Tuesday, 12 July 2011

What do insurance providers do with my money?

Insurance policyholders often wonder what insurance providers do with their money. Some believe that their premiums accumulate in individual accounts until such time as a claim needs to be made. Others are convinced that their money is held in a common fund and that claims for any policyholder are paid out from that account. The reality is that a good deal of your money goes towards secure, long-term growth investments.

While you may feel that your insurance company is taking money intended to pay for claims and investing it for its own economic gain, the reality is that through investments the insurance industry is able to keep premiums lower. Imagine two scenarios: in one, your money is held in common and saved until a policyholder needs to make a claim, in the other your money is put into long-term bonds and other secure investments, growing at 5-10% per year. In the first scenario, the common fund would consist of the sum of the premiums paid towards it. In the second, the fund would not only include the premiums, but also the added income from the investments. Therefore, by putting your money into secure investments, insurance providers require a smaller amount of money for premiums, since there is the added income from investments to help pay for claims. It just makes economic sense.

If you are still concerned that your insurance provider is taking too great a risk with your money, keep in mind that the federal government monitors investments made by insurance companies to ensure that they are low-risk, slow-growth investments, rather than high-risk ventures that could end up bankrupting the company. In compliance with the stipulation that their investments should be stable, insurance providers choose to place three quarters of their investments in government bonds, which are guaranteed by the federal government. They also maintain a reserve of money that can be quickly converted into claim compensation in the event of a natural disaster. The Slake Lake fires showed that the insurance industry was able to pay upwards of $700 million in claims --the second largest payout in history-- in a relatively short period of time. They are able to do this precisely because their investments are secure and easily made liquid.