What Are Insurance Premiums and How Do You Calculate Them?

An insurance premium is the amount of money the insurance company charges you for the insurance policy you buy from it. The insurance premium is the cost of your insurance.

Here are the basics to help you understand what an insurance premium is and how it works.

The Definition and Examples of an Insurance Premium

Everyone knows insurance costs money, but one term that may be new when you first start buying insurance is “premium.” Typically, the premium is the amount paid by a person (or a business) for policies that provide auto, home, healthcare, or life insurance coverage.

An insurance premium is a sum you pay periodically to keep your insurance policy active and in force. Depending on your insurer and the type of policy you have, you can make payments monthly, quarterly, semiannually, or annually. In many cases, you may qualify for a lower rate if you pay your premium in one lump sum annually.

If you forget to make a premium payment, there’s usually a grace period. But after that, an insurance company can cancel your policy—even if the missed payment was an honest mistake.

For example, if you pay $212 per month to keep your car insured, your yearly insurance premium would be $2,544. You may have purchased a six-month policy, which would make your insurance premium $1,272.

How Insurance Premiums Work

Insurance premiums usually have a base calculation. Then, based on your personal information and location, you may have discounts that are added to the base premium that reduces your cost.

In order to get preferred rates, or more competitive or cheaper insurance premiums, additional information is needed. You can learn about these factors in greater detail in the section about the four factors that determine the premium. 

The insurance premium may be paid on an annual, semi-annual, or monthly basis. If the insurance company decides that it wants the insurance premium paid upfront, it may also require that. This is often the case when a person has had their insurance policy canceled for non-payment in the past.

The premium is the basis of your insurance payment. In certain cases, an insurance premium may be considered taxable income to you (for example, coverage for group-term life insurance that exceeds $50,000 and is carried directly or indirectly by an employer). 

Service fees might be added to it, depending on the local insurance laws and the provider of your contract. The National Association of Insurance Commissioners’ Guidelines or your State Insurance Commissioners’ office can provide you with more information on your local regulations if you have a question about fees or charges on your premium.

Any extra charges, such as issuance fees or other service charges, are not considered to be premiums and will be itemized separately on your premium or account statement.

The cost of your insurance premium will vary depending on the type of coverage you are looking for, as well as the risk.

This is why it is always a good idea to shop for insurance or work with an insurance professional who can shop premiums with several insurance companies for you.

When people shop around for insurance, they may find different premiums charged for the cost of their insurance with different insurance companies, and they may save a lot of money on insurance premiums just by finding a company that is more interested in “writing the risk.”

What Factors Determine an Insurance Premium?

An insurance premium is usually determined by four key factors:

1. Type of Coverage

Insurance companies offer different options when you purchase an insurance policy. The more coverage you get, or the more comprehensive coverage you choose, the higher your insurance premium may be.

For example, when looking at premiums for home insurance, if you purchase an open peril or all-risk coverage home insurance policy, it will be more expensive than a named peril home insurance policy that only covers the basics.

2. Amount of Coverage and Your Insurance Premium Cost

Whether you are purchasing life insurance, car insurance, health insurance, or any other insurance, you will always pay a higher premium (more money) for higher amounts of coverage.

This can work in two ways. The first way is pretty straightforward, and the second way is a little more complicated but a good way to save on your insurance premiums:

  • Your amount of coverage can be altered by the dollar value you want on whatever you are insuring. For example, insuring a house for $250,000 will be different from insuring a house for $500,000. It’s pretty straightforward: the more dollar value that you want to insure, the more expensive the premium will be.
  • You can pay less for the same amount of coverage if you get a policy with a higher deductible. For example, with home insurance, you can save up to 25% by increasing your deductible from $500 to $1,000. In the case of health insurance or supplemental health policies, you can choose higher deductibles or look at policies with different options like higher co-pays or longer waiting periods. 

3. Personal Information of the Insurance Policy Applicant

Your insurance history, where you live, and other factors of your life are used as part of the calculation to determine the insurance premium that will be charged. Every insurance company will use different rating criteria.

Some companies use insurance scores, which can be determined by many personal factors, from credit rating to car accident frequency or personal claims history and even occupation. These factors often translate into discounts on an insurance policy premium.

For life insurance, other risk factors specific to the person being insured will be used as well, such as age and health conditions.

Insurance companies have target clients, just like any business. In order to be competitive, insurance companies will determine what the profile of clients they want to attract is, and they will create programs or discounts to help attract their target clients.

For example, one insurance company may decide that it wants to attract seniors or retirees as clients, while another will price premiums to attract young families or millennials.

4. Competition in the Insurance Industry and Target Area

If an insurance company decides that it wants to aggressively pursue a market segment, it may vary rates to attract new business.

This is an interesting facet of insurance premiums, because it may drastically alter rates on a temporary basis, or on a more permanent basis if the insurance company is having success and getting good results in the market. 

Auto Insurance Premium Pricing

Factors that influence your auto insurance premium include:

Age. Drivers under age 25 generally pay among the highest rates, even with a good driving record. Rates start to drop after age 25.

Driving history. Traffic violations and accidents will often cause rates to increase at renewal time.

Type of car. Your vehicle choice will impact rates because insurers will look at claims made by owners of the same model. Also, your vehicle’s value affects the cost of collision and comprehensive insurance. These coverage types pay for repairs—or the value of a vehicle that’s been totaled—due to accidents, theft, fire, collisions with animals, and other problems.

Miles you put on your car. Having lower mileage every year can put you in a lower rate category.

ZIP code. Where you park your car and where you live impacts how much you pay for insurance. For example, if you live in an area prone to theft and vandalism and leave your car on the street, you’ll probably have to pay more for coverage than someone who lives in a low-crime city and parks their car in the garage.

Credit. Depending on where you live, insurers may look at your credit-based insurance score and charge more if you have a poor score.

Past claims. Drivers who cause accidents or make claims will likely see rates rise at renewal time because they are now seen as riskier customers. Not all accidents make rates go up.

Home Insurance Premium Pricing

Factors that influence a homeowners insurance premium include:

Age and condition of the home. Older, vintage homes may cost more to insure since they may require costly materials to rebuild them back to their original condition.

ZIP code. Some states and cities are simply more vulnerable to frequent and/or expensive claims, which affects the rates for everyone in the area.

The cost to rebuild a home. Your dwelling coverage is based on the cost to rebuild the house in the event of a big disaster, like a large fire or tornado. The building materials and additional features of a home can increase the cover price. For example, a home with a tile roof may cost more to rebuild than an asphalt roof.

Additional risks. Pools, trampolines, and even dogs can increase your insurance cost.

Valuable. While a home insurance policy includes coverage of the contents inside, you may need to buy additional insurance for expensive items like jewelry.

Safety and security devices. Installing security systems, alarms or other safety devices such as smoke detectors can lead to an insurance discount.

Credit and past claims. Like auto insurance, credit can be a factor in home insurance premiums, as will past claims.

Renters Insurance Premium Pricing

Factors that influence renters insurance premiums include:

Coverage amount. Your renter’s insurance coverage amount will be based on the value of the belongings you want to insure. For example, in some cases, $20,000 is sufficient to replace your belongings in the event of a disaster. If you own a lot of furniture, decorations, and clothing, you’ll need far more coverage.

ZIP code. Risks vary depending on your rental location. For example, urban areas may have higher renters insurance rates because of higher crime rates.

Credit and insurance history. Past claims and poor credit can cause higher rates.

Life Insurance Premium Pricing

Factors that influence life insurance premiums include:

Age. Life insurers look at life expectancy when pricing a policy. The younger you are, the lower your rates will be compared to someone older who’s in the same health.

Gender. Since women tend to live longer than men they enjoy lower rates.

Health. Your weight, medical history, and family medical history (parents and siblings) play a significant role in life insurance premiums. Anything that potentially reduces your life expectancy can mean a higher rate.

Lifestyle. A criminal record, history of DUIs or speeding, or a hazardous occupation like a pilot will often factor into life insurance premiums. Credit is also a factor that some insurers use in risk scores.

Policy type. Term life insurance is designed to protect you for a certain amount of time, such as 10, 20, or 30 years. It’s the most affordable type of life insurance. Forms of permanent life insurance cost more because they can stay in force no matter when you die and often have a cash value component.

Pet Insurance Premium Pricing

Pet insurance is like health insurance for a pet. Pet insurance premiums consider these factors:

Age. When a pet is younger, they are less prone to illness or injury, so pet insurance rates rise as pets get older.

Breed. Some breeds are more predisposed to hereditary conditions than others, increasing the insurance risk and impacting your rate. Also, coverage for dogs is usually more expensive than for cats.

Gender. Insurance data shows that pet parents submit more claims for male pets than for females, so some insurers charge slightly more for male pets.

ZIP code. Because veterinarian costs vary by location, pet insurance costs will differ as well. If you live in a big city, for example, you can usually expect to pay more for coverage.

Travel Insurance Premium Pricing

Factors that influence your travel insurance premium include:

Age. Age can affect the likelihood you’ll submit a travel insurance claim, with older travelers submitting more claims.

Trip cost. The amount of trip cost you’re insuring is also a primary factor in travel insurance premiums. You want to ensure the amount you would lose in pre-paid and nonrefundable deposits.

Who Decides the Insurance Premium?

Every insurance company has people who work in various areas of risk assessment.

Actuaries, for example, work for an insurance company to determine:

  • The likelihood of a risk or peril
  • The costs associated with the event of a disaster or claim are then created by actuaries, who create projections and guidelines based on this information.

Using the calculations, actuaries determine how much cost will be involved in paying claims as well as how much money the insurance company should collect in order to make sure that that it makes enough money to pay potential claims but also make a profit.

The information from the actuaries helps to shape underwriting. Underwriters are given guidelines to underwrite the risk, and one part of the task is to determine the premium.

The insurance company decides how much money it will charge for the insurance contract it is selling you.  

What Does the Insurance Company Do With Insurance Premiums?

The insurance company has to collect the premiums from many and make sure it saves enough of that money in liquid assets to be able to pay the claims of the few.

The insurance company will take your premium and put it aside, letting it grow for every year you don’t have a claim. If it collects more money than what it pays in claim costs, operational costs, and other expenses, the company will be profitable.

An “earned premium” is the portion of the total premium that an insurance company can show on its income statement as revenue, based on the policy’s duration and how much of the term has passed.

Why Do Insurance Premiums Change?

In profitable years, an insurance company may not need to increase insurance premiums. In less-profitable years, if an insurance company sustains more claims and losses than anticipated, then it may have to review its insurance premium structure and re-assess the risk factors in what it is insuring. In cases like those, premiums may go up.

Examples of Insurance Premium Adjustments and Rate Increases

Have you ever spoken to a friend who was insured with one insurance company and heard them say what great rates they have, but then compared it with your own experience with the prices for the same company, and had it be completely different?

This could happen based on various personal factors, discounts, or location factors, as well as competition or loss experience of the insurance company.

For example, if the insurance company actuaries review a certain area one year and determine that it has a low-risk factor and only charges very minimal premiums that year, but then by the end of the year they see a rise in crime, a major disaster, high losses, or claims payouts, it will cause them to review their results and change the premium they charge for that area in the new year.

That area will then see rate increases as a result. The insurance company has to do this in order to be able to stay in business. People in that area may then shop around and go somewhere else.

By pricing the premiums in that area higher than before, people may change their insurance company. As the insurance company loses the clients in that area who aren’t willing to pay the premium it wants to charge for what it has determined as the risk, the insurance company’s profitability or loss ratios will likely decrease.

Fewer claims and proper premium charges for the risks allow the insurance company to maintain reasonable costs for their target clients.

How to Get the Lowest Insurance Premium?

The trick to getting the lowest insurance premium is to find the insurance company that is most interested in insuring you.

When an insurance company’s rates go too high all of a sudden, it is always worth asking your representative whether there is anything that can be done to reduce the premium.

If the insurance company is unwilling to change the premium it is charging you, then shopping around may find you a better price. It will also give you a better understanding of the average cost of insurance for your particular risk.

Asking your insurance representative or an insurance professional to explain the reasons why your premium increased or whether there are any opportunities to get discounts or reduce insurance premium costs will also help you understand whether you are in a position to get a better price and how to do so. 

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