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An Introduction to the Insurance Industry

According to Asian Insurance Review, Singapore has a premium per capita of around US$3,000. In other words, every Singaporean spends US$3,000 a year on average on their insurance premiums.

Although there are no insurance companies in the Straits Times Index (SGX: ^STI), there are still some notable insurance companies listed in Singapore. Two such examples are Prudential Inc (SGX: K6S) and Great Eastern Holdings (SGX: G07), with market capitalizations of £32.6b (approximately S$67.8b) and S$8.43b respectively.

Let us take a closer look at some of the basics of the insurance industry.

Life and General Insurance

There are generally three basic types of insurance operators: those that deal with life insurance, general insurance and reinsurance. For instance, Great Eastern, which is a majority-owned subsidiary of Oversea-Chinese Banking Corporation (SGX: O39), operates as both a life and general insurer.  Prudential, meanwhile, also provides mainly life insurance and some general insurance.

Insurance is a form of risk management which an individual or a company can utilize to protect themselves. The basic idea is that a purchaser will pay an insurer a premium in return for a huge payout if something bad does happen to the former.

Take life insurance for example. If you are the sole breadwinner in your family, you might buy a life insurance policy that covers you, ensuring that your family will get a sum of money from the insurance company to tide over tough times in the event that something untoward happens to you.

General insurance deals with anything other than protecting the life of the purchaser. Property, car and medical insurance can all be considered as general insurance.

Reinsurance

There is a type of insurance that the general public would not normally hear about and that is Reinsurance. It is a type of insurance that’s specifically designed for insurance companies to shift away some big risks if they see the need for it. The concept is similar to a basic insurance policy, but with a slight twist – unlike, say, life insurance, where the purchaser is generally an individual, the purchaser in a reinsurance contract are often other big institutions or insurance companies themselves.

For instance, a property insurer might have received big premiums to insure many valuable properties. That’s some nice income for the property insurer but that also means that the insurer is liable to make a huge payout if somehow, these valuable properties are all destroyed or damaged together. As such, the property insurer might prefer to pass on some of those risks to other insurers in a reinsurance contract.

There is only one reinsurer listed here, the aptly-named Singapore-based Singapore Reinsurance Corp (SGX: S49).

How Do Insurance Companies Make Money?

An insurance company would collect premiums from its customers in return for the promise that it would hand its customers a payout in the future if something happens to them.

Every year, an insurer would need to payout claims to customers who have suffered legitimate mishaps. If the premiums that the insurer collect each year is more than the claims paid out, the insurance company would have recorded an underwriting profit. Meanwhile – and this is the important bit – the insurance company can invest the premiums collected every year on financial instruments like shares and bonds and keep some portion of the profits for its shareholders.

Foolish Summary

Insurance is a fascinating business to explore and insurance companies are in fact, one of the basic building blocks that American billionaire investor Warren Buffett has used to build his wealth. Investors would definitely gain much from understanding the dynamics behind this wonderful industry.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.