What Is An Insurance Premium And How Does It Work?

What is an insurance premium? If you’ve yet to apply for and set up a home, life, auto or health insurance policy, it helps to know the answer. Even more so as you’ll face the prospect of paying these expenses for some time to come.

The short answer is that an insurance premium represents money that you pay to keep your policy active. But, as with many financial instruments, there’s more to the concept of insurance premiums. 

Let’s take a closer look at how premiums work, what factors influence the size of potential payments, and what you can do to lower your total out-of-pocket expenses overall.

What Are Insurance Premiums?

If you sign up for an insurance policy, your insurance company will require you to pay a premium on a regular and consistent schedule. Your insurance premium essentially functions as the cost of keeping your insurance policy active. At odds with other out-of-pocket costs that you’ll be obligated to pay, like an insurance deductible or copay, it’s essentially what you’re charged for taking out the plan itself.

Any insurer that you work with will clearly spell out what your insurance premiums are before you sign a contract. Note that the cost of the premium will also vary depending on a variety of factors such as your age, health, location of residence, type of coverage, total amount of the policy, etc. as well. For reference, most insurance premiums are generally paid on a monthly or annual basis, meaning that you’ll want to account for them as part of ongoing everyday household expenses.

To put things in perspective: Zoe, a 30-year old working professional, signs up for a health insurance policy. Her insurer charges her $500/month as her insurance premium for taking out the plan. However, should she require medical assistance or visit a doctor, she’ll also be required to pay an insurance deductible and/or copay prior to her insurer picking up the costs of these services.

How Are Insurance Premiums Determined?

A variety of different variables and factors determine the cost of insurance premiums. Note that expenses can further fluctuate from year to year. Several of the most common attributes that influence these costs are noted below.

• Where you live: The location where you reside can play a large role in determining overall insurance premium costs. For example, expenses may be lower if you live in an area of the country with a lower crime rate and cost of living, or one that’s less prone to frequent weather events. By way of contrast, if you reside in an area that’s often hit by flooding or hurricanes or a big city where costs are more substantial, expenses can go up considerably.
• Type or amount of coverage: Different types of insurance policies such as home, auto, life and health can come with considerably different costs attached. So too can the scope of this coverage – for example, if you’re simply covering your home against mechanical defects and wear-and-tear vs. fires and flooding – impact your total expenses here. On top of it, the more monetary coverage that you request, the more a policy will cost as well, reflecting the increased risk to the insurer.
• Age: Keep in mind that your age can influence the cost of any given insurance policy as well. For instance, older individuals may be seen as more likely to require medical assistance by health insurers, resulting in higher insurance premium pricing. Conversely, younger drivers may be viewed as a riskier bet on the roads by auto insurers, resulting in higher premiums.
• Past claims: If you’ve filed one or more past insurance claims, especially in recent months, it could result in higher costs for your insurance premiums. Individuals who file claims more often present potentially greater expense to insurers, who raise rates to help offset potential outgoing costs.
• Deductible amount: A deductible describes out-of-pocket expenses that you’ll pay before financial coverage and contributions from an insurer and insurance policy kick in. The larger the deductible that you’re willing to pay, the smaller that your monthly insurance premium costs will be.
• Risk factors: If you have a preexisting health condition, record of frequent auto accidents, or otherwise present what appears to be a higher risk profile to insurers, they’ll raise insurance premiums to match. In essence, insurance hinges on the practice of risk management, and the higher of a prospective cost risk that any given individual appears to be to an insurer? The more that insurers will boost prices for policies accordingly.

Different Types Of Insurance Premiums

Varying forms of insurance policy will come with different insurance premiums attached. It helps to know what factors and variables may impact expenses associated with each form of billing, as described below.

Auto Insurance 

To drive in the United States, you’re require to carry auto insurance coverage. That means having to pay regular auto insurance premiums, no matter which of all the 50 states that you reside in. Different variables can impact these costs, like the age and mileage on your car and your personal driving history. You can lower your auto insurance premiums by taking out policies with a higher out-of-pocket deductible, keeping a safe driving record, driving less miles overall each month and purchasing an alarm system. Likewise, autos that are less attractive to car thieves – like everyday sedans and compact vehicles vs. high-end sports cars – come with lower policy costs attached.

Health Insurance

The healthier you are, and less of a concerning medical history that you bring to the table, the lower that your health insurance premiums will be. Likewise, policies that are subsidized by an employer, professional group, or trade association can help you decrease your monthly costs. Younger adults also tend to enjoy lowered expenses here, as older individuals are seen as more of a medical risk by insurers. In any event, it’s important to shop around, given that each individual insurer offers its own rates and policy terms and conditions, not to mention how expensive that health insurance can generally be overall. 

Homeowners Insurance 

Lenders will require you to purchase homeowners insurance if you need to secure a mortgage to finance the purchase of a real estate property. In fact, even if you pay for the house, condo or apartment in cash, it helps to take out a policy, which kicks in if your home is damaged or destroyed, or injuries occur on your property. Costs associated with homeowners insurance premiums depend on the total cost, size, location and age of your home and any associated risk factors such as burglaries, weather events, etc. To lower homeowners insurance premiums, you can purchase a home security system, smoke alarms, hail-resistant roofing, or otherwise add safety features.

Life Insurance

Note that life insurance premiums, while common, can greatly vary depending on variables such as your age, weight, health and general lifestyle habits. The less risk of your inadvertent passing that an insurer feels it’s taking on when issuing the policy, and the healthier that you appear, the lower your fees will be. Higher costs are generally associated with smoking, obesity, etc. In essence, the less likely you are to die (and less likely that an insurer is to have to pay out the policy), the less monthly out-of-pocket expenses you can count on.

Renters Insurance 

You’ll want to take a renters insurance policy if you rent a home instead of owning it. It covers the cost of replacing items inside the rental should they become damaged, destroyed or stolen. Renters insurance is smart to take out, because a landlord is generally not responsible for replacing items like appliances, toys, furniture, etc. inside a unit – rather, just repairing inadvertent damage to the unit itself.

4 Ways To Lower Your Insurance Premium 

For those looking to save on insurance premiums, it helps to know a few hints and tips. Keep in mind the below strategies when searching for an insurance policy to put more money back in your pocket. 

• Shop around: Each insurer offers different policies with different insurance premiums, terms and conditions. It’s therefore important to do your research and shop around, as potential costs and options may vary. Happily, online searches and insurance policy aggregator websites (which let you compare prices and policies) make it easy to obtain information with a few quick clicks.
• Choose a higher deductible: You can quickly drop insurance premium costs by accepting a higher deductible. However, that means that you’ll potentially pay higher out-of-pocket costs and take on more risk in the event of needing to file a claim. Deductibles must be paid before an insurer kicks any money in.
• Ask about discounts: Some insurance providers may offer discounts for individuals who are members of different trade groups, social clubs or associations. Others, like. auto insurers, may offer you a lower insurance premium on your car insurance policy if you take a defensive driving course register in an app that lets them track your driving habits over time. In any event, make a point to ask about any discounts that may be available – you could be surprised at just how much deals and specials can help you save.
• Consider bundling: Many insurers will offer you a discount on overall insurance premium pricing if you take out multiple policies with them. For instance, you can often save big by taking out a car and homeowners insurance policy with the same provider. As you compare prices and options, be sure to ask insurers how it can benefit you to bundle services and solutions.

Insurance Premium FAQs

Given the complex nature of insurance policies and premiums, several common frequently asked questions tend to arise. Answers can be found below.

What’s the difference between an insurance premium and a deductible? – A deductible represents money that you’ll have to pay out of pocket before an insurer will pay in the event of your filing a claim. Your insurance premium is the amount of money that you pay on a regular (typically monthly or annually) basis to keep the policy itself active.

Why do insurance premiums go up? – Insurance premiums can go up annually based on increased operating costs to insurers. Also, they may increase due to insurers’ suspicion of increased risk factors (more frequent weather events happening in your area, or your propensity for speeding on the road). Likewise, if you’re prone to filing claims, it can also trigger insurance premiums to go up. 

How can I lower my insurance premium? – Inquire about bundles and discounts. Invest in safety measures and protective equipment. Shop around and compare offers from different insurers. There are many ways to enjoy a discount here.

The Bottom Line 

Your insurance premium is essentially the amount that you’re paying to keep any given home, auto, life, medical or renter’s insurance policy active. It can further fluctuate from year to year, and will vary greatly between individual providers, meaning that it pays to shop around and do your research before agreeing to pay one. 

While an insurance premium is a regular and recurring expense, keep in mind it’s one that you can take active steps to reduce, and one that helps insure your overall financial well-being. Wondering how much of an insurance premium that you can afford based on your current budget? Be sure to download the Rocket Money℠ app today.