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What Is Insurance Premium? Types, Qualities, and Significance Research Team | Posted On Tuesday, August 28,2018, 04:11 PM

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What Is Insurance Premium? Types, Qualities, and Significance



Insurance premium is the cost of buying insurance cover. It is the price that an individual or business wanting to get covered under an insurance policy, pays to the insurer. The insurance premium is an income to the insurer.

The quantum of premium varies depending on insurance policies. It also depends on factors like the type of coverage:

  • Age-group the policyholder belongs
  • Lifestyle
  • Policyholder’s employment
  • The policyholder’s habits like smoking, drinking
  • The policyholder’s medical condition like heart ailments, blood pressure and so on.
  • The area where the policyholder lives or the area where the business operates.
  • The odds of a claim being made
  • The severity of the competition faced by an insurer

The quantum of premiums depends on the risk of insurance. Greater the risk, higher the premiums.

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What Is Insurance Premiums? Types, Qualities, and Significance

How is the insurance premium calculated?

Calculation of the insurance premium depends on the type of insurance policy, for instance, term insurance plan or endowment policy. Let us now see the factors affecting insurance premiums:

1. Personal information:

Before giving the options under various insurance plans, the insurer or insurance agent asks for personal information. Information could be age, occupation, lifestyle, habits like smoking or drinking, the area of residence, annual income, daily commute and so on. This information gives the insurer an idea on the odds of you, making a claim.

Some insurers assign a score based on the personal information you provide. You are given a catalogue of health insurance plans, term insurance policy or any other insurance policy you’re looking for.

The criterion for processing insurance premiums, changes from insurer to insurer. Every insurer may have different premiums for different insurance plans.

2. Type of coverage:

Insurance premiums also depend on the type of coverage a policyholder seeks. You may like to add riders like critical illness, waiver of premium rider, apart from a basic health insurance plan or a term life plan. These increase the coverage under the insurance policy and premiums get costly.

3. Sum assured:

There is a direct relationship between the sum assured and premiums. Sum assured is the guaranteed amount an insurer will pay the policyholder, before bonuses are added. Sum assured is also known as cover or coverage. Higher sum assured means higher premiums. Having said this, there is a way to get the same coverage by paying low premiums: Make your excess high. Let us understand what an excess is.

An excess is your contribution (to be paid by the policyholder) towards a claim that you make on a car insurance policy or home insurance policy. It implies that you’ll assume a certain amount of risk and pay a part of, say the car repairs or home repair charges when you make a claim. Only after you pay the excess, does the insurer settle the claim. Increasing the excess is the most effective way of reducing the premium while getting the same coverage. Be careful; select a level of excess that you can afford. You don’t want to spend out of pocket and disturb your budget while making a claim.

4. Competition:

To attract more customers, insurers offer competitively priced premiums. It just requires one insurer to bring down the premium. Other Insurers follow, fearing loss of customers.

Who calculates premium?

Insurer calculates the premiums. Actuaries, employed by insurers are responsible for calculating premiums, after assessing associated risk and the probability of the policyholder making a claim.

Types of insurance premiums:

There are different types of insurance premiums. Classification is based on:

1. Premium paid

2. Insurance purchased

I. Premium paid:

1. Fixed premium  : Fixed premium is also known as level premium. These premiums remain unchanged till policy maturity.

2. Flexible premium: Flexible premium allows the policyholder to make changes vis-à-vis the policy. The changes can be increasing the number of people covered in a term insurance plan or increasing the sum assured of an insurance policy. The  premiums are calculated based on such changes.

II. Insurance purchased:

Premiums are also calculated based on the type of insurance policy. We discuss three types of insurance plans:

1. Life insurance policy:

Life insurance policy premiums are calculated based on age, occupation, income, health, assets owned, debts to be paid and so on. Calculations also depend on whether the life insurance plan offers saving benefits (endowment policy) or not (term life plan).

2. Health insurance:

Health insurance premiums are calculated based on age. Older you are, greater are the chances of falling sick. Higher the age, higher is the premium. Other factors like pre-existing conditions, income, family size (family floater plans) and so on, influence premium calculation.

3. Car insurance:

Car insurance premiums are calculated based on the type of car insurance plan: Third party liability insurance or comprehensive insurance, riders opted, car model, daily commute, the age of the driver/car, occupation, gender and so on.

See also: No Cost EMI

Modes of paying insurance premiums:

The modes of paying insurance premium depend on the frequency of payment:

1. Lump sum: Pay the total amount before the insurance coverage starts.

2. Monthly: Monthly premiums are paid monthly. These are easy and affordable, but the policy cost increases.

3. Quarterly: Quarterly premiums are paid quarterly (4 times a year). These are lower compared to monthly premiums.

4. Semi-annually: These premiums are paid twice a year and are way cheaper than monthly premiums.

5. Annually: These might be hard on your pocket, as you have to pay a hefty amount once a year. However, the ultimate cost of the premium is much lower than all other modes.

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