What is an Insurance Premium?
An insurance premium is a sum of money an insurance policyholder pays to their insurance company for coverage.
🤔 Understanding an insurance premium
Your insurance premium is the cost of your insurance policy. Depending on your insurance policy and the type of insurance you have, you might pay this premium on a monthly, biannual, or annual basis. In return, your insurance company agrees to cover you if you need to file a claim. Insurance companies use specific calculations to determine your premium, including your age, where you live, past claims, and how much coverage you need. Your insurance premiums likely won’t be the only cost you pay to use your insurance. Depending on the type of insurance, you might also have copays and deductibles that are due.
Suppose Ron has just bought a new car. The first thing he does after driving it home is to sign up for car insurance to ensure he has protection in case of an accident. As a part of his policy, Ron will pay a monthly premium to his insurance company. As long as he keeps paying the premium, they’ll keep covering him if he files a claim.
An insurance premium is like a Netflix subscription…
You pay for your Netflix subscription every month to ensure it’s there when you need it. You still have to pay for it during the months you don’t watch anything. Similarly, you pay your insurance premium every month or year to make sure your coverage is there when you need it. And in the months where you don’t use your coverage, you still pay for it.
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What is the difference between a premium and a deductible?
Your premium is the amount you pay monthly, biannually, or annually for your insurance policy. You pay this amount regardless of whether or not you use your insurance. Your deductible, on the other hand, you only pay when you file a claim.
A deductible is a certain amount of money you have to pay toward your claim before your insurance coverage will kick in. For some types of insurance, you only have to meet your deductible once per year. Health insurance plans usually have this type of deductible. If your health insurance deductible is $1,000, then you’ll have to pay $1,000 out of your pocket before your insurance company will start to cover their portion.
Other types of insurance, such as car insurance, require that you meet your deductible for each claim. For example, imagine you had a car insurance policy with a deductible of $500. If you get into an accident and your car needs repairs, you’ll have to pay the first $500 of repairs, and your insurance company will cover the rest (assuming it falls under your coverage limit). But then if you get into another car accident a few months later, you’ll have to pay the $500 deductible again.
There is a direct relationship between your insurance premium and your deductible. Usually, the insurance policies that have the lowest premiums are those with high deductibles, while those plans with higher premiums tend to have lower deductibles.
What factors determine an insurance premium?
The cost of insurance premiums for any type of insurance depends on risk. The higher-risk you are as a customer, the more you’ll pay for your insurance premiums. Several different factors go into that calculation.
Factor #1: Coverage
The type and amount of insurance coverage you need will be an essential factor in determining your insurance premium costs. When you’re signing up for your insurance policy, you’ll have several options for coverage. You can opt for certain types of coverage while passing on others. You can get a large amount of coverage or relatively little coverage.
For example, let’s talk about car insurance. Most states require drivers to carry liability insurance, which covers your liabilities in a situation where you cause an accident that results in property damage or injury to others. Car insurance companies also offer collision coverage, which covers your own vehicle in the event of an accident. You can choose not to sign up for the collision coverage. Skipping this coverage would lower your premium. You might decide to do this if you have an older car of little value and for which you don’t have a car payment.
The level of coverage you choose plays a role in determining your premiums. Let’s say you’re signing up for homeowner’s insurance. Your insurance company might offer homeowner’s insurance at the levels of $250,000, $500,000, or $750,000. The higher the level of coverage you choose, the more expensive the premium will be.
Factor #2: Individual Risk Factors
Your personal information will also help to determine your insurance premiums. In many cases, your age will be a determining factor. For car insurance, you’ll probably pay a higher premium the younger you are. For health insurance and life insurance, it’s typically the opposite.
Other risk factors come into play as well. In general, living a risky lifestyle will lead to higher insurance premiums. Are you an unsafe driver, as shown by a poor driving record? You’ll probably pay more for car insurance. Do you have a dangerous job? You’ll likely pay more for life insurance.
Factor #3: Location
As with most other things you’ll buy, the cost is partially a result of location. In most cases, insurance companies will offer rates that are competitive with those in the region.
Who decides the cost of insurance premiums?
Insurance companies determine the cost of insurance premiums. More specifically, they employ certain people who do that. Insurance companies hire actuaries, whose job it is to assess the likelihood of certain disasters or claims taking place. They pass this information along to underwriters, who then determine an individual’s premium.
Insurance companies don’t just pocket those premiums as profit. Instead, they set the premiums (or a portion of them) aside to pay for claims that you and other policyholders might file in the future.
How can I get a lower insurance premium?
The best way to lower your insurance premium depends largely on what type of insurance you have. Lowering health insurance premiums is an important issue for many American families, as health care costs have grown significantly over the past several decades. From 1970 to 2018, the national price of healthcare expenditures increased from $75B to $3.6T.
First, be aware that a plan with a lower premium is not always the best plan. A lower premium often means a higher deductible. If you or your family receive medical care often, this could be incredibly cost-prohibitive. But if you’re a young, healthy individual — and you’re confident you won’t be going to the doctor for more than preventative care visits — a high-deductible plan might be the right choice for you to help lower your insurance premiums. These low-premium, high-deductible plans also allow you to use a health savings account (HSA), which will enable you to save for medical costs in a tax-advantaged account.
There are other ways to lower your health insurance premium. First, some health plans tend to have lower premiums. For example, health maintenance organizations (HMOs) require that patients visit in-network doctors and get a referral from their primary care doctor to see a specialist. These types of plans usually have lower premiums than plans such as preferred provider organization (PPO) plans, which offer more flexibility to patients at a slightly higher cost.
Finally, those with an income between 100% and 400% of the poverty level or less might be able to receive financial assistance in paying for their insurance premiums. The Affordable Care Act, passed by Congress and signed into law by President Obama, provides premium tax credits to low-income families who buy their health insurance on the government healthcare marketplace.
When it comes to car insurance, there are even more things you can do to lower your premium. First, as with health insurance, you can often lower your premium by selecting a high-deductible plan. But again, be aware that this could mean a substantial out-of-pocket cost in case of a car accident that is your fault.
Another way to lower your premium is by choosing certain types of cars. The safer the car, the lower your premium will probably be. Additionally, some insurance companies offer discounts to policyholders who choose hybrid vehicles as a more environmentally-friendly alternative.
You can also reduce your insurance premium by driving more safely. When you sign up for car insurance, the insurance company will check your driving record. The worse your driving record is, the higher your premium will be. You might be able to have your rate reduced in the future if you go a certain number of years without a traffic violation.
Finally, you may be able to save on certain types of insurance premiums (including car insurance) by opting to pay bi-annually or annually instead of monthly. These policies last for a period of six to 12 months. Paying for the entire policy in one lump-sum often results in a lower premium than paying your premium in monthly installments.
And, as with any significant purchase, you can find the best deal on premiums by working with an insurance expert and shopping around. If an insurance company knows they’re competing with other companies for your business, they might even give you a lower rate.
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