Commercial insurance companies are in the business of making a profit. They sell policies to customers and charge an annual premium for the protection. An insurance policy is a legally binding contract, and it obligates the company to pay for any of the claims that are covered in the policy. For example, when you buy automobile insurance, you agree to pay the annual premium, and the insurance company agrees to pay for damages from an accident.
Insurance companies have teams of actuaries who estimate the probable amount of claims in each category of things they insure, based on historical averages. The insurance company charges enough premiums to pay for the claims, while still having a profit left over to pay dividends to their shareholders. In most years, if fate behaves, claims replicate their historical averages. However, when unexpected events happen, such as Hurricane Katrina or the West Coast Wildfires, insurance companies lose money.
Since claims occur over the course of a year, insurance companies invest the premiums they collect in short term investments (e.g., in the case of auto or homeowners’ policies) or in long term investments (e.g., in the case of whole life insurance). This gives them another source of profit for their shareholders.
There are insurance companies that are mutual insurance companies. These are analogous to credit unions in the banking sector. In mutual companies, the policyholders are the owners of the company. That means that while a mutual company must cover all their claims, they do not have to generate a profit for their shareholders. If they have extra cash left over at the end of the year, they can send refund checks to their policyholders or reduce premiums the next year. Mutual insurance companies are very competitive in their rates.
When you are new to the insurance market, it is a good idea to use an insurance broker who can advise you on the ins and outs of the market. The broker is paid a commission by the insurance company (normally in the range of 8% of the premium) to place your insurance with them. Once you become confident, try companies that sell by phone or over the internet. This usually saves money because they do not pay commissions to brokers. Make sure you get at least three quotes. Here are some legitimate companies that sell by phone or internet:
- GEICO
- Liberty Mutual
- Progressive
- USAA (for veterans of families of veterans)
I personally switched a number of years ago from a commercial insurance company to Liberty Mutual for both auto and homeowners’ insurance and my premium went down by about 25%.