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What is Insurance Premium? | Definition of Insurance Premium

Insurance premium is an important part of selecting a plan for financial security. One should be careful of the factors affecting it while purchasing a policy.

  • 8,030 Views | Updated on: Apr 15, 2024

When purchasing a plan, one of the key considerations for policyholders is the insurance premium. An insurance premium is the cost of your insurance policy. Think of it like a safety net - you pay a bit now to have a larger sum available if you face a medical emergency, car accident, or other insured situations.

Key Takeaways

  • The insurance premium is the amount paid to the insurer to maintain coverage and is determined based on various factors.
  • Premiums can be level (fixed throughout the policy term) or flexible while the payment modes include monthly, quarterly, semi-annually, or annually.
  • Premiums are calculated based on risk assessment, underwriting evaluation, rating factors, coverage options, and regulatory requirements.
  • The more comprehensive the coverage, the higher the premium. Policyholders can adjust coverage amounts and deductibles to manage premiums.

An insurance premium is the regular payment you make to the insurance company in exchange for being financially protected in case of covered events. 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.

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.

What is Insurance Premium - A Detailed Guide-compressed

What is Insurance Premium?

In simple terms, an 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

How to Calculate Insurance Premiums?

Calculating insurance premiums involves a complex process that varies depending on the type of insurance and the specific factors involved. However, here is a general overview of how insurance premiums are typically calculated:

Assessing Risk Factors

Insurance companies begin by assessing various risk factors associated with the insured individual, property, or entity. These risk factors can include age, health status, driving record, location, claims history, occupation, and more. Insurers use actuarial tables, statistical models, and historical data to quantify the likelihood of claims and losses based on these risk factors.

Underwriting Process

During the underwriting process, insurers evaluate the information provided by the applicant and determine the level of risk they pose. This involves gathering detailed information about the insured’s characteristics, such as medical history, credit score, vehicle details, property features, and any other relevant factors. Insurers may also conduct inspections or assessments to verify the accuracy of the information provided.

Rating Factors

Insurers use rating factors to adjust premiums based on specific characteristics of the insured individual or property. These factors can include age, gender, marital status, location, coverage limits, deductible amounts, and other relevant variables. Each rating factor is assigned a weight or factor that influences the final premium calculation.

Premium Calculation

Once the risk factors and rating factors have been assessed, insurers use mathematical formulas or algorithms to calculate the insurance premium. The premium is typically determined by multiplying the base rate (a predetermined rate per unit of coverage) by the applicable rating factors for the insured individual or property. Adjustments may also be made for discounts, surcharges, or other factors that affect the final premium amount.

Policy Options and Coverage Limits

The premium amount may vary based on the specific coverage options selected by the insured and the limits of coverage chosen. Higher coverage limits or additional policy features generally result in higher premiums, while lower coverage limits or higher deductibles may lower the premium cost.

Market Conditions and Regulatory Requirements

Insurance premiums can also be influenced by external factors such as market conditions, competition among insurers, regulatory requirements, and changes in legislation or risk exposure. Insurers may adjust their premium rates periodically to reflect changes in these factors.

Final Premium Quote

Once the premium calculation is complete, insurers provide the insured with a final premium quote detailing the coverage options, premium amount, payment terms, and any applicable discounts or surcharges. The insured can then decide whether to accept the quote and purchase the insurance policy.

Simple Premium Calculation

The basic formula for calculating insurance premiums is:

Premium = (Risk Factor * Sum Insured) / Coverage Period

In this formula:

  • Risk Factor = Risk associated with the insured item or individual usually expressed as a percentage.
  • Sum Insured = total amount of coverage required.
  • Coverage Period = 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 = initial premium amount determined based on factors like risk assessment and coverage requirements.
  • Experience Modifier = 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:

  • Deductible = the amount the policyholder agrees to pay out of pocket before the insurance coverage takes effect.

What are the Factors Determining Insurance Premiums?

Insurance premiums, the amount paid by an individual or entity for an insurance policy, are determined by various factors that help insurers assess the risk associated with providing coverage. Here are some key factors that typically influence insurance premiums across different types of insurance:

Type of Insurance

Different types of insurance (e.g., health, life) have different risk profiles and factors that influence premiums.

Coverage Amount

The higher the coverage amount or policy limits, the higher the premium since it increases the potential payout for the insurer.

Risk Factors

Insurers assess various risk factors associated with the insured individual or property. These can include:

  • Age and Gender

Younger individuals and males tend to have higher premiums for certain types of insurance, such as auto insurance.

  • Health Status

For health insurance, factors like pre-existing conditions, overall health, and lifestyle choices can impact premiums.

  • Occupation

Some occupations are considered riskier than others and may lead to higher premiums, especially in workers’ compensation insurance.

  • Location

For property insurance, factors such as crime rates, weather risks (e.g., hurricanes, earthquakes), and proximity to emergency services can affect premiums.

  • Credit Score

In some jurisdictions, credit history may be used to determine premiums, as individuals with poor credit may be seen as higher risk.

  • Claims History

Previous claims history can influence premiums for various types of insurance.

  • Smoking Status

For life and health insurance, smokers typically pay higher premiums due to increased health risks.

Deductibles and Coverage Options

Higher deductibles (the amount the insured must pay before the insurance kicks in) generally result in lower premiums, while broader coverage options increase premiums.

Insurance Company Policies and Practices

Each insurance company has its own underwriting guidelines, pricing models, and risk assessment methods, which can lead to variations in premiums for similar coverage.

What are the 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

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

Premium payment is crucial for maintaining an insurance plan. 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.

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.

Wrapping Up

Insurance premiums play a crucial role in the field of insurance, serving as the shield of financial protection against unforeseen events. These premiums represent the cost of securing coverage and are determined through a meticulous process that takes into account various risk factors, coverage options, and individual circumstances. By comprehensively assessing your needs, understanding policy terms, and seeking professional advice when needed, you can explore the options available and protect yourself and your loved ones in the face of life’s uncertainties without overextending your financial resources.

FAQs

1

Why do I need to pay an insurance premium?

Paying an insurance premium ensures that you have financial protection against unforeseen events or risks covered by the insurance policy.

2

Can insurance premiums vary?

Yes, insurance premiums can vary depending on factors like the type of insurance, coverage options chosen, and individual risk factors assessed by the insurer.

3

What happens if I do not pay my insurance premium?

Failure to pay your insurance premium may result in a lapse of coverage, leaving you uninsured and vulnerable to financial risks.

- A Consumer Education Initiative series by Kotak Life

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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