Editing Insurance (section)

===Underwriting and investing===
Insurers' business model aims to collect more in premium and investment income than is paid out in losses, and to also offer a competitive price which consumers will accept. Profit can be reduced to a simple equation:
:Profit = [[cancellation (insurance)|earned premium]] + investment income – incurred loss – underwriting expenses.

Insurers make money in two ways:
* Through [[underwriting]], the process by which insurers select the risks to insure and decide how much in premiums to charge for accepting those risks, and taking the brunt of the risk should it come to fruition.
* By [[investment|investing]] the premiums they collect from insured parties

The most complicated aspect of insuring is the [[actuarial science]] of ratemaking (price-setting) of policies, which uses [[statistics]] and [[probability]] to approximate the rate of future claims based on a given risk. After producing rates, the insurer will use discretion to reject or accept risks through the underwriting process.

At the most basic level, initial rate-making involves looking at the [[frequency]] and [[wikt:severity|severity]] of insured perils and the expected average payout resulting from these perils. Thereafter an insurance company will collect historical loss-data, bring the loss data to [[present value]], and compare these prior losses to the premium collected in order to assess rate adequacy.<ref>Brown RL. (1993). [https://books.google.com/books?id=1j4O50JENE4C Introduction to Ratemaking and Loss Reserving for Property and Casualty Insurance]. ACTEX Publications.</ref> [[Loss ratio]]s and expense loads are also used. Rating for different risk characteristics involves—at the most basic level—comparing the losses with "loss relativities"—a policy with twice as many losses would, therefore, be charged twice as much. More complex [[multivariate analysis|multivariate analyses]] are sometimes used when multiple characteristics are involved and a univariate analysis could produce confounded results. Other statistical methods may be used in assessing the probability of future losses.

Upon termination of a given policy, the amount of premium collected minus the amount paid out in claims is the insurer's [[underwriting profit]] on that policy. Underwriting performance is measured by something called the "combined ratio", which is the ratio of expenses/losses to premiums.<ref>{{cite book |url= https://books.google.com/books?id=Juc4fb1Fx1cC&pg=PA614 |title= The Handbook of Municipal Bonds|first1= Sylvan G.|last1= Feldstein|first2= Frank J.|last2= Fabozzi|year= 2008|page= 614|publisher= [[John Wiley & Sons|Wiley]]|isbn= 978-0-470-10875-8|access-date= 8 February 2010}}</ref> A combined ratio of less than 100% indicates an underwriting profit, while anything over 100 indicates an underwriting loss. A company with a combined ratio over 100% may nevertheless remain profitable due to investment earnings.

Insurance companies earn [[investment]] profits on "float". Float, or available reserve, is the amount of money on hand at any given moment that an insurer has collected in insurance premiums but has not paid out in claims. Insurers start investing insurance premiums as soon as they are collected and continue to earn interest or other income on them until claims are paid out. The [[Association of British Insurers]] (grouping together 400 insurance companies and 94% of UK insurance services) has almost 20% of the investments in the [[London Stock Exchange]].<ref>[http://www.abi.org.uk/About_The_ABI/role.aspx What we do ABI] {{webarchive|url= https://web.archive.org/web/20090907134048/http://www.abi.org.uk/About_The_ABI/role.aspx |date= 7 September 2009 }}. Abi.org.uk. Retrieved on 18 July 2013.</ref> In 2007, U.S. industry profits from float totaled $58 billion. In a 2009 letter to investors, Warren Buffett wrote, "we were ''paid'' $2.8 billion to hold our float in 2008".<ref>{{Cite book|title= Delay, Deny, Defend : Why Insurance Companies Don't Pay Claims and What You Can Do About It|last= Feinman|first= Jay M.|publisher= Portfolio|year= 2010|isbn= 9781101196281|pages= 16|oclc= 883320058}}</ref>

In the [[United States]], the underwriting loss of [[property insurance|property]] and [[casualty insurance]] companies was $142.3 billion in the five years ending 2003. But overall profit for the same period was $68.4 billion, as the result of float. Some insurance-industry insiders, most notably [[Maurice R. Greenberg|Hank Greenberg]], do not believe that it is possible to sustain a profit from float forever without an underwriting profit as well, but this opinion is not universally held. Reliance on float for profit has led some industry experts to call insurance companies "investment companies that raise the money for their investments by selling insurance".<ref>{{Cite journal|last1= Weir|first1= Audrey A.|last2= Hampton|first2= John H.|date= March 1995|title= Essentials of Risk Management and Insurance|journal= The Journal of Risk and Insurance|volume= 62|issue= 1|pages= 157|doi= 10.2307/253703|issn= 0022-4367|jstor= 253703}}</ref>

Naturally, the float method is difficult to carry out in an [[Depression (economics)|economically depressed]] period. [[Bear market]]s do cause insurers to shift away from investments and to toughen up their underwriting standards, so a poor economy generally means high insurance-premiums. This tendency to swing between profitable and unprofitable periods over time is commonly known as the [[insurance cycle|underwriting, or insurance, cycle]].<ref>
Fitzpatrick, Sean, [https://ssrn.com/abstract=690316 ''Fear is the Key: A Behavioral Guide to Underwriting Cycles,''] 10 Conn. Ins. L.J. 255 (2004).
</ref>