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What is Insurance Premium - A Detailed Guide

What is Insurance Premium - A Detailed Guide
  • 20th Jun 2022 |
  • 3,613

Insurance companies assume your risk when you buy an insurance policy. 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 you. You can pay your premium periodically. The frequency can be either monthly, quarterly, semi-annually or annually. Some life insurance policies allow you the option of a single premium during the entire duration of the plan.

We will help you understand what an insurance premium is, why you have to pay it, how it works, and ways to reduce your costs.

Factors determining the insurance premium

What is Insurance Premium?

A common question that many people have is what is an insurance premium? In simple terms, it is an amount that you pay to the insurance company to ensure you receive the coverage under the plan. It refers to the cost of your insurance, whether for health, auto, or life insurance. Companies usually ask you to pay insurance premiums upfront if you have earlier had your insurance policy cancelled for non-payment.

An insurance company decides your insurance premium, basis the type of cover chosen and the probability of filing the claim. Your location, lifestyle, and habits also play an important role in determining the term insurance premium. It is usually decided by an actuary or an underwriter who does base calculations and helps determine the risk to insure you.

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 for 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!

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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 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.

Please check the article for more information on Term Insurance for Smokers.

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. For example, if you have an auto insurance policy that covers liability only, it will be cheaper than if you have a plan with collision, liability, medical payments, and uninsured/underinsured motorist coverage.

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 in the event of death of the policyholder. 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 it 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 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 on the policyholder, the higher will be the premiums. Still, there are different ways that you can consider to lower down 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.

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.

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- A Consumer Education Initiative series by Kotak Life

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