Insurance firms earn profits by taking in more premium incomethan they pay out in policy...

Insurance firms earn profits by taking in more premium income than they pay out in policy payments. Firms can increase their spread between premium income and policy payouts in two ways. Discuss two ways that insurance companies earn profits.

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One way is to decrease future required payouts for any given level of premium payments. This can be accomplished by reducing the risk of the insured pool (provided the policyholders do not demand premium rebates that fully reflect lower expected future payouts). The other way is to increase the profitability of interest income on net policy reserves. Since insurance liabilities typically are long term, the insurance company has long periods of time to invest premium payments in interest earning asset portfolios. The higher the yield on the insurance company's investments, the greater the policy payout (in the case of variable life insurance) and the greater the insurance company's profitability. Since junk bonds offer high yields, they offer insurance companies an opportunity to increase the return on their asset portfolio. However, junk bonds are much more risky and as result of the recent failures of some life insurance firms, the NAIC’s proposed laws limiting insurance company holdings of junk bonds in their asset portfolios.

keosha answered 2 years ago

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