Insurance Premium: Definition, How it Works, Types, and How it is Calculated

Insurance is a type of financial contract between two parties to protect against potential financial losses, commonly due to loss or damage. Insurance protects an individual or business against the financial burden of a loss or damage, by instead paying regular insurance premiums in exchange for limiting their own liability in the event of a loss or damage that could be even more costly. The policyholder agrees to pay insurance premiums so that the insurance company agrees to pay for specified losses or damages in circumstances that it agrees to and states in the contract. There are of course many different types of insurance, but fundamentally they all are similar in the concept of paying insurance premiums to limit your own liability in the event of a loss or damage. An insurance premium is paid by policyholders in order to limit their potential losses in the event of a loss or damage. The most common types of insurance are car insurance, home insurance, life insurance, health insurance and business insurance.

What is an Insurance Premium?

An insurance premium is the amount that a policyholder pays to an insurance company in order to maintain their insurance policy. Insurance premiums are usually paid on a regular basis, such as monthly or annually. Insurance premiums are calculated based on the risk of the policyholder, the type and level of insurance, the length of the policy, the value of what is being insured and the level of risk associated with the insured. Insurance premiums differ a lot between different types of insurance and can vary in cost a lot, but insurance premiums are compensation for the insurance company for them to take on the larger risk of covering the potential costs incurred by loss or damages. These insurance premiums are used in order to cover potential claims and pay operating costs for the insurance company so that they can afford to pay out when they need to in the event of claims. In order to keep your insurance policy active you must keep up to date with your car insurance premium payments, and if you do not keep up to date with your insurance premiums you may have your policy cancelled, and you may not be able to claim against your insurance. The term insurance “premium” refers to the payment being made in advance for the insurance coverage that you have agreed to, as you have to pay in advance of the cover period.

What is an example of an Insurance Premium?

An example of an insurance premium is the amount a driver would pay for their car insurance per month, in order to be covered in the event of an accident. Depending on the level of cover, this insurance premium being paid would mean they are covered for damages to any third party vehicle and their own vehicle, and any medical expenses incurred. Insurance premiums are generally calculated on a yearly basis and then paid on a monthly basis, but you do have the option to sometimes pay a reduced insurance premium if you pay the whole thing up front.

How does an Insurance Premium work?

An insurance premium is an amount calculated by an insurance company relative to the risk taken on by the insurance company. If the potential financial risk is higher for an insurance company, the insurance premium is likely to reflect that and be higher too. There are lots of other personal details and risk factors that are taken into account, but effectively the price of an insurance premium reflects the price that an insurance company is willing to insure the policyholder for. Insurance premiums can go up or down, depending on the changing risk assessed by the insurer, and if you have a claim your insurance is very likely to go up the following year. Insurance premiums are based on actuarial calculations, which work out the likelihood of a claim being made against the policy, how much that claim would cost, and is heavily based on historical statistics.

What are the different Types of Insurance Premium?

There are different types of insurance premiums for every different type of insurance. These are the most common types of insurance, and therefore the most common types of insurance premiums:

• Car Insurance Premium
• Home Insurance Premium
• Health Insurance Premium
• Business Insurance Premium
• Life Insurance Premium
• Disability Insurance Premium
• Long-term Care Insurance Premium
• Commercial Property Insurance Premium
• Travel Insurance Premium

These are just some of the most common types of insurance premiums, and they all differ a lot in price, terms and levels of cover, and there are many more types of insurance premiums not listed here too.

1. Life insurance Premiums

Life insurance premiums are the amount a person pays towards their life insurance policy. Life insurance premiums are typically paid monthly or yearly, and the cost varies on the policyholder’s age, health and level of cover. With life insurance specifically, there are 2 main types of life insurance policies and therefore 2 types of premiums:

• Term Life insurance: Term Life insurance policies are for fixed periods, such as 10 or 20 years, and after that time they generally expire, whether they are still needed or not. This makes Term Life Insurance Premiums cheaper than Permanent Life Insurance premiums, as they are for shorter periods and do not accumulate cash value in the same way.
• Permanent Life Insurance: Permanent Life Insurance policies cover the policyholder for the entirety of their life, as long as their insurance premiums are fully paid. As a result, premiums for permanent life insurance policies are more expensive than term life insurance policies, as they can last a much longer amount of time, and it can accumulate cash value over time.

The cost of life insurance premiums will also be affected by the individual who is insured under the policy. If the person is older, in poorer health with an unhealthy lifestyle and a high level of cover, they will pay far higher life insurance premiums than a younger person who is in good health, leads a healthy lifestyle and has a low level of cover. If you do want to reduce your life insurance premiums you can always consider the level of cover you need and the length of cover you need, as reducing these may give you less cover for less time, but it will cost you less in life insurance premiums.

For example, a 30 year-old male who is in good health and has a low level of cover may pay an annual premium of around $400 for a 10-year term life insurance policy. Whereas, a 50 year-old male who is in poor health and has a high level of cover may pay a much higher annual premium of around $1,000 for a permanent life insurance policy.

2. Health Insurance Premiums

Health Insurance Premiums are the amount of money that a policyholder pays for their health insurance policy, whether it is an individual or a business. Health insurance premiums are typically paid on a monthly or yearly basis, and the amount it costs will vary depending on the policyholder’s age, health and the level of health insurance cover they are paying for. There are 3 main types of health insurance premiums:

• Group Premiums: Typically offered by employers and organisations, often lower cost premiums than individual policies as the risk is spread out amongst a large group of people, so the per-person cost is lower.
• Individual Premiums: Purchased by individuals, the cost of health insurance premiums for individuals will vary greatly depending on their individual circumstances such as their age, health and lifestyle.
• Medicare/Medicaid: These Government-sponsored health insurance policies are generally cheaper than individual policies, and whilst they may cover less, their level of cover and the price of the premium for them varies greatly from State to State.

Similarly to life insurance policies, health insurance premiums will be cheaper for those who are younger, in better health and with healthier lifestyles. Health insurance premiums can also be affected by government subsidies, and these can help lower health insurance premiums, particularly for low-income individuals and families. For example, an individual in their 20s who is in good health and does not smoke might be able to obtain an individual health insurance policy for less than $200/month. However, an individual in their 60s who is in poorer health and smokes might need to pay up to $700/month for a similar policy.

3. Car Insurance Premiums

Car Insurance Premiums are the amount that a policyholder pays to a car insurance company in order to be insured for the level of cover that they have agreed to. Car Insurance Premiums are paid on a monthly or yearly basis and the cost of car insurance premiums vary a lot based on the personal details of the insured, the vehicle details, and the history of driving offences or points on their licence. These specific details are what insurance companies use to calculate your insurance premium, and they use statistics and the information you provide them with to assess how high or low risk insuring you and your vehicle will be, and your premium will be set accordingly.

These are the main factors that affect how much your car insurance premium will cost:

• Vehicle Details: Make and model of the vehicle, how old the car is, how safe the car is and how expensive the car is are all factors taken into account.
• Personal Details: Your age, marital status, occupation will all be considered when insurance companies calculate your car insurance premium
• Location: Where and when you drive have an impact on how statistically likely you are to have a claim and therefore how much your car insurance premium will be
• Driving Record: How long you have driven for, your history of accidents and claims, and any driving convictions or traffic violations are considered when your insurance company calculates your car insurance premium
• Level of Coverage: How long your policy is, the level of cover, your vehicle use and expected yearly mileage are all important factors to your car insurance company when they work out your car insurance premium
• Deductibles: The level of your deductibles and effectively how much financial risk and liability you are willing to take on as the policyholder influences how much risk your insurer has to take on and therefore how much your car insurance premium will be.

Whilst these are the main factors that go into deciding how much your car insurance premium will be, every insurance company is slightly different in how much weight they put into each factor, and whilst some will charge really high premiums for young drivers, others will charge really high premiums for high value cars. Each insurance company acts differently and has their own ways of calculating car insurance premiums. Following on from this, different insurance companies offer car insurance discounts depending on different factors such as no claims bonus, good student discounts, or even usage-based discounts so to get the best price for your car insurance premiums it is important to shop around and see what level of cover and premium suits you best for your individual needs.

For example, a 25-year-old male living in the city with a clean driving record who owns a 5 year old mid-range sedan will likely pay an average car insurance premium of $1,000 a year. This premium will likely be higher if the car is a high-end model, and lower if the car is a lower-end model. If the same driver had a few minor speeding tickets, their premium would be slightly higher. If they had a few more serious traffic violations, the premium could be much higher than the average.

4. Homeowners Insurance Premiums

Homeowners Insurance Premiums are the payments that a homeowner regularly makes in order to maintain their level of insurance coverage on their home and belongings. Typically, homeowners insurance premiums are made every month or in some circumstances every year, and they are calculated on the basis of risk and value within the property. The cost of Homeowners Insurance Premiums is also influenced by the risk of dangers to the property of loss or damage, such as if the home is in an area of high flood risk, the cost of the Homeowners Insurance Premiums is likely to be higher, or if the home is in an area of high crime and increased frequency of home invasions and robberies. Increasing the security of your home with safety features can be one way to reduce the cost of your Homeowners Insurance Premiums, as this will make your home more secure and less likely to experience damage or loss.

5. Renters Insurance Premiums

Renters Insurance Premiums are the amount paid by tenants of a property to an insurance company in order to protect their personal property and limit their liability in the event of other damages or losses such as fire or theft. Similar to homeowners insurance, Renters Insurance Premiums are largely affected by the property’s own security and safety, including its location. The safer the property is generally deemed to be, the lower renters insurance premiums will be. Renters Insurance Premiums can cover the contents of the landlord and/or the contents of the tenants, and one way to reduce the cost of your Renters Insurance Premiums is by only getting limited coverage for one of these.

For example, if you are renting a studio apartment in a safe neighbourhood, you may be able to get away with limited coverage for your personal items such as furniture, electronics, and clothing. This could mean you get a lower premium as you are only covering your belongings and not the property itself. However, if you are renting a multi-bedroom home in a higher risk area, you may need to get full coverage for both the property and your personal items. This could lead to a higher premium as you are covering a larger space and more items.

6. Travel Insurance Premiums

Travel Insurance Premiums are the cost that individuals pay to an insurance company to be covered by their travel insurance. Travel Insurance Premiums can vary a lot in price, depending on the level of coverage, location, length of the trip, age, and health of the traveller. Travel Insurance is there to offer you financial protection whilst you are on your travels in the event of anything like lost luggage or incurred medical bills, and whilst the range and level of cover can vary, generally it will reflect the risk of travel based on your destination and the circumstances and details of the individual. Travel Insurance Premiums will also cost more if you need it for certain higher risk trips and activities, such as if you are going skiing or doing any other high risk sporting activities, you would have to pay higher travel insurance premiums for that level of coverage.

For example, if you are travelling to Europe for a two week holiday, you may pay a travel insurance premium of around $50. This would cover your standard medical bills and lost luggage up to a certain amount. However, if you were travelling to Europe for a skiing holiday, then you would pay a higher premium of around $100 for the extra coverage for any accidents or injuries related to skiing.

7. Level Premium

A Level Premium is a type of insurance premium where the price is fixed for the duration of the policy, or for a certain period of time. Level Premiums are typically used for longer term insurance policies, such as life insurance and long-term care insurance, where the policies can be for many years, and the price will be fixed for the duration of the policy. A Level Premium can be useful for policyholders, and they know how much the policy will cost every month, and the price will not fluctuate, making it easier for them to budget ahead of time, knowing the expense every month. However, level premiums are also more likely to be expensive in general, as whilst the cost is fixed for the period of the policy, insurance companies will not want to lose out in the event that coverage becomes more expensive, and they are unable to charge that customer more for the duration of the policy. This does mean that level premiums can be more expensive than flexible premiums, but it can save you money in the long term if the premiums have increased over the period of the policy.

For example, if a customer took out a 20-year life insurance policy, they could choose to pay a level premium every month. This means they will pay the same amount every month for the duration of the policy, and the amount will not increase or decrease. This can provide financial peace of mind for the policyholder, as they will know exactly how much the premiums will cost for the duration of the policy.

8. Flexible Premium

A Flexible Premium is a type of insurance premium where the policyholder can choose how often and how much they want to pay towards their policy, and the level of coverage they want as a result of that. Flexible Premiums are common in life insurance policies, so the insured can pay in a lump sum, or make multiple smaller payments whenever it is convenient to them. Level Premiums can be really useful for customers who want and need that greater financial flexibility, and perhaps whose financial situation is less regular than fixed monthly incomes. If your income is more variable, perhaps it is harder to commit to paying level payments every month, and instead it makes more sense for you to have a flexible premium where you can pay your premiums when you can. The amount of coverage you receive will reflect the amount you pay in flexible premiums, and naturally if you pay in less, your level of cover on your life insurance will be lowered. Whilst flexible premiums can be convenient for some people, this convenience can come at a higher cost overall than if they were to pay through level premiums.

For example, if you choose a flexible premium life insurance policy, you may choose to pay a lump sum at the start of the policy, or you can make multiple smaller payments over time. If you choose to make smaller payments, you will need to pay attention to the terms of the policy, as the amount of coverage you have will depend on the amount you have paid in. If you stop making payments, your coverage will be lowered. The cost of the policy may also be higher than if you were to pay a level premium.

How is Insurance Premium calculated?

Insurance Premiums are calculated by insurance companies based on the financial risk of damage or loss to the insured, and an assessment of the value and financial compensation that could be required as a result. This calculation varies greatly for different types of insurance and from company to company, but the overall calculation for insurance premiums is effectively at what price an insurance company believes it is worthwhile to take the financial liability for the thing that you are insuring, should it be damaged or lost. Insurance Premiums will vary a lot depending on what type of insurance it is, as if it's home, life or car insurance, they all have different factors to consider. Some factors remain the same whatever type of insurance it is, and these factors are always taken into account when calculating insurance premiums:

1. Risk: The likelihood of damage or loss occurring is one of the most important factors insurance companies take into account when calculating insurance premiums, as the higher the risk of damage or loss, the higher the insurance premium will be.
2. Value: The value and therefore the potential cost to the insurance company is also a key contributor to the cost of insurance premiums, as the higher the potential payout for the insurance company, the higher insurance premiums will be in order to cover this.
3. Coverage: The level of cover chosen is a flexible but important element in calculating insurance premiums, and is one of the few factors that customers can influence. By choosing a lower level of coverage you will be insured for less value and fewer circumstances, but you will generally reduce your insurance premiums.
4. Demographics: Age, gender and occupation can all influence the cost of insurance premiums, as depending on what type of insurance it is, this may make you higher or lower risk. For example, younger people will typically pay less for their life insurance premiums but will pay more for their car insurance premiums.
5. Location: Where you are, live, travel or keep your insured will influence how much you pay in insurance premiums as some locations are regarded as higher risk due to certain environmental or social factors.
6. Claims History: If the policyholder has a history of making claims, they will be regarded as higher risk and their insurance premium will be higher as a result.
7. Discounts: Some insurance premiums will offer discounts to certain customers, whether it is due to their experience, qualifications, demographics or occupation, these discounts are taken into account when calculating insurance premiums and can help reduce their costs.

Every insurance company will put different weight on different factors and with many different types of insurance there are also different factors to consider for each type, but these are the main factors taken into account when calculating insurance premiums.

How to Calculate Insurance Premiums?

Insurance premiums are calculated in different ways for different types of insurance and by different insurance companies. Insurance Premiums are calculated through a combination of the assessed risk by insurance companies, and giving a total premium that reflects the risk that the insurance company believes the insurance provides them with. Every insurance company will have different priorities and costs, and their insurance premium calculator will be based on their own assessment of risks and value. The likelihood of a claim, the potential value of any claims and the level of coverage are the main factors that insurance companies use to calculate insurance premiums.

Firstly, the likelihood of a claim is considered, and the more likely someone is to have damages or losses that would lead to a claim the higher the cost of an insurance premium is likely to be. The likelihood of a claim to occur is assessed from a number of factors such as the insurer’s assessment of how likely the insured is to make a claim, including an individual's claims history and the safety and security of the insured.

Secondly, the potential value of a claim is taken into account, as the higher the potential value of a claim, the higher the insurance premiums will be. Insurance companies will ask and agree on a value for the thing that they are insuring, and they will have terms and conditions, often restricting the maximum potential payouts in order to limit the potential liability. If you are insuring something with a low value with a low potential payout, the cost of your insurance premium will be lowered.

Lastly, the level of coverage chosen is a major factor in calculating the cost of an insurance premium. The lower the level of coverage, the cheaper your insurance premium is likely to be. The level of coverage is one factor that policyholders can choose in order to reduce their insurance premiums, as the less liability that insurance companies take on, the less they will charge in insurance premiums.

What are the determining factors that affect Insurance Premiums?

Insurance premiums are determined by factors that influence the level of risk to the insurance company. Insurance companies assess different factors that increase the risk of damage or loss and calculate the insurance premium accordingly. These factors include personal information, type of insurance coverage, amount of insurance coverage and your insurance history.

1. Personal Information

Your Personal Information is an important factor that affects your insurance premium, whether it's your age, your location, your occupation or your experience, your personal details will be an important influence on how much your insurance premium will cost. For some insurance types such as car insurance, young people will have more expensive insurance premiums whilst for life insurance, they are likely to have much cheaper insurance premiums.

2. Type of Insurance Coverage

What type of insurance coverage you have and what level of coverage you choose will have a significant impact on the price of your insurance premium. Different types of insurance will obviously cost different amounts, as your health insurance is unlikely to have the same insurance premium as your car insurance. Different types of insurance will cost different amounts depending on what it is they cover, how long for, and what level of cover they provide.

3. Amount of Insurance Coverage

The amount of insurance coverage has a large impact on how much your insurance premium will be. The level of cover and how long you are covered for will influence how much your insurance costs. The more cover you have and the longer your cover is for will make your insurance premium more expensive.

4. Insurance History

Your insurance history will directly affect the price of your insurance premium. If your insurance history is many years of no claims then your insurance premium will be cheaper, as insurance companies will think you are a safer risk, and less likely to make a claim than someone who has made lots of claims in their insurance history.

What are the different ways to pay your Insurance Premiums?

Different Insurance companies and different insurance policies will have their insurance premiums paid in different ways and with different regularities. Some Insurance premiums will be per year, per month, or even per week, and whilst you can have some control over how often you pay your insurance premiums, this will often be decided by the insurance company. It is also important to make sure you know how much you will pay in total after you have made all payments, as often the more payments you make, the more interest you will pay on your insurance premium in total.

• Monthly: Most Insurance companies will allow you to pay your insurance premiums on a monthly basis, and this is the most common method of paying for your insurance premium.
• Quarterly: Some Insurance companies will offer the option of paying your insurance premium over four, quarterly payments.
• Semi-Annually: Insurance premiums can also sometimes be paid semi-annually, where the entire insurance premium is split over 2 payments in a year.
• Annually: Most insurance companies will happily allow you to pay your entire insurance premium up front for the year in one payment, and this can save you the interest amounts that can sometimes be applicable on the more regular payment methods, such as monthly.

How do Deductibles affect your Insurance Premiums?

Deductibles affect your insurance premium, as the higher you are willing to have your deductible, the lower your insurance premium will be. The higher your deductible is, this shows your insurance company your willingness to pay towards the first amount of any incident or claim, which reduces the likelihood of your insurance company having to pay out in the event of a claim. The higher your deductible is, the lower your insurance premium will be. If you want a low deductible because you do not want to pay much out of pocket in the event of a claim, you will have to pay a higher insurance premium for your insurance company to be willing to take on more of the financial risk.

Is it better to have a Deductible or No Deductible?

Yes. It is better to have a deductible, as it can lower your overall insurance premiums. Whether a deductible is a good or bad thing depends on a few factors. Firstly, how likely you are to have a claim. If you know there is no chance whatsoever that you are going to have a claim, it does not matter how high it is, as you will never have to pay that amount out of pocket anyway, but it will make your insurance premiums cheaper. If you think there is a high chance you may have to make a claim, it is better for your deductible to be as low as possible, as you do not want to have to pay out that deductible in the event of a claim. It is best to make your own risk assessment, and accordingly decide the balance between deductible and premium.

Who determines an Insurance Premium?

Insurance companies, and in particular underwriters, are the people who decide on the price of insurance premiums, as they assess risks of lots of different factors and price things according to the risks portrayed by the statistics they have. All insurance companies determine insurance premiums in different ways, and have different statistics that they pay attention to, so whilst they may all look at similar data, it is always worth looking around at different insurance companies as they will have determined their insurance premiums in different ways, meaning some will be cheaper for you than others.

Is Insurance Premium an expense?

Yes. Insurance Premiums are regarded as an expense. It is a regular payment made by an individual or a company to an insurance company in order to maintain their insurance coverage, and this expense is paid on a regular basis such as monthly, quarterly or annually.

Is Insurance Premium an asset?

Yes. Insurance Premiums are not an asset, but a liability for the policyholder. The policyholder has an obligation to pay their insurance premium on the regular basis that they have agreed to. The coverage itself may be an asset to the policyholder as it is a reduction in their financial risk and liability, but the insurance premium itself is an expense.

Can you get a refund for Insurance Premiums?

Yes. You can get a refund for an insurance premium. Refunds for Insurance premiums are dependent on the type of insurance, the insurance company’s terms, and the length remaining on the insurance policy. If the policy is new and has been paid in full up front, most insurance companies would give you a refund pro rata for the remaining period of the policy, minus their cancellation fees and admin fees. This means that whilst it is possible to get a refund on a policy if there is a long period on it still, and you have paid in full, you are unlikely to receive the full amount that you would expect for that period. Furthermore, if you cancel your policy towards the end of the policy period, you are less likely to get any refund. Each insurance company has its own terms for refunds, so it is advisable to enquire with them if you think you may need to claim a refund.

Can Insurance Premiums be also applied to Dentals?

Yes. Dental insurance policies also have insurance premiums, so if you have a dental insurance plan, you will have to pay Dental Insurance premiums. These premiums are usually paid on an annual basis, but sometimes can be split over monthly insurance premiums too.

What is the difference between Insurance Premiums and regular Insurance?

Insurance premiums refer to the payments that you make for your insurance, whilst regular insurance is the coverage itself. Insurance premiums are the amount that you pay in order to maintain your regular insurance coverage. Insurance is the cover, Insurance premiums are the payments for that cover.