Life insurance companies are clearly making a profit from the products they are offering, but it can seem strange that anyone could know how or when someone was going to die. In order to make a profit, it would seem that life insurance companies would need a crystal ball. However, once you understand the power of statistics, you will understand that the secret to making money with life insurance is in the numbers.
Life insurance companies use actuaries
To begin with, life insurance companies have access to large amounts of data and the ability to analyze them in mathematical ways. Life insurance companies have men and women who are dedicated to both the gathering and analysis of this data. These people are referred to as actuaries, and they are the heart and soul of the life insurance industry. Understanding how long people have lived in the past, their physical health at the time of their death and the cause of death can be used to extrapolate future probabilities for the longevity of those alive today.
The way an actuary predicts the future
It is true that no actuary can determine the exact day that person will die, but if they are given the proper data about an individual, they can construct probabilities for the length of time that a person will live. There are many factors that when combined will produce a number for a large group of people with these attributes. For example, an actuary can take a man’s age, weight, height, specific medical conditions and compute the average age he will live to. Although a specific man may die sooner or live longer than average, he will typically live to the age computed based upon past data.
Actuaries analyze new data to protect against financial loss
Actuaries use past data to construct probabilities for different classifications of individuals, but they are also involved in the gathering of new data. It is important to spot new trends in life expectancy and the different factors that are affecting people’s longevity. If there has been a change in behavior that is related to a reduced lifespan, an insurance company needs to know this. Premiums must be increased to reflect this change. If the probability of death is increasing without a corresponding increase in premiums collected, the increase in claims paid out will hurt profits. In extreme circumstances, a life insurance company can be driven out of business.
Actuaries analyze new data to stay competitive
A change in the other direction is also important for actuaries to discover. It would seem that this would not be a major concern. If people are living longer, but are paying the same premiums, profits will only increase. However, this neglects the fact that life insurance companies are competing with each other. If discounted life insurance policies are offered by one company but not another, the insurance company offering the lower rates will get most of the business. Keeping up with changes in statistics can protect or increase profits.
Another key element in profits
In order for a life insurance company to make a profit, it is important to have accurate data on the individual applying for life insurance. Without the correct data, it is easy to compute the wrong premiums to charge the customer. If premiums are lower than they should be, a life insurance company can easily lose money on a policy. This is why it is a bad idea for an individual to lie on their life insurance application. If a person were to state they are a non-smoker in order to get a lower life insurance rate only later to die from complications related to cigarette smoking, the claim would likely be denied by the insurance company.
Sam Patterson is a freelance writer out of the University of Toronto. He is currently working in affiliation with My Insurance Broker on creating a knowledge base pertaining to the diverse world of insurance. The intricacies of Home, Auto and Business Insurances’ are a few of the various products Sam delves into at insuremetoo.com.