How insurance companies make money

This article has been updated from a previous version. 

Insurance premiums may be the most visible way insurance companies make money, but it’s just the beginning. 

Behind the scenes, insurers use a combination of strategies to stay profitable while covering claims. These include underwriting, risk pooling, and investing premiums in low-risk assets like government bonds. 

Understanding how the insurance business model works—from how premiums are calculated to how insurers manage risk and generate returns—can help policyholders make more informed decisions about their coverage.  

How the insurance business model works 

An insurance policy protects a person from financial liability in the case of any peril or event outlined in their policy in exchange for a monthly or annual fee, or premium.  

The idea is that the premiums collected are a fair financial tradeoff for the likelihood of an event actually happening. This is largely based on the practice of grouping insured clients with similar risk profiles together. 

“Insurers may talk about a high-risk pool,” says Mary Kelly, professor in finance and chair in insurance at Wilfred Laurier University. 

“These insureds all have characteristics that would make them more likely to have a loss, for example, location for property insurance or a car that is likely to be stolen for comprehensive coverage,” she adds. 

The underwriting process helps insurers assess risk and set premiums accordingly. Customers are grouped into risk pools, and the premiums they pay go toward covering potential claims within that pool.  

In essence, many pay so that a few can claim—and the higher the risk profile of a group, the more its members are likely to pay for coverage. 

How are insurance premiums determined? 

While it can be stated that in general, higher risk = higher premiums, the process of setting those premiums varies across different insurance verticals, such as home and auto.  

Auto insurance premiums will undergo different risk classification variables than say, home insurance. 

“For example, in many jurisdictions, credit ratings can't be used to price auto insurance, but they can be used to price personal property,” says Kelly. 

Although all property and casualty insurance in Ontario is regulated by the Financial Services Regulatory Authority of Ontario (FSRA), only auto insurers have to get rate changes approved by FSRA.  

So, while auto insurers can increase rates to make sure they’re still making a profit, the process is highly regulated. Risks are different when insuring a car compared to a home. 

Your car insurance rate will depend on things like your vehicle make, model, and year, age, and car insurance history, while a home insurance rate will depend on things like how much it costs to replace your home (or replacement value), how well maintained it is, and your proximity to a fire hydrant. 

While some few risk classification variables may overlap across insurance categories, “the statistical modelling would be very similar,” says Kelly.  

In a nutshell, insurers charge higher premiums based on how much risk you present as a customer. 

Related: How do home insurance claims affect your rates? 

Where is the money you put into your premiums going? 

Underwriting, which is the process of accepting financial risk in exchange for payment, is the main way that insurance providers make money.  

But fulfilling claims is not the only way they put those premiums to work. They also invest part of their revenue, with the expectation that the investment will later compound, or otherwise provide greater returns. 

“Most insurers invest heavily in fixed income, typically government,” says Kelly. For instance, “overall, in 2022, the industry held 73% of its invested assets in fixed income, 13% in cash and short duration securities, and 9% in common and preferred shares.” 

If the company is smaller, it may outsource its investment management, whereas larger providers are more likely to have in-house investment managers.  

Depending on how much risk the company is willing to take on, portfolios can vary. 

“Typically, property and casualty insurers are fairly risk-averse, so they'll hold a well-diversified portfolio of both Canadian and international equities,” Kelly says. 

While it’s possible for insurance companies to make money from investments, they may only make small returns. 

How reinsurance helps insurance companies manage risk 

Reinsurance, often called "insurance for insurance companies," helps insurers manage large-scale risks by sharing the financial burden of major claims.  

For example, if a natural disaster causes widespread damage, reinsurance allows the primary insurer to recover some of the costs from their reinsurer. 

However, reinsurers have their own risk limits. When insurers spread risk across multiple reinsurers, it can drive up costs for both companies and customers, threatening the balance of affordability. 

“Insurers do rely heavily on reinsurance,” Kelly notes. “And there's been considerable pushback from the global reinsurance market to make the domestic market retain more risk.” 

What happens when customers can’t afford or access coverage? 

The business of insurance is complicated, and it evolves with our changing times. 

According to the Insurance Bureau of Canada, insured damages from severe weather events across the country surpassed $8.5 billion in 2024—making it the costliest year for weather-related losses in Canadian history. 

As these major climate disasters continue to rise, fewer people may find themselves able to access and afford adequate insurance. 

While mandatory auto insurance coverage is likely to remain affordable for those who choose vehicles within their price and risk range, property insurance is a different ballgame. 

When it comes to personal property insurance, weather related perils that are included in a home insurance policy like wind, snow, hail, and fire are more common and can’t be controlled by the customer. 

 “There could be parts of the country where premiums might become prohibitively expensive,” says Kelly. 

What it means for Canadian homeowners 

As climate-related disasters grow more frequent and severe, insurance affordability and availability are under pressure. If premiums rise too high or coverage becomes too limited, some Canadians may choose not to insure—or even avoid purchasing property in high-risk areas altogether. 

In these cases, government intervention may become necessary, especially for perils like flooding that are increasingly difficult to insure privately. 

Insurance companies operate on a delicate balance of premium pricing, risk management, and investment strategy. But as the landscape shifts, understanding how these systems work can help policyholders make smarter decisions. 

Staying informed, reviewing your policy regularly, and knowing your risk profile are key steps to ensuring you’re protected in an increasingly unpredictable world. 

Read next: One third of homeowners worried about extreme weather damage