What Are Insurance Premiums?

Written by Erin Gobler / June 14, 2022

Quick Bites

  • An insurance premium is an amount you pay to an insurance company in exchange for providing financial protection.
  • Insurance companies can be paid monthly, biannually, or annually, and rates may be discounted for in-full payments.
  • There are insurance premiums for all different types of insurance policies, including auto, home, health, and life insurance.
  • Many factors affect insurance rates, but they’re primarily based on the amount of risk you pose to the insurance company.

Insurance premiums are the cost of having insurance policies. We make smaller and regular payments to ensure that we are protected from greater financial loss in case something happens to our cars, our homes, our pets or ourselves.

To help you understand how premiums work, we’ll break down the different kinds and the factors that can affect your insurance premiums.

Inside this article

  1. What are insurance premiums?
  2. How do insurance premiums work?
  3. Types of insurance premiums
  4. Insurance premium vs. deductible
  5. What affects premiums?
  6. FAQ

What are insurance premiums?

An insurance premium is an amount an individual or organization pays to maintain an insurance policy. Just like your rent is an amount you pay each month to ensure you have a place to live, your insurance premium ensures you have coverage when you need it. In return, your insurance provider guarantees to compensate you in a variety of situations depending on your policy.

For insurance companies, premiums are a form of risk management. Your cost will depend on how much of a risk they think you or whatever it is your insuring will represent. They make money knowing that only a portion of their insured will end up filing claims.

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How do insurance premiums work?

When you sign up for an insurance policy, the provider sets a certain premium based on the level of risk it deems the insured represents. Depending on your insurance policy, you might pay your insurance premium monthly, biannually or annually.

Your insurance contract — and your insurance company’s responsibility to pay for damages — are entirely dependent on you continuing to pay your premiums. If you stop paying your premium, you put your policy at risk.

If you’re in a car accident, for example, and you’re not up-to-date on your payments, the insurance company could deny the claim. Essentially, you didn’t follow through on your end of the deal, so they won’t follow through on theirs.

Types of insurance premiums

As we mentioned, there are several common types of insurance premiums that many of us might pay at some point in our lives.

“Each type of insurance—for example, life, auto, home, health, disability, or long-term care—all have different factors used to create your risk profile,” says Jeff Sachs, a financial advisor and founder of Sachs Financial, a retirement-focused firm. “This profile is the insurance company’s determination of how likely you are to file a claim.”

Car insurance

Car insurance is a policy designed to protect you from losses involving your car. Most people are required to have liability insurance, which pays for damages to other drivers and their property if they’re at fault for an accident. However, many drivers choose to upgrade to full-coverage insurance, which also protects their vehicle.

Car insurance premiums vary based on many factors, including whether you have just liability coverage or full coverage and whether you have a clean driving history. Car insurance companies allow drivers to pay their premiums monthly, but many offer a discount if you pay annually or biannually.[1]

Home insurance

Home insurance is designed to protect you from financial loss related to damage to your home or liabilities related to your home. There are two primary types of home insurance: renters insurance and homeowners insurance.

Renters insurance premiums are usually paid monthly, but you may also pay them annually, often for a discount.

Homeowners insurance policies can be paid in several different ways. First, you could pay your insurance company directly on the agreed-upon schedule. Often, homeowners pay their home insurance premiums with their mortgage payments. The funds are deposited into an escrow account and sent to the insurance company each year to pay the policy premium.[2]

Health insurance

Most people have a firm grasp of how auto and home insurance work, but health insurance is far more complicated. In the U.S., most people receive health insurance through their employers. Often an employer will pay a portion of the premium, while the employee pays the rest. In most cases, health insurance premiums can be deducted from your paycheck before taxes.[3]

If you don’t have health insurance through your employer, you likely pay your premiums to an insurance company for a private policy.

Life insurance

A life insurance policy is one you take out to financially protect your loved ones in case you die. Life insurance policies often have terms up to 30 years. During those 30 years, you pay a monthly premium to the insurance company. If you die within those 30 years, your insurance company provides a payment to your beneficiaries based on the terms of the policy.

Once the 30 years end, so does the policy. You’ll no longer have to pay the monthly premium, but your insurance company will no longer provide coverage. If you want continued life insurance, you’ll have to take out a new policy with new—often higher—premiums.

You can also opt for permanent life insurance policies that last your entire life. However, those policies often have very expensive premiums and aren’t necessary for most people.[4]

Insurance premium vs. deductible

Insurance premiums are one of two major out-of-pocket expenses related to insurance. The other is the deductible, which is the amount you’ll pay for damages if you file a claim. Once you’ve paid the deductible, your insurance company will cover the rest, up to your coverage limit.

There’s a strong relationship between your insurance premiums and deductibles. In general, the lower your deductible, the higher your premium. This is because when you have a lower deductible, the insurance company is taking on more of the risk. When you increase your deductible, you're accepting more of the risk, meaning your insurance company won’t charge you as high of premiums.

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What factors affect insurance premiums?

In general, insurance premiums are about risk. The more of a risk the insurance company sees in you—meaning the more likely it feels you are to file a claim—the higher your insurance premiums will be.

Insurance premium factors differ based on the type of insurance you buy. For example, when it comes to life insurance, your health is a major factor. Older individuals and those in poor health are more likely to pay higher premiums because they’re more likely to die during the policy term.[5]

“If you are healthy but like to ride motorcycles and scuba dive, you have more risk in your life and it’s more likely the insurance company will have to pay out a claim,” Sachs says.

In the case of car insurance, your insurer considers how likely you are to get into an accident. To determine that, it will look at your driving history, your age (since younger drivers tend to be less-safe drivers) and other factors.[6]

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Your state’s laws may also impact your premium. For example, several states have laws limiting what car insurance companies can consider when setting insurance rates. Some states prohibit car insurance companies from considering your credit score, for example, while others prohibit companies from considering your gender.[7]

Your insurance premium is also based on the amount the insurance company would have to pay if you filed a claim. Not surprisingly, expensive cars and homes cost more to insure because they would be more costly to replace. Likewise, someone with $1 million in life insurance coverage will pay more than someone with $100,000 because the potential cost to the insurance company is far greater.

FAQ

  • How do I get the lowest insurance premium?

There are many ways to lower your insurance premiums, including reducing your coverage amounts, increasing your deductible and shopping around.

“Knowing how to get the lowest premiums is tricky, because insurance companies don’t disclose how they calculate the internal cost to insure you,” Sachs says. “But if you reduce your risk factors, it will help.”

  • Who is an insurance premium paid by?

Insurance premiums are generally paid by the customer, whether it be an individual paying the premium for a personal policy or an organization paying for a business policy.

  • Is an insurance premium monthly or yearly?

Whether you pay your insurance premium monthly or yearly depends on the type of insurance. Additionally, some companies offer discounts for customers who pay in full biannually or annually.

  • What are the types of insurance premiums?

There are insurance premiums for each different type of insurance, including auto insurance, health insurance and life insurance.

Article Sources
  1. “Car Insurance Payment Discounts for Simpler Billing.” American Family Insurance. https://www.amfam.com/resources/articles/understanding-insurance/discounts-for-simpler-billing
  2. “Escrow and homeowners insurance.” Progressive. https://www.progressive.com/answers/escrow-and-home-insurance/.
  3. “How does the tax exclusion for employer-sponsored health insurance work?” Tax Policy Center. https://www.taxpolicycenter.org/briefing-book/how-does-tax-exclusion-employer-sponsored-health-insurance-work.
  4. “Term vs. whole life insurance: Which is right for you?” Guardian Life. https://www.guardianlife.com/life-insurance/term-vs-whole.
  5. “8 factors that affect life insurance premiums.” Fidelity Life. https://fidelitylife.com/learn-and-plan/insights/factors-that-affect-life-insurance-premiums/.
  6. “What factors may affect your car insurance premium?” Allstate. https://www.allstate.com/resources/car-insurance/what-affects-premiums-and-rates.
  7. “Credit Scores and Auto Insurance.” AutoInsurance.com. https://www.autoinsurance.com/articles/credit-scores/.

About the Author

Erin Gobler

Erin Gobler

Erin is a personal finance expert and journalist who has been writing online for nearly a decade. Erin’s work has appeared in major financial publications, including Fox Business, Time, Credit Karma, and more.

Full bio

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