Updated on: 23 June 2023
Insurance plays a vital role in mitigating financial risks and providing a safety net against unforeseen events. When purchasing a plan, one of the key considerations for policyholders is the insurance premium. You need to pay a premium amount to get the benefit from the insurance coverage. It is an amount paid to your insurer, which keeps your coverage in place. Insurance companies determine the premium amount after evaluating the risk involved in insuring your life.
Key takeaways
- An insurance premium is the amount of money the policyholder pays to an insurance company to obtain and maintain the coverage.
- Your insurance company decides the amount of your premium, basis the type of cover chosen and the probability of filing the claim.
- An insurance actuary is someone in an insurance company who analyzes the financial risk linked with a policyholder using statistical data.
- You can calculate your insurance premiums by multiplying the risk factor with the sum insured and dividing the value by the coverage period.
The best insurance providers allow you the flexibility to pay your premium periodically. The frequency can be either monthly, quarterly, semi-annually or annually. Some insurers also provide you with the option to pay a single premium during the entire duration of the plan.
This blog will help you understand what an insurance premium is, why you have to pay it, how it works, and ways to reduce your costs.
What is Insurance Premium?
In simple terms, insurance premium is the amount that you pay to the insurance company to ensure you receive coverage under the plan. It is thus a fundamental concept that lies at the heart of insurance contracts.
An insurance company decides your insurance premium based on numerous factors. From the type of cover chosen and the probability of filing the claim to your location, lifestyle and habits, these factors play an important role in determining the term insurance premium.
The insurance premium amount may also be determined based on your insurance history. Different companies use different criteria to determine premiums - some use insurance scores based on personal factors like credit rating, car accident frequency, personal claims history and occupation. If the possibility of filing the claim is more likely, you will have to pay a higher premium and vice versa.
An insurance premium is also paid for non-life plans, such as motor insurance. In the case of such plans, the insurer may reduce the annual premium amount if you do not file a claim during the policy term. This is known as the No Claim Bonus (NCB) and accumulates every year when you do not file a claim. Now you are confident about what is meant by premium in insurance, let’s move forward!
Factors that Determine Insurance Premium
Various factors play a role in deciding the term insurance quote and the premium you shall pay. It varies from insurer to insurer. These include but are not limited to the following:
Age
Your age is a crucial metric when deciding the premium quote, which is why it is advised to buy an insurance policy when you are younger. As you grow older, the premium rates keep rising, with a higher probability of getting health risks. At a younger age, you can avail of a term plan at an affordable cost if you are healthy and do not have any lifestyle habits.
Insurance companies consider the policyholder’s age because that can predict the likelihood that they will need to use the insurance. The younger generation is less likely to need medical care with health insurance, so their premiums are generally cheaper. On the other hand, the premium amount increases as the age of the policyholder increases - since the chances of availing of medical services are high.
Gender
Most insurance companies use statistical data to figure out the life expectancy of the two genders. Such a factor benefits one gender resulting in a lower premium rate for them.
Health
Your past and current health records help the insurer understand your health history. The insurance company can also ask you to undergo a medical test, but if you opt out of it, a higher premium rate might be your fate. Smoking and drinking habits also play a significant role in deciding the price.
Lifestyle Habits
If you have any lifestyle habits like drinking alcohol and smoking, you have a higher probability of getting diagnosed with some illness in the future. This can lead to you getting higher premium quotes, with some premium rates being double the amount of a non-smoker or non-drinker’s premium.
Medical Records
The medical records include your family’s medical history, aiding the insurer in understanding the potential risk of you getting diagnosed with such illnesses. For example, a family history of heart problems can give rise to an increase in the premium price.
Profession
If you have a profession, like in the mining industry, which is dangerous or poses a danger to your life can affect the premium quote.
Type of Coverage
The insurer provides several options when you want to purchase a life insurance policy. You will have to pay a higher premium if you opt for greater and more comprehensive coverage. For example, the premium amount is greater if you opt for a term insurance plan with higher coverage. In general, you have several options when you buy an insurance policy. The more comprehensive coverage you get, the more expensive it will be.
Coverage Amount
A commonly used and known term when you look for an insurance policy is the sum assured. The premium amount and the sum assured are directly proportional, which means that greater coverage entails a higher premium. However, some ways may enable you to procure more coverage at an affordable premium. One way to reduce the premium amount is to increase the excess. This is the amount that you must pay in case of a covered event occurring before the insurance company accepts your claim.
Competition
Although this factor does not directly relate to you, it benefits you in terms of a competitive premium for your insurance plan. Because insurance companies want to increase their customer base, they attract new clients through reduced premiums. Another aspect of the competition is that when one insurer reduces the premium, most other insurance companies follow suit, making it beneficial to you.
Apart from all these, insurance companies also consider the mortality cost, i.e. the minimum sum that is paid by an insurance company to the nominee if the policyholder dies. This is also worked out by assessing the factors mentioned above. Also, the operational costs of the insurance companies, like the rent of office space, salaries of employees, commissions of agents, etc., help in determining the insurance premiums. At last, even the interest earned on invested premiums is also considered before the premium calculation.
As can be seen, the premium calculation is a multi-layered process, depending on several factors and varying from one person or policy to another. Therefore, you should always use a calculator to determine the insurance premium payable on your life insurance policy before choosing the same or renewing it every year. These calculators are available on the websites of most insurers.
Who Calculates the Premium?
An insurance actuary is someone in an insurance company who analyzes the financial risk linked with a policyholder using statistical data and mathematics. They also make sure that the insurer remains financially stable and can pay off the insurance claims. Hence, the actuary determines a standard premium rate for various factors but does not work on premiums for specific policyholders. Instead, the underwriter appointed by the insurer is the one who takes the premium rate table and determines the premium you will have to pay based on the factors that apply to you.
Different Types of Premiums
In addition to knowing what a term insurance premium is, you should understand the types of premiums. There are two types of premiums, as listed below.
Level Premium
This is a basic type of insurance premium where you pay a fixed amount during the entire policy duration. It is not complicated and is self-explanatory.
Flexible-Premium
This is slightly more complex. When you choose a flexible premium option, you have the choice to make certain changes to the insurance policy. You may choose to enhance the insurance coverage or increase the number of people covered under the same plan in the future. Based on the modifications you make, the premium will change.
Modes of Insurance Premium Payment
You can pay your premiums with multiple payment frequency options made available to you. This enables you to pay at your convenience. Here are the four modes of payment:
Monthly Payment
This mode of payment allows you to pay every month, but it is observed this method leads to paying a higher price for the policy when compared with other modes.
Quarterly Payment
This mode enables you to pay four times per year and is known to be a more lucrative option than the monthly method.
Semi-Annual Payment
For the semi-annually mode, you will have to pay your premiums twice a year, consisting of shelling out a higher amount compared to the above-given methods.
Annual Payment
An annual payment mode can lead to a higher amount of premium that would have to be paid every year. But this method gives you a policy at a lesser cost than the other modes of payment.
How to Calculate Insurance Premiums?
Insurance is an essential part of financial planning and risk control. Whether it is life insurance, term insurance, health insurance or any other type of coverage, understanding how insurance premiums are calculated can help you make informed decisions and ensure you get the right coverage at a fair price.
Identify the Type of Insurance
Insurance premiums play a critical role in our lives, providing protection and financial security against unexpected events and risks. From safeguarding our health and property to mitigating liability and business-related risks, insurance policies offer peace of mind and help us navigate uncertain circumstances. However, with the vast array of insurance options available, understanding and identifying the right type of insurance can be a daunting task.
Assess the Risk Factors
Insurance companies assess the risk associated with providing coverage to individuals or entities. They consider various risk factors specific to the type of insurance. For instance, when calculating health insurance premiums, insurers evaluate factors such as age, lifestyle, medical history, and occupation. These risk factors help determine the likelihood of a claim being made.
Gather Relevant Information
Insurance premiums are often personalized to the individual or entity being insured. Therefore, you will need to provide personal information before calculating insurance premiums, such as your age, gender, marital status, and occupation. These details help insurance companies assess the risk associated with insuring you.
Consider Coverage Limits and Deductibles
Insurance premiums are also influenced by coverage limits and deductibles. A coverage limit is the maximum amount an insurance company will pay for a covered loss. Higher coverage limits generally result in higher premiums. Deductibles, on the other hand, are the amount you must pay out of pocket before the insurance coverage kicks in. Higher deductibles often lead to lower premiums because you are assuming more risk.
Evaluate Insurance Company Factors
Different insurance companies may have their own criteria for calculating premiums. it is essential to research and compares multiple insurance providers to find the best coverage and rates. Consider factors such as the company’s reputation, financial stability, customer service, and claims settlement history. Working with a reputable and reliable insurer is crucial to ensure you receive fair premiums and prompt claims handling.
Obtain Insurance Quotes
Once you have gathered all the necessary information, it is time to request insurance quotes from multiple providers. Insurance companies will use the data you provide to calculate premiums based on their specific algorithms and risk assessments. Obtaining quotes from multiple insurers allows you to compare prices and coverage options, enabling you to make an informed decision.
Review and Adjust Coverage as Needed
Review your insurance policy regularly to ensure your coverage aligns with your current needs. As circumstances change, you may need to adjust your coverage limits and deductibles or even switch insurance providers to obtain more favorable premiums. Regularly evaluating your insurance coverage will help you maintain appropriate protection while managing costs effectively.
Simple Premium Calculation
The basic formula for calculating insurance premiums is:
Premium = (Risk Factor * Sum Insured) / Coverage Period
In this formula:
- The risk Factor represents the risk associated with the insured item or individual, usually expressed as a percentage.
- Sum Insured denotes the total amount of coverage required.
- The coverage Period represents the duration for which the insurance coverage is valid.
Premium Calculation with Experience Rating
In some cases, insurance companies use experience rating to adjust premiums based on the policyholder’s past claims history. The formula for calculating premiums with experience rating is
Premium = Base Premium + (Experience Modifier * Base Premium)
In this formula:
- Base Premium is the initial premium amount determined based on factors like risk assessment and coverage requirements.
- Experience Modifier is a factor that adjusts the base premium depending on the policyholder’s past claim experience. It is often represented as a percentage.
Premium Calculation with Deductibles
If a policy includes a deductible, the formula for calculating premiums becomes:
Premium = [(Risk Factor * (Sum Insured - Deductible)) / Coverage Period] + Deductible
In this formula:
The deductible represents the amount the policyholder agrees to pay out of pocket before the insurance coverage takes effect.
How Can You Lower Your Insurance Premium?
The task of an insurance company is to assess the risk and help the policyholders to stay financially secure. The higher the risk to the policyholder, the higher the premiums will be. Still, there are different ways that you can consider lowering your premiums.
Premiums are affected by the type of coverage you purchase. If you buy more comprehensive coverage, it will lead to an increase in your insurance premium. Apart from this, deductibles can reduce your insurance premiums. An insurance deductible refers to the cost you pay before the insurance company pays anything.
What to Consider While Buying an Insurance Policy?
Choosing the right insurance policy can be a daunting task with the multitude of options available in the market. To make an informed decision, here are some key factors to consider while buying an insurance policy.
The Financial Strength of the Insurer
It is crucial to choose an insurance company with a strong financial standing. Look for insurers that have a high credit rating from independent rating agencies. This indicates their ability to meet their financial obligations and pay out claims in a timely manner. You can find this information on the insurer’s website or through reputable financial resources.
Coverage and Exclusions
Read the policy documents thoroughly and understand the coverage and exclusions provided. Pay attention to specific details such as the duration of coverage, circumstances under which claims are payable, and any deductibles or co-pays. Ensure that the policy adequately covers your needs and offers protection against potential risks you may face.
Premiums and Affordability
Consider the premium cost and ensure that it fits within your budget. Compare quotes from different insurers to get an idea of the market rates. However, keep in mind that the cheapest policy may not always provide the best coverage or service. Strike a balance between affordability and the level of coverage offered.
Claim Settlement Process
A smooth and efficient claim settlement process is crucial when it comes to insurance. Research the insurer’s reputation for claim settlement and read reviews or seek recommendations from others who have had experience with the company. Look for insurers with a reputation for prompt and fair claims handling.
Customer Service and Support
Good customer service is essential when dealing with insurance matters. Consider the insurer’s reputation for customer support, responsiveness, and accessibility. Check if they have a dedicated customer service helpline or online portal for policyholders to manage their policies and file claims.
Seek Professional Advice if Needed
Insurance can be complex, and if you are unsure about certain aspects or need assistance, do not hesitate to seek advice from a trusted insurance agent or financial advisor. They can help you navigate through the different policies, explain the fine print, and guide you towards the most suitable options based on your needs.
Review and Update Your Policy Periodically
Once you have purchased an insurance policy, it is essential to review it periodically to ensure it continues to meet your changing needs. Life events such as marriage, having children, or significant purchases can impact your insurance requirements. Stay proactive and update your policy accordingly.
How to Choose an Insurance Policy with Adequate Coverage?
With the vast array of insurance options available, selecting the right policy with adequate coverage can be a daunting task. Let us now guide you through the process of choosing a policy that suits your needs and provides sufficient coverage.
Assess Your Needs
Before diving into the world of insurance policies, take some time to evaluate your specific needs. Identify the risks you want to protect against and the coverage you require. Consider factors such as your age, health condition, family situation, financial responsibilities, and personal assets. This assessment will serve as a foundation for selecting an insurance policy that adequately addresses your concerns.
Research Different Policies
Once you have a clear understanding of your needs, start researching the different insurance policies available in the market. Explore reputable insurance providers and examine their offerings, terms, and conditions. Focus on policies that align with your requirements and offer comprehensive coverage for potential risks.
Understand Coverage Types
Insurance policies offer various types of coverage, and it is crucial to comprehend what each type entails. For instance, in health insurance, understand the difference between basic coverage, specialized treatments, prescription drugs, and emergency services.
Determine Coverage Limits
Coverage limits define the maximum amount an insurance company will pay for a claim. Assess your financial situation and consider potential liabilities or expenses you may face in case of an incident. For instance, in-home insurance determines the cost of rebuilding your home or replacing your belongings. In life insurance, calculate the income replacement needed to support your family in case of your untimely demise. By determining appropriate coverage limits, you can ensure your insurance policy provides adequate financial protection.
Evaluate Deductibles and Premiums
Deductibles and premiums are critical factors to consider while choosing an insurance policy. A deductible is the amount you pay out of pocket before your insurance coverage kicks in, while a premium is the cost of the insurance policy itself. Strike a balance between a deductible you can comfortably afford and a premium that fits your budget. Remember, lower premiums may lead to higher deductibles and vice versa. Evaluate different combinations to find the right balance for your needs.
Read and Understand the Policy
Before finalizing any insurance policy, thoroughly read and understand the terms and conditions. Pay attention to exclusions, limitations, waiting periods, and any other clauses that may affect the coverage. If you have questions, seek clarification from the insurance provider or consult with an insurance agent. A clear understanding of the policy will help you make an informed decision and avoid any surprises in the future.
Seek Professional Advice
If you find the insurance selection process overwhelming or require expert guidance, consider seeking advice from an insurance professional or independent agent. They can assess your needs, provide personalized recommendations, and help you navigate the complexities of insurance policies. Professional advice can be particularly valuable when dealing with complex policies like business insurance or specialized coverage.
How Does Deductible Affect Insurance Premium?
The relationship between the deductible and insurance premiums is fairly straightforward. Generally, a higher deductible leads to a lower insurance premium, while a lower deductible results in a higher premium. This inverse relationship exists because the deductible represents the level of risk the policyholder is willing to assume.
When an insured individual opts for a higher deductible, they are essentially taking on more financial responsibility in the event of a claim. As a result, the insurance company’s risk exposure decreases, allowing them to charge a lower premium. On the other hand, choosing a lower deductible shifts more risk to the insurance company, increasing their potential liability and, consequently, the premium.
Suppose Sarah is looking to purchase a term insurance policy with a coverage amount of ₹500,000 for a 20-year term. She has the option to choose a deductible amount, which is the portion of the claim she agrees to pay out of pocket before the insurance coverage kicks in.
Option 1: ₹0 Deductible
In this scenario, Sarah selects a term insurance policy with a ₹0 deductible. This means that if she were to make a claim during the policy term, the insurance company would cover the entire amount of up to ₹500,000 without any out-of-pocket expense from Sarah. However, since the insurance company assumes more risk in this case, they will charge a higher premium to compensate for the potential claims.
Option 2: ₹1,000 Deductible
Alternatively, Sarah has the option to choose a ₹1,000 deductible. If she selects this option, she agrees to pay the first ₹1,000 of any claim out of her own pocket, and the insurance company will cover the remaining amount, up to ₹500,000. By accepting a higher deductible, Sarah is assuming more risk herself, which reduces the risk for the insurance company. As a result, the insurance company will charge a lower premium compared to the ₹0 deductible option.
Option 3: ₹5,000 Deductible
In this scenario, Sarah decides to opt for a ₹5,000 deductible. With this choice, she agrees to pay the first ₹5,000 of any claim, and the insurance company will cover the remaining amount, up to ₹500,000. By selecting a higher deductible, Sarah further reduces the insurance company’s risk, and as a result, her premium will be lower than the previous two options.
In general, the deductible and the insurance premium have an inverse relationship. A higher deductible means a lower premium, as the policyholder is assuming more risk and the insurance company is exposed to less potential payout. On the other hand, a lower deductible results in a higher premium, as the insurance company bears more risk and may need to pay out more in claims.
Final Words
When you want to understand what is a life insurance premium, you will only gain some basic understanding. In most instances, nobody except insurance companies can completely comprehend your premium. The actuaries are responsible for calculating the insurance premium based on several factors. You may contact such actuaries to understand life insurance premiums further thoroughly.
FAQs
1
Can the Premium Change During the Tenure?
Yes, the premium can change during the tenure of an insurance policy. The premium is the amount of money that the policyholder pays to the insurance company in exchange for coverage. It is typically determined at the beginning of the policy and is based on various factors such as the type of insurance, the coverage amount, the policyholder’s risk profile, and the insurer’s underwriting guidelines.
2
What Happens if I Cannot Pay the Insurance Premium on Time?
If you cannot pay your insurance premium on time, there may be consequences depending on the specific terms and conditions of your insurance policy. Here are some potential outcomes:
- Policy cancellation
- Grace period
- Lapsed coverage
- Reinstatement
- Credit score impact
3
Can I Make a Claim During the Grace Period?
Yes, you can make a claim during the grace period, but it depends on the specific insurance policy and the terms and conditions set by the insurance provider.
4
What Is the Waiver of Premium Rider?
The Waiver of Premium rider is a provision or add-on to a life insurance policy that provides a valuable benefit to policyholders. It is designed to protect the insured from the financial burden of paying premiums during a qualifying disability or illness that prevents them from working and generating income.
5
What Happens if I Stop Paying Insurance Premiums?
If you stop paying insurance premiums, the consequences will depend on the type of insurance policy you have and the specific terms and conditions outlined in your policy agreement. Here are some general outcomes that could occur:
- Lapse in Coverage
- Termination of Benefits
- Loss of Policy Features
- Penalty Fees and Interest
- Difficulty in Reinstatement
- Limited Coverage Options
