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What Is An Insurance Premium (Explained: All You Need To Know)

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What Is An Insurance Premium

Insurance premium refers to the amount of money that a person or company must pay to be insured against different types of risks.

In other words, when a person or company signs up for an insurance policy, it will be required to make “insurance premium” payments to the insurance company to get the protections outlined in the policy.

When you think of insurance premiums, think of the cost to purchase insurance coverage.

You can have insurance premiums charged for any type of policy such as:

  • Home insurance
  • Car insurance
  • Healthcare insurance 
  • Life insurance 
  • Medical insurance

For example, if you are looking to get car insurance and you are given a car insurance quote of $100 per month or $1,200 for the year, that’s the price you need to pay to get and keep your car insurance.

Policy Effectiveness

For an insurance policy to remain in effect, the policyholder must pay the stated insurance premiums.

If the premiums are paid on time and there’s a covered peril that takes place, the insurer will pay for the damages.

However, if the policyholder does not pay the stated insurance premium, then the insurance company will not have any obligation to pay for a claim even if it was a covered peril.

Premium Calculation

Insurance premiums are calculated by insurance companies using complex formulas, data, statistics, and models.

The insurance company’s main objective is to provide insurance a large number of people from a certain risk and collect premiums from them and pay for any losses or covered claims.

If the insurance can collect more premiums from policyholders than what it pays out, then it’s operating a profitable business (otherwise, it will go out of business).

Traditionally, insurance companies worked with actuaries to determine their risk exposure and the right amount of premium to charge.

Today, sophisticated computer systems and algorithms are used in addition to that to further accurately predict risk and calculate premiums.

Payment Frequency

You can have different insurance premium payment cycles such as monthly payments, annual payments, semiannual payments, or quarterly payments.

To get a better understanding of what are insurance premiums, let’s look at how they work.

How Insurance Premiums Work

In its essence, an insurance premium is the price you are required to pay to get covered under an insurance policy.

Insurance companies have a method for calculating how much a specific type of insurance should cost (their base calculation).

Depending on the type of insurance that you buy and the nature of the risk covered by the insurance company, your premiums may vary.

In other words, the price you need to pay to purchase a specific type of insurance will depend on various factors such as the nature of coverage you are purchasing, where you live, your age, your past insurance claims, and so on.

Let’s look at the factors insurance companies generally consider when giving you an insurance premium quote for different types of insurance products.

Car Insurance Premiums

Your insurance company will quote you an insurance premium for your car based on the following factors:

  • Your age
  • Your driving record
  • The type of car you are insuring 
  • How much you drive
  • Your car insurance claims history
  • How much coverage you are getting
  • Your deductibles 

For example, the cost of insuring a teenage driver is going to be more expensive than an adult driver.

Life Insurance Premiums

Typically, life insurance premiums will get calculated by taking into consideration the following aspects:

  • The insured’s age
  • The insured’s sex
  • The insured’s lifestyle
  • The insured’s medical history
  • The insured’s credit history 
  • The coverage limit requested 
  • Policyholder’s employment status 
  • Type of policy taken (whole life insurance or term life insurance)
  • Your coverage limit and deductibles 

For example, a young person without medical conditions will get a cheaper insurance premium quote than an older individual with medical issues.

Renters Insurance Premiums

In general, your renters insurance premiums will be established on the following factors:

  • The value of your personal belongings
  • If the building has an alarm system or not
  • Location of the property 
  • Your age
  • Your claims history
  • The coverage limit
  • Your deductibles 

For instance, if you live in an area where there’s a high level of criminality and theft or you live in a building that does not have a burglary system installed, you may have to pay higher premiums than someone living somewhere else.

Homeowners Insurance Premiums

When getting quotes for your homeowners insurance, the insurance provider will usually look at:

  • The value of your home
  • The location of your property 
  • Type of property insured
  • The cost to rebuild your home
  • Specific risks related to your home
  • The valuables in your home 
  • Your credit score 
  • Your claims history
  • The nature of coverages you take
  • The coverage amount you are buying 
  • The deductible you choose 

For example, insuring a property in a building or complex can be different than a single-family home.

Pet Insurance Insurance Premiums

Your pet insurance is similar to health insurance but for your animal where the premiums you’ll pay will depend on:

  • Your pet’s age
  • The type of animal you are insuring
  • Your pet’s gender
  • Where you live
  • Your coverage limits and deductibles

Travel Insurance Premiums

Many factors can affect the amount of premiums you will need to pay to purchase travel insurance, such as:

  • Your age
  • Your trip cost
  • The type of trip you are making 
  • The duration of your trip
  • The nature of your coverage
  • Your deductibles 

Frequently Asked Questions

Let’s look at a few common questions related to what is an insurance premium?

What Is A Premium In Insurance

Insurance premium represents an amount of money a person pays an insurance company in exchange for insurance coverage under a specific insurance policy.

Depending on the type of insurance you are taking and the risk factors considered by your insurance company, the amount of premium you’ll be asked to pay may vary.

There may be hundred of factors that insurance companies consider when giving you a premium quote so you can expect to receive a different premium quote for the exact same coverage by different companies.

How Is An Insurance Premium Calculated

There may be hundreds of factors that insurance companies assess in calculating the premiums that they charge clients under a policy.

Some factors will be specific to the type of policy purchased while other factors relate to the policyholder or the characteristics of what’s being insured.

For example, the factors that typically affect home insurance and car insurance policies are coverage limits, the amount of deductibles chosen, the policyholder’s prior claims, and credit score.

On the other hand, the same person taking term life insurance will pay approximately 5 to 10 times less in premiums than someone taking whole life insurance.

In this case, the nature of the policy affects the premiums charged by the insurance company as they calculate the risk of a whole life policy to be much higher than term life insurance.

When the risk factors are identified by the insurance provider, they will analyze them using statistical models and complex algorithms to assess their liability exposure.

Why Do Insurance Companies Charge Insurance Premiums

The only way an insurance company can remain in business is to charge their clients premiums in exchange for providing financial coverage under the policies they underwrite.

The insurance company’s main objective is to collect more premiums from policyholders than what it pays out.

When the insurance premium is received, the insurance company can use that money to invest it to generate additional returns, provide discounts under some types of policies, or maintain liquidity should it be required to make payments under different policies.

How Deductibles Impact Your Insurance Premiums

An insurance deductible is an amount of money that you must pay to trigger the coverages under your policy.

In other words, for an insurance company to make a payout or pay you for a covered claim, you must first pay the deductible.

The higher the amount of deductible you are required to pay, the lower your insurance premium.

Conversely, the lower your deductibles, the higher your insurance premiums.

For example, if you take insurance for your home at a rate of $1,200 per year with a $250 deductible, you may be able to reduce your premiums to $1,000 if you assume a $500 deductible instead.

This means that you can get a $200 reduction in your yearly premium if you were to accept to pay a higher amount for your deductibles.

What Is Monthly Insurance Premium

A monthly insurance premium is when you pay your insurance premiums under your policy on a monthly basis as opposed to other payment cycles.

What Is Annual Insurance Premium

Annual insurance premium is when you pay the amount you owe your insurance company under your policy annually.

What Is Insurance Premium Takeaways 

So there you have it folks!

What does premium mean in insurance? 

What is policy premium in simple terms?

In a nutshell, an insurance premium is an amount of money that you pay an insurance company under an insurance policy in order to get the benefits outlined under the policy.

The insurance premium is your cost of getting insurance.

Every insurance company will assess their risk differently and so the premium you will be asked to pay by one provider may not be the same as another provider for the exact same type of insurance.

The establishment of your insurance premium will depend on the nature of your insurance, your coverage limits, your claims history, and many other factors considered by your insurance company.

If you are happy with the insurance premium quote that you get, you can then purchase the offered insurance policy.

Then, to maintain your policy in effect, you’ll need to keep up with your premium payment obligations where you can pay annually, semiannually, quarterly, or monthly depending on what your insurance company accepts.

In the end, you need to pay the premiums to benefit from the financial protection benefits set out in your insurance policy.

I hope I was able to answer your question related to what is the insurance premium and how it works.

Good luck!

Let’s look at a summary of our findings.

What Is An Insurance Premium Summary

  • An insurance premium is the amount of money you pay to purchase and keep an insurance policy 
  • Under an insurance policy, an insurance company agrees to cover you for certain losses or risks in exchange for you to pay a certain amount of money called premium
  • Insurance premiums are calculated using complicated actuarial models and adjusted based on the risk factors specific to a particular policy 
  • The main factors that affect insurance premiums are your coverage limits, deductible amounts, your past claims, and your credit
  • You should shop around to get different quotes from different insurance companies to compare coverage and price so you can make the best purchase decision 
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