How Do Life Insurance Companies Make Money?

Jacqueline DeMarco

Writer

When you are young and healthy, life insurance is so cheap it's hard to understand how the life insurance company makes money. Actually, life insurance companies make money in several ways — including investing the premiums.

Before you buy a life insurance policy, it’s important to have a firm grasp of how these policies work. Not only that but also an understanding of the financial incentives of the life insurance companies behind them.

What’s in it for the insurance providers? How do life insurance companies make money by paying out such big life insurance policies? Here’s what you need to know about how insurance providers make money on life insurance.

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  • Life insurance companies make money through policy premiums they collect from policyholders.
  • Insurance companies often invest in those premiums in order to generate investment income.
  • If a policyholder allows a policy to lapse by not making payments, or a term policy expires, insurance companies keep the premiums without having to pay out anything.

How do life insurance companies make money?

Life insurance companies generate revenue in a handful of different ways, namely premiums, investing, and forfeited premiums. Let’s break down how each of these leads to profit for insurance companies.

Premiums

The primary way that life insurance companies make money is through policyholder premium payments. This is the money you pay to keep your policy active. How much your life insurance premiums depends entirely on your unique needs. Your age, health status, chosen policy type, and coverage amount can all play a big role in how high your premium is. The higher your risk of dying in the foreseeable future (this is where age and health status come in), the more you can expect to pay. 

Investing

To help make the most of customers’ premium payments, life insurance companies invest that money. Providers typically do this by investing in a diversified portfolio of assets to help spread out their risk. The reason they can afford to do this is they don’t have to pay out anything on life insurance policies until the policyholders die, so in many cases, they have decades of premium payments to play with. These investment earnings can help offset the cost of expensive death benefits and operating expenses. 

Lapses and expirations

One significant way that life insurance companies profit is when an insured person either allows their policy to lapse or their term policy expires before their death. In either case, the insurance companies don’t have to pay out a death benefit but keep any premium payments you make. 

How life insurance works

The way that life insurance works primarily depends on what type of policy you choose. There are two main types of life insurance policies: term life insurance and permanent life insurance

How term life insurance works

When you buy a term policy, you only receive coverage for a set amount of time. Usually, these terms range from 10 to 30 years. You only make premium payments during that period and your beneficiaries only receive a death benefit (aka an insurance payout) if you die during that term. Term life insurance is usually the more affordable option and can be a good fit for young families on a budget who want to ensure their kids will have financial protection until they come of age. 

How permanent life insurance works

With a permanent life insurance policy, your policy will remain in effect your entire life as long as you continue to make payments. This option is more expensive, but you gain a cash value that grows over time in addition to the death benefit. You can borrow against this cash value or spend it before your death, but when you do, it lowers the amount of money your beneficiaries receive on your death. The cash value also grows tax-deferred over time. If you have a spouse or child who will need financial support for the rest of their lives, this is the better option. 

Two different types of permanent life insurance are whole life and universal life. These types of policies include the option to invest the cash value of the policy. Investing this money can pay off, but it also comes with risk, just like any other investment.

Related: Term Vs Permanent Life Insurance: Key Differences

Couple discussing life insurance: How do life insurance companies make money?

Managing your life insurance

The most important thing to remember about any of these policy types is to always make payments on time (this may be monthly, quarterly, or annually, depending on the policy terms) to keep the policy active. A lapse in payments could mean your beneficiaries won’t receive the full death benefit in the event of your death. 

Designating beneficiaries

Speaking of beneficiaries, you don’t have to leave your entire death benefit or cash value to just one individual. You can choose to split these payments up among multiple different people, such as a spouse and your children. If your beneficiaries do ever receive a payout, a major benefit of life insurance is that they won’t have to pay income tax on that money.

It can be a good idea to prepare your beneficiaries on what steps they need to take upon your death to cash in on the policy. Usually, the beneficiaries have to file a claim after the policyholder dies and provide a death certificate and other key documentation. 

FAQs

How much is life insurance? 

Generally, you can expect to spend anywhere between $15 and $200 per month on life insurance premiums.  However, the best way to understand how much life insurance will cost you is to request quotes from a handful of different life insurance providers. The type of policy, desired benefit amount, your age, and many other factors can all influence how much you spend for coverage. 

How do I know my life insurance company is stable?

When you choose a life insurance company, you want to feel confident the company will be around for a good long time and able to pay out claims (ideally, many decades in the future). The good news is that experts do a lot of this research for you. Check out financial stability ratings for any insurance companies you may want to work with, such as those offered by A.M. Best, Standard & Poor's, Moody's, and Fitch Ratings. You may have to create a free account to view these ratings.

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I'm an award-winning lawyer and personal finance expert featured in Inc. Magazine, CNBC, the Today Show, Business Insider and more. My mission is to make personal finance accessible for everyone. As the largest financial influencer in the world, I'm connected to a community of over 20 million followers across TikTok, Instagram, YouTube, Facebook and Twitter. I'm also the host of the podcast Erika Taught Me. You might recognize me from my viral tagline, "I read the fine print so you don't have to!"

I'm a graduate of Georgetown Law, where I founded the Georgetown Law Entrepreneurship Club, and the University of Notre Dame. I discovered my passion for personal finance after realizing I was drowning in over $200,000 of student debt and needed to take action-ultimately paying off my student loans in under 2 years. I then spent years as a corporate lawyer representing Fortune 500 companies, but I quit because I realized I wanted to have an impact; I wanted to help real people and teach them that you can create a financial future for yourself.

Advertiser Disclosure

Our aim is to help you make financial decisions with confidence through our objective article content and reviews. Erika.com is part of an affiliate sales network and receives compensation for sending traffic to partner sites, such as MileValue.com. This compensation may impact how and where links appear on this site. This site does not include all financial companies or all available financial offers. This in no way affects our recommendations or article content.

Advertiser Disclosure

Our aim is to help you make financial decisions with confidence through our objective article content and reviews. Erika.com is part of an affiliate sales network and receives compensation for sending traffic to partner sites, such as MileValue.com. This compensation may impact how and where links appear on this site. This site does not include all financial companies or all available financial offers. This in no way affects our recommendations or article content.

Advertiser Disclosure

Our aim is to help you make financial decisions with confidence through our objective article content and reviews. Erika.com is part of an affiliate sales network and receives compensation for sending traffic to partner sites, such as MileValue.com. This compensation may impact how and where links appear on this site. This site does not include all financial companies or all available financial offers. This in no way affects our recommendations or article content.