Insurance makes money on float and usually loses money on insuring something over the long term. I can't remember the exact numbers, but GEICO might payout something like 103% (or 3% MORE than you paid them) over the term of your policy with them.
Basically they invest your premiums during the time you are paying them and make money off of holding your money. Then the other insurance agencies might lower their costs and end of paying out 104% (or whatever) of what you've paid in. This competition pressures the market to close the gap between what you can make on the float and what you can charge your customer, but there is going to be some gap and that is the profit margin.
If the insurance company can make a high ROI on the float, they can charge less in insurance rates and still make money.
Insurance companies usually lose money on underwriting.
However, GEICO is not a good example, because it is the exception to the rule. GEICO usually makes an underwriting profit -- often a very large underwriting profit.
In fact, all of Berkshire Hathaway's insurance operations make a long-term underwriting profit. Unlike GEICO, the reinsurers do not make a profit every year, because hurricanes and earthquakes are unpredictable. (Whereas car crash statistics change very slowly from year to year.) But averaged out over a long period of time, they make a profit.
This is the secret of Warren Buffett's success as an investor. He is essentially buying stocks on margin, at a negative interest rate.
Data collected from Berkshire Hathaway annual reports:
2012: $680 million profit on $11,578 million float
2011: $576 million profit on $11,169 million float
2010: $1,117 milion profit on $10,272 million float
2009: $649 million profit on $9,613 million float
2008: $916 million profit on $8,454 million float
2007: $1,113 million profit on $7,768 million float
2006: $1,314 million profit on $7,171 million float
2005: $1,221 million profit on $6,692 million float
2004: $970 million profit on $5,960 million float
Not broken out separately prior to 2004
This profitability streak is truly exceptional. As Warren Buffett pointed out in his 2012 letter, State Farm has made an underwriting loss in 8 of the previous 11 years. The insurance industry as a whole has made an underwriting loss in 37 of the previous 45 years.
How do they make money? http://seekingalpha.com/article/419731-buffett-on-insurance-...
Basically they invest your premiums during the time you are paying them and make money off of holding your money. Then the other insurance agencies might lower their costs and end of paying out 104% (or whatever) of what you've paid in. This competition pressures the market to close the gap between what you can make on the float and what you can charge your customer, but there is going to be some gap and that is the profit margin.
If the insurance company can make a high ROI on the float, they can charge less in insurance rates and still make money.