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What is an insurance premium?

Fact-checked with HomeInsurance.com

Shopping for insurance for the first time can be overwhelming, especially when you come across foreign terminology. One of the most important insurance-related terms you need to know is ‘premium,’ because it’s related to the price of your coverage. If you’re not totally sure what an insurance premium is and what it means, this article will be helpful. 

Insurance premium defined

Simply defined, an insurance premium is the price of your insurance policy. When you buy home or auto insurance, you sign a contract that says you agree to pay your premium in exchange for a certain amount of coverage from the insurance company. 

Your insurance premium is calculated as an annual or semi-annual cost, but many people choose to pay their premium in monthly installments. Some insurance premiums are also subject to taxes and service fees that can slightly increase the amount you have to pay. 

How are insurance premiums determined?

Insurance premiums are highly personalized. Regardless of what type of insurance policy you have, each policyholder pays a different rate. Insurance premiums are calculated based on a number of different factors, including:

  • Location: Your city and state have a big impact on your insurance rate. The average cost of insurance can vary significantly by state, sometimes by thousands of dollars. Home, auto, and renters insurance are typically the most impacted by location. Life and health insurance premiums do differ by state, but not as much.
  • Personal information: Your personal information, including your age, gender and marital status can all impact your insurance premium. Additionally, insurance companies may look closely at your credit score to determine your rate. People who have a low credit score are considered to be high-risk, so they typically pay much more for their insurance than those who have a good credit score. 
  • Type of coverage: The type of coverage you get will also impact your premium. For instance, full coverage car insurance costs significantly more than minimum coverage. For homeowners insurance, open peril coverage costs more than named peril coverage. Insurance coverage that is robust and comprehensive always has a higher premium than bare bones coverage.
  • Amount of coverage: If you’re looking for a large amount of coverage, be prepared to pay a more substantial premium. The higher your policy’s coverage limit is, the more money you’ll pay for it. This is because the insurance company is responsible for compensating you with a bigger payout after a claim.
  • Endorsements: If you add any endorsements, also called add-on policies, it will raise your premium. For car insurance, common endorsements are accident forgiveness and roadside assistance. For property insurance, most insurance companies offer replacement cost coverage and water backup coverage. The more endorsements you add, the higher your premium will be, but the more protection you’ll have against loss.

Do insurance premiums change?

Yes, your premium can and probably will change over time due to many factors. Insurance companies are businesses, and after a bad financial year, some might choose to increase premiums to make up for their losses. Your premium can also change if your insurance company finds that the rate of crime, severe weather or major claims in your area has gone up. 

Also consider the lifestyle factors that can cause your rate to change. For example, a teen driver will see a noticeable decrease in their car insurance premium when they enter their late 20’s. A homeowner who makes a major renovation can also get a lower rate. If you get into a car accident or get a speeding ticket, your premium will also increase. If you get diagnosed with a chronic illness, your life insurance premium could increase (depending on the policy type).

Discounts can also affect your rate, but in a more positive way. For example, young drivers can take advantage of a good student discount to see a rate decrease. As eligibility for discounts can change though, always ask your provider what you may or may not qualify for each time you renew your policy.

How are insurance premiums used?

Insurance premiums are used by insurance companies to make sure they have enough money to reimburse policyholders after a loss. When you pay your premium, your insurance company sets the money aside and allows it to grow until you need to file a claim. When you do file a claim, the provider uses some or all of that money for your payout (minus your deductible), plus contributions over time from other policyholders if the claim is significant in cost.

An insurance company can also use premiums to determine how profitable the company is. If premiums bring in more money than what the company spends in the form of claim payouts, employees costs and other operating expenses, the provider is considered profitable. You can determine how profitable an insurance company is by looking at their financial strength rating from an organization like AM Best

How to find the lowest insurance premiums

Insurance isn’t cheap, particularly in some states. But if you’re shopping for insurance on a tight budget, there are a few ways that you can get a better, more affordable rate. Here are some suggestions:

  • Shop around: The best way to find a low insurance premium is to shop around and get quotes from a few different providers. That makes it easy to compare rates and see which company can give you the best rate for the type and amount of coverage you need.
  • Look for discounts: Whether you’re shopping for home, auto, life, health, renters or any other type of insurance, most insurance companies offer discounts for that product type. When you’re shopping for coverage, pay special attention to the companies that offer several discounts you can take advantage of.
  • Improve your credit score: Improving your credit score is another effective way to lower your premium. Generally speaking, the lower your credit score is, the higher your premium will be. If you can raise your credit score, even just slightly, you’ll probably be able to get a cheaper premium.

When you’re looking for an affordable insurance premium, you might also consider working with an agent or broker. An agent can reach out to several insurance companies and collect quotes on your behalf. They can also help you determine how much coverage you need, and how much you should be paying for insurance. Most insurance agents are paid on commission, so they work hard to help you find a policy that fits your budget. 

The takeaway

  • An insurance premium is essentially the cost of your insurance.
  • Most people pay their premium in monthly installments, but you can also pay annually or bi-annually.
  • There are a number of factors that impact your premium, like your location, age, and credit score.
  • Your premium can change over time due to the insurance company’s performance and risk factors in your area.

Of all the insurance terms out there, ‘premium’ is one of the most important ones to know. The price of your insurance is determined by many different factors, and it’s common for your premium to change over time. For all insurance products, comparing multiple quotes is the best way to make sure you’re paying the lowest rate for the coverage you need.

Elizabeth Rivelli

Elizabeth is an insurance writer for coverage.com, where she covers insurance providers and reviews policies to help consumers find comprehensive and affordable coverage for every area of their life. She has more than three years of writing experience for top online insurance and finance publications.

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