How are Life Insurance Companies able to pay Large Claims compared to the Low Premiums they charge?

Alright, I have a question for you. Have you ever thought about how life insurance companies can pay larger claims despite charging relatively low premiums from the policyholders??

Read the question again and let it sink in. Did you just experience the “Aha” moment? Well, last week I too had the same question. So, let’s learn more about it.?

• Law of Large Numbers: Life Insurance companies have a lot of policyholders and not all of them will make claims simultaneously. So, the premiums collected by many can be used to pay for the few. This method is known as the law of large numbers which helps spread the risk and stabilize the company’s finances.?
• Accurate Accutarial Predictions: Insurers use detailed actuarial tables to accurately predict life expectancy and mortality rates. This helps them understand the number of claims they are likely to pay and when making them stay proactive with the funds.?
• Investments: Insurance companies invest the premiums collected from the policyholders in some assets which gives them returns over time. The returns help them grow their capital and pay for claims despite collecting lower premiums.?
• Underwriting and Risk Selection: Insurance companies carefully assess the health, lifestyle, and other risk factors of applicants before issuing policies. Their main goal is to always select low-risk applicants which reduces the likelihood of paying claims.
• Policy Lapse: Many policies especially term life products lapse before a claim is ever made. When this happens, the company gets to keep the premiums without paying any death benefit. This offsets the cost of claims placed by other policyholders.?
• Reinsurance: Usually insurance companies purchase reinsurance to protect themselves against large claims. So, the concept is transferring some of the risk to a reinsurance company, they reduce the potential impact of paying huge claims.?
• Different products: Life Insurance companies have diversification in their products like term life, whole life, annuities, final expense, etc., allowing them to balance risk across different types of policies.?
• Capital Reserves: Life Insurance companies are required by regulators to maintain significant capital reserves to ensure they can meet their obligations. It acts as a financial cushion allowing them to pay claims during emergencies.?

So, these are some of the reasons why life insurance companies can manage to pay large claims even after charging lower premiums from policyholders.?