What is an insurance premium?

Insurance Q&A: “What is an insurance premium?”

Seems like about half of our weekly paychecks! Right? Well, hopefully it’s not that bad for most of us.

Jokes aside, an insurance premium is just a fancy industry term to describe the price you pay for insurance coverage during a given period of time, whether it’s one month, six months, or an entire year.

It is essentially the cost you must pay for the risk the insurer is willing to take should they have to make a payout following a claim. Insurance costs are based on a range of factors. If you’re buying auto insurance, just about everybody needs it. So there are many options for high-risk drivers with a complicated driving record, those with a perfect record, people in different cities and neighborhoods, and more.

All insurance plans, whether it’s auto insurance, health insurance, home insurance, or life insurance, require that you pay this premium cost, which will vary based on the type and amount of coverage, along with certain risk factors.

Instead of paying for accidents and other unforeseen events out of your own pocket, you pay a company beforehand to take on that risk instead. Then they pay you the agreed upon amount if you file a claim and adjust your premium upon renewal. Of course, insurance providers are only agreeing to it because they like their chances (of a positive return on their investment).

Why is it called a premium and not a payment?

• The word premium is an old-fashioned term
• Or perhaps a good sales tactic
• Because payment doesn’t sound as good
• As asking someone to pay the premium

As to why it’s referred to as a premium, it’s likely an old-timey term that has stood the test of time. Why it’s not just called a payment is perhaps a mystery, or maybe just a good sales tactic to make it seem a little less unappealing.

One could argue that it’s not a bill because you’re paying in advance for something that might not happen. Or rather, paying to protect yourself from something that may happen.

Whereas other purchases are generally for defined benefits, such as rent for a roof over your head. You won’t maybe get shelter, you will get shelter if you pay your rent.

With insurance, you may get nothing, though you still are technically getting something in the way of the transfer of risk, even if you never actually use it. The longer you go without making a claim, the cheaper this transfer of risk will be.

Many people will interchangeably use the term “insurance rate,” as in, “my insurance rate is way too high!”

How your insurance premium is determined is a whole other conversation. Just know that your credit history (insurance score), the coverage you choose and your personal history will all play a role in how much premium you end up paying.

Now that we’ve defined the term “insurance premium,” let’s get into some other pertinent details.

Is the entire insurance premium due upfront?

• The premium cost can generally be paid in full or in installments
• If you pay the premium in full you may receive a discount
• A premium payment that is split up might have a higher total cost

For almost every insurance policy sold, the insurer charges a premium to be paid upfront or in installments, in exchange for a certain type and amount of coverage for a specified time period.

For example, a $500 insurance premium may provide 100/300/100 liability limits of auto insurance coverage for a one-year period. Your annual premium would change dramatically if you added collision and comprehensive coverage.

You may be given the option to pay the $500 insurance premium in one lump sum or monthly at a rate of $41.67 per month. Depending on the company, you might have the option to pay in other installments as well (such as quarterly payments). The more you add to your auto policy such as collision coverage, the more likely you are to schedule more payments.

But watch out for installment fees (read our full “Five Insurance Fees To Watch Out For” for more information) if you elect to make monthly payments. These fees can range from $2.00 to $15.00 per month, pushing up the true cost of your insurance premium!

The term, or length, of your policy is a factor in determining the cost of your insurance premium (how car insurance rates are determined).

Put simply, you may end up paying more for your insurance if you commit to a shorter term.

If you were to purchase 12, single-month policies, you would end up paying more in insurance premiums than if you bought an annual policy.

Remember, the insurance company has to pay people to process every new policy they write; therefore, the cost gets passed on to you in the form of a higher insurance premium.

How do I choose a premium policy length?

• Compare a variety of car insurance companies (or other lines if you’re shopping for something different)
• Preferred auto insurance premiums typically ask for a 6-month minimum policy
• Non-standard companies may allow 1-, 2-, and 3-month policies
• All companies should offer several payment options including cash, check, credit card, etc.

Insurance policy premiums vary widely by the type of insurance you purchase and the type of insurance company you elect to purchase your coverage from. Traditional comprehensive coverage is typically sold in 6 or 12-month terms.

Typically, “preferred” auto insurers will not write less than a six-month policy, while “non-standard” auto insurers will write one, two, or three-month policies, but do not offer coverage above what is required by your State Department of Insurance – although some may offer slightly higher than minimum car insurance limits. Insurance companies are balancing their books between not giving you a low rate for too long if you file a claim and minimizing the administrative fees and risk incurred every time they reset your rates and terms.

The difference between preferred and non-standard insurers typically has to do with your insurance history, i.e. prior coverage, tickets and accidents and your insurance score. (For more information, read our “How much does insurance go up after a ticket?“).

Be sure to work with your insurance company and/or an independent insurance agent to determine what your options are. (For more information, read our “Independent Agent vs. Captive Agent“).

It is recommended that you shop around for insurance quotes online and elsewhere to determine if you’re really getting a good deal.

Do insurance premiums increase every year?

• Most stuff we buy gets more expensive over time
• Insurance has actually bucked this trend lately
• Insurance rates generally drop if you avoid claims and minimize other risk factors while staying with the same company
• If you’re into saving money, be sure to shop around extensively and collect several insurance quotes

Seems like it, doesn’t it? This is always a tricky question to answer.

The bottom line is; EVERYTHING that’s useful gets more expensive over time.

For example, a VHS recorder costs less now than it did in 1985, because it’s not useful any more. Cars and food, on the other hand, are still useful and have increased in cost since 1985.

But do insurance premiums go up every year? NO, they don’t. In fact, insurance rates have been going down every year for a long time now. More importantly, the longer you go without filing a claim, the better your rates will be. Things like what car you drive, the zip code you live in, credit scores, etc. also play into your rates. The unique mix of factors that determine your premium can vary depending on which auto insurance company you’re working with.

But if you’re not “shopping” your rate, you may experience a yearly increase in your car insurance premium or health plan.

It cannot be said enough. Shop your rate online and visit a local independent insurance agent to get multiple quotes all at once.

This is the single best way to keep your premium from increasing, and you may even be able to snag a lower premium than what you had last year.

If you work with a “chain” insurer who can only offer you one rate…and it goes up…you’re stuck with it.

And Lebron James isn’t going to make up the premium difference for you, especially after losing to Golden State in the finals…

Tip: Will my premium go up if I file an insurance claim?