Car insurance works in the same way as all types of insurance. It basically boils down to the insured gambling with the insurer. The insured is gambling that he or she will need to claim on the insurance during the time period of the policy while the insurer is gambling that the insured will not need to make a claim for the period of the insurance policy.
Where car insurance differs from other types of insurance is in the fact that it is compulsory, it is a requirement by law to have a minimum level of insurance cover.
So how does the insurance broker make money by offering insurance?
When you get a quote for your car insurance the broker will ask you many questions about your car, your personal life and your business life. The insurance broker does this to be able to predict how likely you are to make a claim. The likelihood of you making a claim on your policy is what sets the cost of the policy along with the value of the car if you are looking for fully comprehensive insurance.
Insurance companies have the process of calculating the likelihood of you making a claim down to a science. While a lot of the quote is down to formulas there is an element of previous experience in the quote as well which is where quotes can differ from insurance company to insurance company.
For example a high street insurer may be more concerned about a modified Nissan 200SX, Japanese import insurance or Honda insurance than a company that specialises in insurance for Japanese imports. This is why it sometimes pays to shop around the specialist car magazines to find the best deal.
Okay, so the insurance company has taken your money, then what?
The insurance company will take their cut and the rest will be paid into a pool of money which other insurance companies also pay into. This pool of cash is then used to pay any claims that arise. The pool of cash is also invested.
The insurance company will take their share of the profits on the money they have paid into the pool and if there is not a claim by the end of the insurance policy period they can take their money back.
However if there is a claim on the insurance policy they must pay out by using the premium they have taken from the client who is a claiming on their policy as well as other insurance premiums they have collected from drivers who have not made a claim.
To work out the profit of a car insurance company you would use something like the following formula
(All insurance policy premiums + interest from all investments) – (Admin costs of all policies (overheads) + claims costs)
If the number left is positive the company makes money, if the number is negative the company loses money.
The potential profits in insurance are vast, for example profit on a policy that was not claimed on can be 100’s of %. For example the premium cost the driver 300GBP, the driver does not make a claim so the only cost for the insurer are the admin costs for setting up the policy which for example can be 30GBP. So the profit on this policy at termination is 500% + investment interest.
Bu the potential for losses are also very high as insurance claims can cost many time the premium of the policy.
Nevertheless, there is massive competition in the car insurance market, just take a look at the back of most car magazines to see the amount of companies vying for your business which suggests that car insurance is a very profitable industry.
Here is another StrikeEngine article giving more specific car insurance information
Wikipedia has a more in depth article on insurance and it can be found here