What Is an Insurance Premium?

Quick Answer

An insurance premium pays for a policy you buy to cover a car, a home or a life, among other things. A policyholder might pay their premiums on a monthly, quarterly, semiannual or annual basis.

A woman going over insurance paperwork on her laptop

When you buy an insurance policy, the issuer of the policy requires you to pay an insurance premium. An insurance premium is the sum of money you pay—every month, three months, six months or year—to maintain coverage of your car, your home, your life or other things that can be insured.

In short, insurance premiums are money you pay for a policy to help offer financial protection.

Depending on the type and amount of coverage, an insurance premium might range from less than $100 per month to thousands a year. Premium amounts vary depending on the type of insurance you're purchasing, what it covers and how much financial protection you can expect.

How Do Insurance Premiums Work?

Insurance premiums pay for coverage that kicks in when, say, you crash your car and need money to repair it. In this case, the coverage would enable you to file a claim to recover at least some of the cost of fixing your car.

An insurer collects premiums and pools that money to pay claims. In hopes of turning a profit, an insurer tries to keep the total amount of claim payouts below the total amount of premiums collected.

It's important to know that, if you fail to keep up with your premium payments, the insurance company likely will drop your coverage.

Of course, premiums for car, homeowners and life insurance don't work exactly the same, since these policies cover three different categories. But there are similarities.

How Do Car Insurance Premiums Work?

Nearly every state requires motorists to carry auto liability insurance. Therefore, most U.S. motorists pay some type of car insurance premium.

When you pay the premium for a car insurance policy that just covers liability, the policy can protect you when you cause an accident that injures someone else or damages someone else's property. Generally, the premium goes up as you add other types of coverage, such as comprehensive and collision.

Comprehensive coverage applies to theft, fire and other incidents that damage your car. Collision coverage applies to damage to your car caused by running into another vehicle or crashing into an object like a fence. These two types of coverage are optional, although a lender may require you to buy both comprehensive and collision coverage if you finance your car.

Aside from the kinds of coverage you purchase, factors that generally affect your car insurance premium include:

  • Age
  • Gender
  • Driving record
  • Type of car you drive
  • Size of deductible
  • Dollar limits for coverage
  • Where you live

How Do Homeowners Insurance Premiums Work?

Homeowners insurance premiums pay for a policy that helps you recover from financial losses triggered by incidents like fires and burglaries. For instance, a homeowners insurance policy typically helps repair damage caused by a wildfire.

Many mortgage lenders require borrowers to buy insurance for their homes. If so, the insurance premium might be part of your monthly mortgage payment, with the lender paying the premium when it's due. Otherwise, you may be able to pay your premiums on a monthly, quarterly, semiannual or annual basis.

Among the factors that can determine your homeowners insurance premium are:

  • Types of coverage
  • Estimated cost to rebuild or replace your home
  • Age and condition of your home
  • Location of your home
  • Size of deductible
  • Dollar limits for coverage

How Do Life Insurance Premiums Work?

At its core, life insurance pays your beneficiaries after you die. Some policies let you take advantage of benefits while you're alive, such as the ability to tap into a policy's cash value to pay for things like a down payment on a new home.

A term life insurance policy covers you for a certain period of time, such as 10 or 20 years, while a whole life policy lasts throughout your life. Premiums might be due monthly, quarterly, semiannually or annually.

Some of the factors that normally go into setting life insurance premiums are:

  • Types of coverage
  • Age
  • Gender
  • Health
  • Lifestyle
  • Occupation

How Are Insurance Premiums Calculated?

Calculations for insurance premiums differ depending on whether you're insuring a car, home or life, for example.

Generally, though, insurers rely on their own systems to determine premiums. Insurers feed all sorts of information into these systems to forecast risks for various groups or individuals based on factors like age and gender. An insurer then crunches this risk data to come up with insurance rates. Insurers apply these rates to their premium calculations.

A premium takes into account all risk factors for a policyholder. In general, higher risk factors lead to higher premiums and lower risk factors lead to lower premiums.

What Factors Impact Insurance Premiums?

Factors that impact insurance premiums vary based on the type of insurance. For example, the factors for car insurance aren't the same as the factors for life insurance. Nonetheless, some factors are common for car, homeowners and life insurance.

  • Types and amounts of coverage: The more coverage you buy, the more your premium typically is. For instance, adding optional comprehensive and collision coverage to auto liability coverage normally bumps up your premium, as does increasing the payout amount on your life insurance policy.
  • Age: Age plays a big part in determining how much your premiums are. For instance, a life insurance premium typically is higher if you're over 50. On the other hand, younger drivers tend to pay higher premiums for car insurance based on their lack of experience on the road. Meanwhile, older homes usually cost more to insure than newer homes.
  • Gender: In some states, an insurer can use a motorist's gender to calculate their car insurance premium. A female motorist's car insurance premium may be lower than a male motorist's because, statistically speaking, females get into fewer accidents and rack up fewer drunk driving convictions. When it comes to life insurance, men tend to pay lower premiums than women because their average lifespans are shorter.

The Bottom Line

Insurance is designed to help protect you financially in the event of a loss or catastrophic event. In addition to purchasing insurance, maintaining a good credit score can help soften the blow of any financial losses you may experience as the result of a car accident or house fire should you need to borrow money. You can check your credit score and credit report with Experian, and figure out what steps to take to improve your score if necessary.