Is it all just a scam?
06:45Let us know your thoughts in the comments.
06:47Also, be sure to check out our other video called US Teachers vs UK Teachers.
06:51Thanks for watching, and as always don't forget to like, share, and subscribe!
06:55See you next time!