Understanding Premiums, what are they and how are they calculated?

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Key Takeaways

  • An insurance premium is a periodical payment as the cost of being secured against financial loss.
  • Premiums are paid monthly, quarterly, semi-annually or annually.
  • A default in payment of premium results in cancellation of the policy.
  • The amount of insurance premium may alter in the future depending upon the profitability factor of the customer as well as the insurance industry.
  • Tax deductions can be claimed on premiums paid for certain policies.

What is an insurance premium?


Insurance premiums can be viewed as the cost of security against contingent loss. It is a periodical payment required by the insurance provider in exchange for financial protection in case of uncertain events.


The entire amount of premium can be paid as a one-time payment or it can be paid in installments. Installments are paid periodically with fixed intervals. An individual or business can choose to claim protection over auto, home, life and health. Usually, the concept of insurance premium remains the same for all types of policies.


The premium paid works as income to the insurance company. Therefore, a default in payment of premium on or before the due date results in the cancellation of the policy.


Insurance policies should be selected only after completely understanding the different policies offered by the insurance companies, their coverage type, terms of renewal, benefits, etc.


What are the different insurance premiums?


Life Insurance Premium


When premiums are paid in order to receive a death benefit in case of the insured individual’s death, it is known as a life insurance premium. The face value of the policy is given to the beneficiaries of the insured person. Age, medical history, gender, employment status, current health, etc. are a few important factors that are taken into consideration while determining the premium amount. The basic motto is ‘higher the risk, higher the premium.’ Based on the length of the insurance period, there is whole life insurance and term life insurance.


Auto Insurance Premium


In return for the security provided by insurance companies, in case of theft or accidental damage to automobiles, the policyholder is bound to pay periodical premiums. Auto insurance delivers coverage against damages to the vehicles involved in an accident, any injuries that took place during the accident, related medical expenses, etc. The geographical location of the individual, the engine on the vehicle, coverage type and many other elements impact the premium amount in auto insurance policies.


Health Insurance Premium


Health insurance premiums are paid by the policyholder to get the protection of health. These premiums are paid directly by the individual or they are deducted from the payroll by their employer. The medical history and current health of the individual are taken into view while deciding health insurance premiums.


How are insurance premiums calculated?


Insurance premium starts off with a base calculation. Further, the premium rates are determined or customized by actuaries by using a list of factors such as;

  • Likelihood of making claim
  • Type of policy
  • Financial standing
  • Medical history, etc.

A greater risk involved in recovery leads to a higher premium amount. Generally, insurance providers offer discounts or rebates on certain high sum policies. The premium is finalized only after a detailed analysis of the determinants and the probability of risk. It is beneficial to be well-informed of the outline of the premium before entering into any insurance policy.


Who are actuaries?


Actuaries are professionals tasked with the responsibility of calculating the possibility of future events and the financial risks and consequences that come along with them. The mathematics and theories involved together compose what is known as “actuarial science”. Also, actuaries help to formulate plans to reduce the impact of such risks.


What are the consequences of non-payment?


In exchange for the premiums received, insurance companies are liable to safeguard the insured against uncertain losses. On that account, a failure in payment of premium on or before the due date results in cancellation of the policy. However, before such cancellation, the policyholder is offered a grace period to correct such default in payment. Most of the time, the grace period is a length of 25 to 30 days. Termination of a policy takes place when an individual fails to honour such payment for 3 consecutive years from the beginning of the insurance contract. In order to revive a policy, one has to pay various fines and penalties along with the outstanding premiums.


What factors affect insurance premiums?


Insurance premiums are determined only after assessing a large number of factors that govern them. Premium usually varies with the type of coverage that has been undertaken. Another factor that affects the premium amount is the age of the individual. For example, given the likelihood of an old individual’s demise, the amount of premium paid for life insurance would be relatively high as compared to that of a young and healthy individual. Moreover, the claim history of a person plays a major role in deciding on a premium amount.


Do insurance premiums change over time?


Insurance companies have to pay for numerous costs and fluctuations in the financial market. In the event of extra cost or unfavourable financial circumstances, companies are likely to increase the premium amounts in order to deal with such additional costs. A decrease in the credit score of the insured can also result in an increase in the insurance amount paid by the individual. Further, at the time of insurance renewal, insurance premiums are subject to change based on add-ons and customization to the existing policy. However, the extent to which a premium can be altered is under constant regulation.


Tax benefits available on insurance premiums


Apart from the perk of being secured against financial loss, policyholders can also claim tax exemptions if sufficient premiums are paid towards the policy. A modest deduction is granted to individuals participating in life and health insurance policies for the respective financial year.


Sec 80D – Medical Insurance


This section allows the taxpayer to avail tax deduction on premium paid on medical insurance for self, spouse and dependents.


Sec 80C – Life Insurance


Deduction up to Rs 150000 is allowed on the premium paid towards life insurance policy subject to the conditions stated in the section.

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