What is an insurance premium?
Insurance comes with premiums that need to be met to maintain cover, no matter the type of policy. But what exactly is an insurance premium?
Discover more with this Hiscox guide.
Online quote in 5 minutes
Get a quote
What does insurance premium mean?
An insurance premium is the amount you pay for your insurance policy.
An insurance policy helps protect against financial losses from risks to you, something you own, or your business. There are many types of insurance policies, including:
Some types of insurance are required by law or a contractual obligation. Others could simply offer reassurance and make good sense. Premiums apply for all these types of insurance.
Premiums provide the insurer with an income and confirm they’re obligated to provide cover to you or your business. However, if these go unpaid, you may not be covered and the insurer could cancel the policy.
Why is it called an insurance premium?
The word ‘premium’ depicts a price point. In insurance terms, it describes the amount you pay to safeguard against financial risks. The word has Latin origins and is taken from the word ‘praemium’ – which means ‘reward’ or ‘prize’.
How does an insurance premium work?
Once you select the insurer and insurance policy, you’ll receive a premium payment schedule. You can usually choose how you would like to divide these payments. You may choose one annual amount, monthly installments, or even quarterly payments.
It’s important to note you won’t receive your funds back if you don’t make a claim. Instead, this money goes to the insurer.
If you need to claim against your insurance, your insurer will pay out as per your agreement. These funds will come from the money they receive from their policyholders.
How are insurance premiums calculated?
Several factors go into calculating an insurance premium, including:
- The use of data to work out how likely it is the insured risk might happen
- The result is compared against the risk profile of an average insured person – is this risk higher or lower than the average?
- This information helps to figure out the price of your premium – if the risk is higher for the insurer, then the premium sum will increase
- The type and amount of coverage you wish to have will also determine how much the premium will cost. If you opt for a more comprehensive policy with higher coverage amounts, the premiums will cost more.
Actuaries are risk assessment and management experts employed by insurance companies to calculate what an insurance premium is going to cost by working out the total they need to charge.
The Institute and Faculty of Actuaries (external link) use principles, skills and experience to help with their assessments, including :
1. Considering the context
- Defining the situation and establishing who is relevant within it
2. Describing what system will be used
- Gathering relevant data, plus views from experts about the situation
- Establishing a connection between the discovered risks
- Building a model framework to help explore the risk and how it might change
3. Measuring the risk
- Examining all potential outcomes
- Making allowances for how the level of uncertainty might change over the period in question
- Challenging how the system might run and adapt to changes
- Testing resilience using stress testing and analysis of scenarios
- Having an awareness of personal biases
4. Managing the risk
- Developing an effective strategy for risk
- Mitigating the possibility for ongoing risk reduction
- Monitoring the risk via analysis and comparison with other sources of data.
An underwriter is an expert in finance who works with actuaries to evaluate risk, assess the policy and establish fair rates for these policies. Underwriters use information and guidelines provided by actuaries to work out the cost of each customer’s premium. Beforehand, they ‘underwrite’ the risk based on this guidance.
Factors that can affect the price of insurance premiums
Aside from the primary data used for calculating insurance premiums, other factors may impact the price. Actuaries and underwriters will also consider the following:
- Inflation – unfortunately, when inflation rises, so can insurance premiums due to the increasing costs of repairs and replacements
- Changes to your risk – if there are changes to your risk exposure, whether that’s an increase or decrease, your premium can change
- The number of claims (by sector) – actuaries and underwriters will look at the number of claims by industry. If there is an increase, this can heighten premiums.
What about insurance premium tax?
Insurance Premium Tax (IPT) is a type of tax on insurance premiums. It can, therefore, also impact the cost of your premium as it’s added to the overall total. IPT has two rates (external link) – 12% (standard) and 20% (higher) – which apply to different types of insurance .
Learn more about Insurance Premium Tax in our FAQ guide.
Premiums and business insurance - things to consider
Now you know what an insurance premium is, there are a few things to consider before applying.
Firstly, the types of insurance products a business needs will depend on the business itself. The number of these you add to a policy can impact the overall cost of the premium.
For instance, it’s possible to tailor a Hiscox business insurance policy with products relevant to your business. Your insurance premium will likely be higher the more insurance products you add to your overall policy.
The price of the insurance premium can also depend on the business size, the industry and where the work is carried out. Additionally, cover limits can be amended if more coverage is required due to heightened risk – this can impact the price of the premium, too.
Check out our FAQ on how much business insurance costs for more detail.
Institute and Faculty of Actuaries, "Risk management: An actuarial approach".https://www.actuaries.org.uk/system/files/field/document/Risk%20Management%20booklet.pdf.
GOV.UK, "Insurance Premium Tax: guide for insurers".https://www.gov.uk/guidance/insurance-premium-tax.
Tell us about your business – we’ll build your business insurance quote and help you explore any other insurance needs.Start my quote