Takeaways
- Insurance premiums are the regular payments made to keep your insurance active.
- Insurance premiums vary widely depending on the insurance you are purchasing.
- Insurance premiums are calculated using a variety of personal and consumer data.
- Insurance premiums cover your claims but fund admin expenses for insurance companies.
- Insurance premiums should be incorporated into your budgeting process.
What is an Insurance Premium?
When you sign up for insurance, whether for your car, life, apartment, home, or pet, one of the first terms you start hearing about is insurance premium. If you are left wondering, what is an insurance premium? You are not alone.
An insurance premium is the amount you pay the insurance company to keep insurance coverage active. Insurance premiums are usually paid monthly, quarterly, semi-annually, or annually (depending on your policy).
Your insurance premium is not a one-size-fits-all expense; it varies based on several factors, like the type of insurance you buy, your risk profile, and the amount of coverage you want. Essentially, an insurance premium is the price you pay to keep your insurance policy active. While insurance premiums are a vital piece of calculating the total costs of insurance, they are not the only component of the puzzle to consider. Do not forget to include insurance deductibles. An insurance deductible is the upfront amount you must pay to cover an expense before the insurance company starts paying.
5 Types of Insurance Premiums
Insurance premiums can vary widely depending on what type of insurance coverage you are trying to get. For example, life insurance premiums are calculated very differently than car insurance premiums because these policies factor in different variables. Here are five insurance premiums to consider when thinking about getting insurance:
Life Insurance Premiums
Life insurance premiums are payments made for policies that provide financial support to you or your family members or beneficiaries if you or your spouse passes away prematurely. Insurers calculate premiums based on factors like your age, health, lifestyle, and the coverage amount. Younger, healthier individuals usually pay lower premiums because insurers view them as low-risk customers.
Personal factors support the cost calculation of your life insurance policy. However, there are various types of life insurance policies, and coverage costs can vary widely from policy to policy. For example, term life insurance is less expensive because it only covers a specific period, usually 10-30 years, from when the policy takes effect. Contrast this with permanent life insurance, which is more expensive because it covers your entire life.
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Example: Your spouse is involved in a fatal work accident.
Life Insurance Can Cover: The burial expenses and pay your family a lump sum to help support you and your children.
Car Insurance Premiums
Car insurance premiums are the payments made to insure your vehicle is insured against accidents, theft, and other random damages. Car insurance is required in most states in the U.S. and can help protect your wallet against unexpected costs from accidents involving your car or truck.
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Car premiums are based on variables like the kind of car you drive (Porsche 911 vs. Honda Civic), your age (younger drivers tend to be more expensive), your driving history (bad drivers are penalized), how often you drive, and even your geographical location. Safe drivers with a clean record typically enjoy lower premiums because they are considered less risky. Insurance premiums vary widely, but the average cost of car insurance in 2022 was approximately $1,588[1]. Consider your car insurance premium the price of admission to drive, so make sure you budget for car insurance premiums and deductibles.
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Example: Another driver rear-ends you when you are sitting in traffic.
Car Insurance Can Cover: The cost of replacing your bummer and fixing your car.
Renters Insurance Premiums
Renters insurance premiums help cover the replacement value of your possessions within a house, apartment, or condominium you are renting. These premiums are relatively affordable – averaging around $15 per month – and depend on the value of your belongings (clothes, jewelry, furniture, etc.), the rental location, your credit score, and the coverage level you choose. Renters insurance can be a small price to pay for protecting your items from theft, damage, or loss.
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Example: There is a fire in your apartment complex while you are at work.
Renter Insurance Can Cover: The cost of your clothes, couches, computers, and more.
Homeowners Insurance Premiums
Homeowners insurance premiums are necessary for protecting your home and belongings. Factors like the home's location, size, age, safety features, and coverage amount influence these premiums. For example, living in areas prone to natural disasters (e.g., hurricanes, mudslides, or tornadoes) or having an older home can increase the cost of your premiums.
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Example: Someone breaks into your house, damaging walls, appliances, and furniture.
Homeowners’ Insurance Can Cover: The cost to repair the house and replace/repair the furniture.
Pet Insurance Premiums
Pet insurance premiums provide coverage for your pet's medical expenses. The cost of these premiums varies based on your pet's age, breed, and health history. Generally, getting pet insurance for younger pets is cheaper, as they are less likely to have health issues. Pet insurance can be a wise investment to avoid high veterinary bills in the future.
Example: Your puppy accidentally swallows your sock.
Pet Insurance Can Cover: The cost of surgery and getting your dog back to good health.
How Are Premiums Calculated?
Understanding how insurance companies calculate premiums is crucial for finding the best price. Insurance companies use a process called underwriting to assess risk. Part of this risk assessment involves evaluating several factors to determine how likely you are to claim your policy (and cost the insurance company money). For instance, in car insurance, they look at your driving history, age, and the type of car you drive.
Health insurance companies consider your age, lifestyle, and medical history. From the insurance company’s perspective, the higher the risk of you filing a claim, the higher your premium. It's a balancing act between the risk of a claim and the cost of the premium, aiming to be fair to you and financially viable for the insurer.
You can affect the process by cleaning up variables you know insurance companies will consider. For example, improving your credit score can make you a better candidate for renters’ insurance because you establish a healthy history of timely repayment.
Factors Affecting Insurance Premiums
Several key factors influence the cost of your insurance premiums [2]. Age is a significant factor; younger individuals usually pay less for life insurance but more for car insurance. Your health, especially for life and health insurance, plays a vital role in the cost of your total coverage. A history of chronic illness or poor lifestyle choices can increase premiums.
Factors Affecting Insurance Premiums:
- Age
- Location
- Tobacco Use
- Individual vs. Family Enrollment
- Type of Insurance
- Credit History
The type of coverage and the amount you choose also affect the cost. Opting for a policy with a higher deductible, where you pay more out of pocket if there is a claim, can lower your premium. Finally, your personal risk profile, which includes factors like driving history or home location, is also considered.
How Are Premiums Used?
You might wonder where your insurance premiums end up. Insurance premiums go into a pool of capital used by insurance companies to pay out claims. When you and others insured under the same policy class make a claim, your payout comes from this collective source of capital. Insurance companies also use a part of the premiums to cover operational costs like employee salaries, marketing, and administrative expenses.
A portion of premiums is reserved to ensure the insurance company can meet future claims, especially for unexpected disasters. The most commonly accepted split follows the 80/20 Rule, where 80% of the money an insurance company collects goes to the insurance they are covering – health care, pet, renters, car, etc. – or quality improvement, and 20% goes to marketing, administration, and overhead [3]. Your premiums provide you with coverage and additionally sustain the insurance company.
Smart Summary
Getting insurance for financial protection is a smart money move. This could mean ensuring your dog, car, or house has full coverage. With so many types of insurance plans, take your time analyzing the best options. Consider consulting a financial advisor to talk through the various scenarios to provide you with the best coverage.
(1) Insurance Information Institute. Facts + Statistics: Auto Insurance. Last Accessed December 1, 2023.
(2) Heathcare.gov. How Insurance Companies Set Health Premiums. Last Accessed December 1, 2023.
(3) Heathcare.gov. Rate Review & The 80/20 Rule. Last Accessed December 1, 2023.
