Insured Profits

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Gross Profits Insurance

What Is Gross Profits Insurance?

The term gross profits insurance refers to a type of business interruption insurance that provides funds in the amount of profit lost if an insurable event, such as property damage, occurs. Gross profits insurance is most commonly used in the United Kingdom and Canada. This type of insurance differs from gross earnings insurance, which is more commonly found in the United States.

Key Takeaways

  • Gross profits insurance is a type of business interruption insurance that covers lost profit if an insurable event occurs.
  • Policy coverage extends through the time in which the insured rebuilds or repairs its business property.
  • The policy covers losses experienced while the business is not able to function normally, with a pre-defined indemnification period usually set at a three-year maximum.
  • Coverage doesn’t cover everything, as proximate cause is used to determine whether or not an event caused the insured party to experience a loss.

Understanding Gross Profits Insurance

Gross profit is calculated as turnover minus purchases and variable costs. The loss formula looks at turnover over a specific period of time—such as twelve months—though extenuating circumstances that affect turnover during the examination period may need to be smoothed out.

As mentioned above, gross profit insurance is commonly used in both Canada and the United Kingdom. It is a type of business interruption insurance—insurance that replaces lost income because of a disaster—designed to bring the insured back to where it would have been financially assuming the insurable event had not occurred. Insurance events include things like fires or natural disasters. The amount of loss a business experiences is calculated based on a pre-defined formula and typically relies on historical rates of turnover to determine the amount a business is losing.

Policy coverage extends through the period of time in which the insured rebuilds or repairs its business property. The policy covers losses that the business experiences while not being able to function as it normally would have, though a pre-defined indemnification period is usually set at a maximum of three years. If the business still rebuilds at this point, any losses fall outside of the indemnification period and thus, are no longer be covered.

Special Considerations

Gross profit insurance coverage does not apply in all situations. In most cases, proximate cause is used to determine whether or not an event caused the insured party to experience a loss. The policy covers the increased costs of working, which are additional expenses incurred in order to keep sales from falling. The policy also covers the loss of any finished goods that could have been sold had they not been damaged.

Challenges of Gross Profit Insurance

One of the primary difficulties in establishing coverage levels for gross profits insurance is defining what constitutes gross profit, as standards can vary among accountants and business people. Turnover, work-in-progress (WIP), and opening and closing stock are easily determined in accordance with normal accountancy methods. Meanwhile, uninsured working expenses refer to costs—sometimes called specified working expenses—which vary in direct proportion to turnover. So, if turnover is reduced by 30%, the costs will also be reduced by 30%. An accountant’s gross profit calculation will subtract any cost that varies in proportion to production—for insurance purposes, they must vary in direct proportion. This is a key distinction and the source of much underinsurance.

Defining what constitutes gross profit can be challenging as standards vary among accountants and business people.

Gross Profits Insurance vs. Gross Earnings Insurance

Gross earnings insurance, commonly used in the United States, is another form of business interruption insurance coverage. But there are key differences between this kind of coverage and gross profits insurance. Gross earnings are the total amount of sales or revenue, minus the cost of goods sold (COGS). This kind of insurance covers a reduction in the insured party’s gross earnings stemming from direct damage loss.

Unlike gross profits insurance, gross earnings insurance is generally less costly for the insured. Because gross profits insurance has broader coverage, premiums are higher. Premiums for gross earnings insurance, on the other hand, are cheaper because the coverage is less comprehensive.

Understanding insurer profits

Health Insurers Battle Rising Costs

By TheStreet.com Ratings Staff
TheStreet.com
January 16, 2008

Health insurers continued to boost profits in the second quarter, even as they struggled to raise premiums in line with health care costs. TheStreet.com Ratings’ review of the financial performance of the 648 health insurers it tracks found that total net income rose by 27.5% during the first six months of 2007 to $8.8 billion, up from $6.9 billion the prior year.

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Investment gains helped bridge the gap. They comprised 43.4% of industry profits, up from 35.7% the prior year, growing 55% to $3.8 billion through June 30, 2007 — up from $2.5 billion a year earlier. By comparison, profits from insurer’s core underwriting business increased just 9.1% to $5.8 billion through June 30, 2007, up from $5.3 billion the prior year.

(The study is based on the latest available statutory filings with the National Association of Insurance Commisssioners.)

Donna O’Rourke, senior financial analyst with TheStreet.com Ratings, explains.

Q.
Are rising health care costs the biggest risk for insurers?

A. On the one hand, insurers are dealing with rising health costs, and on the other hand — as a result of competitive pressures and unwillingness by consumers to absorb more premium rate increases — the ability to raise additional revenue to cover those costs.

But the industry also does business in an uncertain political environment. Revamping the financing of health care is a hot topic among the presidential hopefuls and many state governors.

The industry has also recently placed a lot of its efforts on the unstable Medicare line of business that is often the target of cost-cutting and heavy oversight by the federal government.

Q. But if profits are rising, should investors — and consumers — be worried?

A. The industry has been going strong for several years, really since 2003, when we came out of the last recession.

This continued profitability and strong market capitalization is reflected in the latest rating review; we upgraded 27 insurers and only downgraded four. This follows first-quarter ratings upgrades of 21 insurers and nine downgrades.

But health care costs continue to rise at a faster pace than revenue, because insurers struggle with raising premiums, and this is starting to affect their bottom line.

Q. Should we be concerned about a rise in investment gains? Are insurers making riskier investments?

A. Not necessarily. Normally, the industry makes some of its money by investing its liquid assets gained through prior years gains in various investments while making most of its profits from the actual business of health insurance.

An increase in investment income is not in itself a bad thing. But in an environment where margins on the core business are starting to narrow, it could become a concern in the future. What we see happening is an uptick in the percentage of profits coming from investments.

Health insurers, which are highly regulated, typically don’t own high-risk investments. If they continue to hold low-risk investments, the income generated from them may not be sufficient to offset a decline in their business.

If insurers choose to raise the risk profile of their portfolios, they will need to make sure they have sufficient capital in place to pay out claims if their bets move in the wrong direction.

Q. Where are the largest areas of growth for health insurers?

A. The Medicare line of business, both the Medicare Advantage business and Medicare Part D, has had the biggest impact in terms of growth on the industry. Margins are very high and have been compensating for the highly competitive employer health insurance market. While this is still very small, we are also seeing growth in the individual private insurance market, and insurers continue to expand their offerings to self-funded employers.

Q. This competition should be good news for consumers, though, right?

A. That’s right. Competition in these lines of business means more choice for consumers and downward pressure on premiums.

Comment:

By Don McCanne, MD

A few observations:

* The $12 billion or so in annual profits from the insurers’ core underwriting business is a comparatively small proportion of our $2260 billion national health expenditures. If we eliminated these profits, we would not see much change in the overall health care budget. That said, $12 billion would buy a lot of health care and certainly should not be ignored. And it is a $12 billion expenditure that is an inappropriate use of funds designated for health care spending.

* The $8 billion or so of annual investment income is often excluded from discussions of improving financing efficiency. But should it be? That income is derived from the investment of our premium dollars that the insurers are holding in trust for our future health care. Since those are our funds, shouldn’t the investment income accrue to us? If we established our own public health insurance program, the investment return on the reserve funds would be used to reduce the taxes that finance the program.

* Although the diversion of health care profits to the private insurers makes us angry, we have to keep in mind what the greater problem is. The private insurers are a major component of our highly flawed, fragmented, multi-payer system of financing health care. Between the administrative excesses of the insurers and the administrative burden placed on the providers of health care, we waste about $350 billion that could be recovered by changing to an administratively efficient single payer system. We do want to recover that $12 billion from the core underwriting business, but it is far more important to recover the $350 billion through structural reform of our system of health care financing.

* The greatest growth for the private insurers has occurred with Medicare Advantage and Medicare Part D. Margins have been very high in these programs – much higher than in the employer health insurance market. But these are our own public programs. We have handed them over to the private insurers along with a massive excess infusion of our own taxpayer funds. This constitutes a flagrant betrayal of trust by our legislators (which is a definition of treason). Every legislator that participated in this massive fraud should be voted out of office in the next election.

* The insurance industry remains concerned about doing business in an uncertain political environment, including concerns about the unstable Medicare line of business. No problem. By establishing our own national health insurance program, we can provide the insurers with the certainty of knowing that they will no longer have to manage our universal risk pool.

How Do Insurance Companies Make Money?

May 30, 2020 10:42 AM EDT

Insurance companies make money by betting on risk – the risk that you won’t die before your time and make the insurer pay out, or the risk your house won’t burn down or your SUV won’t be totaled in a crash.

The concept that drives the insurance company revenue model is a business arrangement with an individual, company or organization where the insurer promises to pay a specific amount of money for a specific asset loss by the insured, usually by damage, illness, or in the case of life insurance, death.

In return, the insurance company is paid regular (usually monthly) payments from its customer, for an insurance policy that covers life, home, auto, travel, business, and valuables, among other assets.

Basically, the insurance contract is a promise by the insurance company to pay out for any losses to the insured across a variety of asset spectrums, in exchange for regular, smaller payments made by the insured to the insurance company.

The promise is cemented in an insurance contract, signed by both the insurance company and the insured customer.

That sounds easy enough, right? But when you get down to how insurance companies make money, i.e. earn more revenues than they pay out, things get more complicated.

Let’s clear the air and examine how insurance companies make money, and how and why their risk-based revenue has proven so profitable over the years.

How Insurance Companies Make Money

As an insurance company is a for-profit enterprise, it has to create an internal business model that collects more cash than it pays out to customers, while factoring in the costs of running their business.

To do so, insurance companies build their business model on twin pillars – underwriting and investment income.

Underwriting

For insurance companies, underwriting revenues come from the cash collected on insurance policy premiums, minus money paid out on claims and for operating the business.

For instance, let’s say ABC Insurance Corporation earned $5 million from the premiums paid out by customers for their policies in a year’s time.

Let’s also say that ABC Insurance Corp. paid $4 million in claims in the same year. That means on the underwriting side, ABC Insurance earned a profit of $1 million ($5 million minus $4 million = $1 million).

Make no mistake, insurance company underwriters go to great lengths to make sure the financial math works in their favor.

The entire life insurance underwriting process is very thorough to ensure a potential customer actually qualifies for an insurance policy. The applicant is vetted thoroughly and key metrics like health, age, annual income, gender, and even credit history are measured, with the goal of landing at a premium cost level where the insurance company gains maximum advantage from a risk point of view.

That’s important, as the insurance company underwriting business model ensures that insurers stand a good chance of making additional income by not having to pay out on the policies they sell. Insurance companies work very hard on crunching the data and algorithms that indicate the risk of having to pay out on a specific policy.

If the data tells them the risk is too high, an insurer either doesn’t offer the policy or will charge the customer more for offering insurance protection. If the risk is low, the insurance company will happily offer a customer a policy, knowing that its risk of ever paying out on that policy is comfortably low.

That sets insurance companies far apart from traditional businesses. An auto manufacturer, for example, has to invest heavily in product development, paying money up front to build a car or truck that consumers want. They only recoup their investment when they sell the car.

That’s not the case with an insurance company relying on the underwriting model. They put no money up front, and only have to pay if a legitimate claim is made.

Investment Income

Insurance companies also make a bundle of money via investment income.

When an insurance customer pays their monthly premium, the insurance company takes the money and invests in the financial markets, to increase their revenues.

Since insurance companies don’t have to put cash down to build a product, like an automaker or a cell phone company, there’s more money to put into an insurer’s investment portfolio and more profits to be made by insurance companies.

That’s a great money-making proposition for insurance companies. An insurer gets the money up front from customers, in the form of policy payments. They may or may not have to pay off a claim on that policy, and they can put the money to work for them right away earning investment income on Wall Street.

Insurance companies have an out, too, if their investments go south – they just hike the price of their premiums and pass the losses on to customers, in the form of higher policy costs.

It’s no wonder that Warren Buffet, the Sage of Omaha, invested so heavily in the insurance sector, buying Geico and opening its own insurance firm, Berkshire Hathaway Reinsurance Group.

Buffet knows a sure thing when he sees one.

Other Ways Insurance Companies Come Out Ahead Financially

While underwriting and investment income are far and away the largest sources of revenues for insurance companies, they have other avenues to profit, as well.

Cash Value Cancellations

When consumers who have whole life insurance plans discover they have thousands of dollars via “cash values” (generated through investment and dividends from insurance company investments), they want the money, even if it means closing the account down.

Insurance companies are only too happy to oblige, with full knowledge that when a customer takes cash value money and closes the account, all liability ends for the insurer. The insurance company keeps all the premiums already paid, pays the customer with interest earned on their investments, and keep the remaining cash.

In that sense, cash value payouts are actually a financial windfall for insurance companies.

Coverage Lapses

All too often, consumers fail to keep current on their insurance policies, which triggers a profitable scenario for the insurance company.

Under the insurance policy contract, a policy lapse means the actual policy expires without any claims being paid out. In that situation, insurance companies cash in again, as all previous premiums that are paid by the customer are kept by the insurer, with no possibility of a claim being paid.

That’s another cash bonanza for insurers, who allow the consumer to take on all the risk of keeping a policy active, and walk away with the money if the customer either outlives the coverage timetable or doesn’t keep up with premium payments.

The Takeaway on How Insurance Companies Make Money

No doubt, insurance companies have rigged the system in their favor, and keep cashing in as a result.

Industry data shows that for every 100 insurance customers paying their premiums every year, only three of those consumers make a claim. Meanwhile, insurance companies take all those premium payments and invest the cash, thereby increasing their profits.

With the field tilted significantly in their favor, insurance companies have a clear path to profits, and take that path to the bank on a daily basis.

It’s been a recipe for financial success for hundreds of years, and will be the same going forward – and there’s not much the average insurance customer can do about it, except keep paying their premiums and hope for the best.

It’s never too late – or too early – to plan and invest for the retirement you deserve. Get more information and a free trial subscription toTheStreet’s Retirement Dailyto learn more about saving for and living in retirement. Got questions about money, retirement and/or investments? We’ve got answers.

Are Health Insurance Companies Making Unreasonable Profits?

Understanding the Profit Margin of Private Health Insurers

Virojt Changyencham / Getty Images

One of the common criticisms leveled at private health insurance companies is that they are profiting at the expense of sick people. But let’s take a closer look at the data and see where it takes us. Do private health insurance companies really make unreasonable profits?

How Common Is Private Health Insurance?

Before addressing the question about profits, it’s important to look at how common having private health insurance really is in the United States. In other words, how many people might be affected by this question.

According to Kaiser Family Foundation data, roughly a third of Americans had public health insurance in 2020 (mostly Medicare and Medicaid).   Another 9 percent were uninsured, but the rest had private health insurance that they either purchased on their own in the individual market (6 percent) or coverage provided by an employer (49 percent). Nearly half of Americans have coverage provided by an employer, although 60 percent of them have coverage that’s partially or fully self-funded by the employer (that means the employer has its own fund for covering medical costs, rather than purchasing coverage from a health insurance carrier; in most cases, the employer contracts with a commercial insurance company to administer the benefits—so the enrollees might have plan ID cards that say Humana or Anthem, for example—but it’s the employer’s money that’s being used to pay the claims, as opposed to the insurance company’s money). 

But many Medicare and Medicaid beneficiaries also have coverage that’s provided via a private health insurance company, despite the fact that they are enrolled in publicly-funded health care plans. Thirty-three percent of Medicare beneficiaries are enrolled in Medicare Advantage plans run by private health insurance carriers.   Thirty-nine states have Medicaid managed care contracts with private carriers to cover some or all of their Medicaid enrollees. Even among Original Medicare beneficiaries, a quarter have Medigap plans purchased from private health insurance carriers and this number is increasing (it increased 2 percent from 2020 to 2020 alone). 

When we put all that together, it’s clear that a significant number of Americans have health coverage that’s provided or managed by a private health insurance company. And private health insurance companies tend to get a bad rap when it comes to healthcare costs.

Are Insurer Profits Unreasonable?

Numerous articles have been written by people attempting to find coverage during periods of open enrollment. Some of these appear to conflate revenue with profits which adds to the confusion. Of course, major health insurance carriers have significant revenue, given that they’re collecting premiums from so many insureds.

But regardless of how much revenue carriers collect in premiums, they’re required to spend most of it on medical claims and health care quality improvements. And although a common criticism is that health insurance companies pay their CEOs too much, that’s more reflective of the fact that CEO salary growth, in general, has far outpaced overall wage growth over the past several decades. There are no health insurance carriers represented among the 40 firms with the highest-paid CEOs, although there are several pharmaceutical companies. 

So while a seven or eight-figure CEO salary seems absurd to the average worker, it’s certainly in line with the corporate norm. And health insurance company CEOs are not among the highest paid CEOs of large companies. The fact remains that salaries are part of the administrative costs that health insurance companies are required to limit under the Affordable Care Act’s medical loss ratio (MLR) rules. And so are profits.

Under the MLR rules, insurers that sell individual and small group health insurance coverage must spend at least 80 percent of premiums on medical claims and quality improvements for members. No more than 20 percent of premium revenue can be spent on total administrative costs, including profits and salaries. And for insurers that sell large group coverage, the minimum MLR threshold is 85 percent. Insurers that fail to meet these guidelines (ie, they spend more than the allowed percentage on administrative costs, for whatever reason) are required to send rebates to their members. From 2020 to 2020, under the MLR rule implementation, insurers rebated $5.3 billion to consumers. 

How Much Do Health Insurers Profit?

If we look at average profit margins by industry, health insurance companies are in the single digits. For perspective, the legal, real estate, and bookkeeping industries have average profit margins in excess of 17 percent.   As far as health care goes, there are certainly some very profitable sectors, including medical and diagnostic laboratories and the pharmaceutical industry. The Government Accounting Office shows the profit margins over 15 percent from 2006 to 2020. 

But health insurance doesn’t have the sort of profitability those industry segments are able to generate—partly because health insurance is much more regulated. As described above, the ACA effectively limits the profits insurers can generate, by capping total administrative costs (including profit) as a percentage of revenue. But there’s no similar requirement for hospitals, device manufacturers, or drug manufacturers.

However, profits in the health insurance industry have been growing in recent years, fueled in large part by growth in the Medicare Advantage and Medicaid managed care markets. The ACA’s medical loss ratio rules don’t apply to the private plans that participate in the Medicare and Medicaid markets, although those plans have to win contracts with the governments (state governments for Medicaid managed care contracts, and the federal government for Medicare Advantage plans). So they have to provide a net value to the government in order to win those contracts.

Bottom Line on Profits for Private Insurance Companies: Reasonable or Unreasonable?

Health care costs are the driving factor behind health insurance premiums. It’s true that private health insurance companies pay their CEOs competitive salaries and they must remain profitable in order to stay in business. But their profits are modest when compared with many other industries.

There is certainly a valid argument in favor of removing the profit motive from health care altogether, which is fueling the surge in support for single payer in the U.S. Proponents of a single payer system generally contend that health care is inherently different from other industries, and should not be profit-driven. On the other hand, supporters of a profit-based health care system believe that profit is essential for encouraging innovation and quality improvements.

Currently, health insurers are the only segment of the health care industry in which profits are directly curtailed. In the rest of the industry (ie, hospitals, device manufacturers, pharmaceuticals, etc.), a more free-market approach is taken. There is certainly an argument to be made for eliminating or further curtailing the profits generated in the health insurance industry, but there is a similar argument for reducing or eliminating profits in health care in general.

If you have further questions after reading about profits, learn about the best resources for finding information about health insurance and health policy.

Insured Profits

April 2020 WAJ President’s Column

Insurance Companies Hit Record Setting

Profits at the Expense of the Consumer

By Jeff Pitman, 2020 WAJ President

Auto insurance companies are racking up some impressive profits, record-setting in fact, at the expense of their policyholders. But what may surprise you is how the providers are maintaining that healthy bottom line.

In 2009 the Wisconsin Legislature passed “Truth in Auto Insurance” requiring drivers to have a minimum of $50,000 in coverage for the injury or death of a person, requiring underinsured motorist coverage, eliminating reducing clauses and allowing stacking of insurance coverage. Truth in Auto did not allow insurance companies to reduce coverage by taking away benefits paid by the policyholder.

In 2020 the Republican controlled state legislature repealed every aspect of the Truth in Auto law except for the requirement that all drivers have to purchase auto insurance. This repeal reversed and restored minimum coverage levels to 1982 levels: $25,000, $50,000 and $10,000.

In arguing for the repeal, insurers had insisted that the higher coverage would require premiums to rise each year. However, when the law was repealed in 2020, premiums didn’t go down. This allowed insurance companies to increase profit while reducing their risk. Profits are soaring.

To say auto insurers have done well over the last couple of years is truly an understatement.

Wisconsin-based American Family, the largest insurer of homes and auto in Wisconsin, reported a net income of $360.5 million, a 22% increase over 2020. Nationally, American Family recorded a 4.6% increase in assets bringing the company to a staggering $17.9 billion overall.

State Farm, the second largest insurance provider in Wisconsin and the largest U.S. home and car insurer, saw profits quadruple as claims cost declined, reporting an increase in net income of $3.2 Billion. State Farm’s net worth climbed to $65.4 billion at the end of 2020 an increase of almost $5 billion from 2020.

AllState Corp, the second-biggest home and auto insurer in the U.S. recorded an annual profit of $2.3 billion in 2020, almost triple the amount from 2020.

Progressive, the fourth-largest car insurer in the nation, also started off 2020 with an increase in profits. Reporting a 9% increase in premiums earned, going from $1.46 billion at the end of 2020 to $1.59 billion at the end of 2020.

You would think with rising profits and a healthy bottom line, auto insurers would be satisfied; not so. In last month’s article I discussed a new piece of legislation regarding the changes to the collateral source rule in Wisconsin (March President’s Column.)

Auto insurance companies are now some of the chief proponents of changing Wisconsin’s collateral source rule. In Wisconsin, an injured person can recover the reasonable value of the medical care associated with an accident, which is presumed to be the amount billed by the health care provider. In many cases, your health insurer will cover the initial cost of the medical care, but they often negotiate lower rates than the actual amount billed. The person that caused your injuries is not allowed to benefit from these negotiated reductions by arguing that he or she is only liable for what the health insurer paid. The proposed law will allow the evidence of health insurance payments into evidence.

The change in the collateral source rule would allow the person who hit you to pay you less money. In essence, taking the premiums you paid for health insurance coverage and pocketing the benefit paid for by your premium. That is Premium Theft. Such a change would mean that an injured person who has worked hard, planned ahead, and made sacrifices to obtain health coverage, and other benefits would receive less for the same injury than someone who never bothered to buy insurance.

By allowing health insurance payments into evidence, the drunk driver who hit you and his or her auto insurance company could save millions of dollars, further increasing insurance company profits.

With auto insurers profits rising each year at the expense of the policyholders, there is no reason Wisconsin legislators should continue to give additional handouts to insurance companies. Legislators should reward responsible citizens rather than punish them.

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