Insurance company profit example

Give a simple numerical example of what an insurance company does to turn a profit

Here’s a very simple toy example showing how an insurance company makes money:

Assumptions

• You sell 1,000 identical policies.
• Each policyholder pays a \$100 annual premium.
• The insurer estimates a 5% chance any one policy will result in a claim, and that the average claim size is \$1,000.
• The company has other operating costs (salaries, marketing, overhead) equal to 20% of total premiums.

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1. Premium revenue

   $$ 1{,}000\ \text{policies} \times \$100 = \$100{,}000 $$

2. Expected claims cost

   $$ 1{,}000\ \text{policies} \times 5\% \times \$1{,}000 = \$50{,}000 $$

3. Operating expenses

   $$ 20\% \times \$100{,}000 = \$20{,}000 $$

4. Profit

   $$ \underbrace{\$100{,}000}{\text{Premiums}} - \underbrace{\$50{,}000}{\text{Claims}} - \underbrace{\$20{,}000}_{\text{Expenses}} = \$30{,}000 $$

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• Break‑even “loss ratio” here would be claims / premiums = 50%, and expense ratio = 20%.
• Together they give a combined ratio of 70% (50% + 20%), leaving 30% as profit margin.

In reality, insurers use actuarial models to set premiums so that, over many policies and years, the combined ratio stays below 100%—that gap is their profit.