What is an Insurance Premium? [Explained by Hippo]

When shopping around for any type of insurance policy, the premium will likely be one of your top concerns. That’s because an insurance premium is the factor that determines how much you will pay for your coverage over the course of that policy. 

If you’re looking to lock in great coverage for the lowest cost — whether it’s auto insurance, life insurance, or homeowners insurance policy — shopping around for a competitive premium is probably your focus. Read on to answer some of the most common questions about insurance premiums, including what an insurance premium is determined by, whether premiums fluctuate over time, and how to find the best discounts on your next insurance policy.

Key takeaways

• Insurance premiums are a consumer’s cost of insurance coverage or the price they pay for a specific policy term.

• Premiums are impacted by factors such as policy type, location, coverage limits, personal risk factors, and the details of the asset(s) being covered.

• Truly understanding what is a premium in insurance — and what goes into calculating this number — means looking at one’s individual coverage selections, risk factors, and more.

• Premiums collected by an insurance company are often invested in income-generating portfolios; the funds generated can then be used to cover operating expenses and pay out eligible claims as needed.

• There are ways to decrease your insurance premiums, whether by bundling multiple policies with the same carrier, qualifying for certain discounts, paying the entire premium upfront, or adjusting coverage limits.

Insurance premium definition

An insurance premium is the cost of an insurance policy and is what allows you to purchase coverage for an insurable asset. Premiums can be used to pay for insurance on valuables such as your home, vehicle, motorcycle, boat, valuable personal property, or even your life.

In exchange for making your premium payments, you are given insurance coverage for a defined period of time. If you experience a covered loss on your insured asset(s) during that time and have paid your premiums as promised, your carrier will pay for coverage under the policy, such as to repair or replace your asset up to your policy’s coverage limits.

How do insurance premiums work?

Premiums are determined for each customer and individual policy based on a number of relevant factors. They are typically calculated on an annual basis, though some policies may renew on a different cycle (and therefore, your premiums have the potential to change that often). Premiums can usually be paid all upfront or divided into equal semi-annual, quarterly, or even monthly payments. 

If you opt to make payments in installments rather than forking over your policy’s entire premium in full, you will sometimes be charged an additional fee. If you stop making these premium payments at any time, you can also expect your coverage to lapse, leaving you and your assets unprotected. 

Most of the time, you will pay your premiums directly to your insurance carrier. This is typically the case with renters insurance, auto insurance, life insurance, health insurance, and valuable personal property (VPP) insurance policies. However, homeowners insurance may be handled differently and may sometimes be paid directly by your mortgage lender instead. If this occurs, premiums for this coverage will be added to your monthly mortgage payment, and the funds will be held in escrow until premiums are due.

What factors determine an insurance premium?

There are a few important factors that go into calculating your policy’s premium. Insurance costs will vary from one policy type to the next; the process of calculating how much you should be charged for your insurance coverage is called underwriting. 

Among homeowners insurance coverage, you can expect your premiums to be influenced by things like your:

• Location

• Home’s age and condition

• Home’s value

• Coverage limits and deductible

• Type of homeowner’s insurance policy purchased

• Credit score

• Claims history 

If you live in an area that’s prone to certain natural disasters, for example, you may have higher premiums than the same home in another location. You can also expect higher premiums if you have a large home with upgrades or high-end materials and fixtures compared to a home with more basic features. Your premiums may also be impacted if you have a history of homeowners insurance claims or even a low credit score.

Who decides the insurance premium?

Each insurance company is responsible for setting premiums for its own customers. These premiums are determined using proprietary formulas, the characteristics of your home, and actuaries, advanced mathematics professionals whose job it is to calculate things like risk. Based on these results, your cost for insurance coverage will likely fluctuate from one carrier to the next. Depending on the type of coverage, the factors used to calculate the premium must be approved by the state insurance department.

Why do insurance premiums go up and down?

Over time, you will likely see your insurance premiums go up and possibly even go down. These fluctuations are due to several important factors, some of which won’t even be in your control.

There are many internal and external factors that can — and often will — continue to affect your insurance premium. Examples can include:

• Increased losses in your area (such as extreme weather events or other natural disasters)

• Changing construction, appliances, and materials costs

• Increased rates of theft 

• Inflation

• Skilled labor shortages

In many cases, you may see your insurance rates increase year over year, even if you don’t make any changes to your policy or file a single claim against that coverage. If expenses go up, it becomes more costly to make any repairs to your home, or if there have been a lot of recently filed claims for losses, you can expect your own premiums to increase at renewal time.

While it’s much less common, premiums can sometimes decrease over time, too. This could occur if, for example, inflation reversed (called deflation), there was suddenly an influx of skilled labor in your area, the price of materials went down, or theft and loss rates decreased substantially. You can also find your own ways to decrease your insurance premiums by bundling multiple policies together with the same carrier, raising your deductible, adjusting your coverage limits, or qualifying for various discounts.

What do insurance companies do with insurance premiums?

An insurance premium is paid by a policyholder to maintain coverage for a specific period of time or term. And at the end of the day, the most important part of an insurance carrier’s business model is their ability to mitigate risk and generate more in premiums and revenue than they pay out in expenses and claims. But what does the insurance company actually do with those premium payments?

In most cases, insurance carriers invest the funds they collect as premiums. This allows companies to generate revenue on those funds, increasing revenue without raising premiums further. Depending on your carrier, this often involves an investment portfolio of various stocks, bonds, and even real estate assets, each of which can generate additional income and provide long-term investment stability for the carrier. 

Then, as you might expect, premium payments — and any additional revenue generated by these dollars — are also used to cover various administrative and operating expenses incurred by the insurance carrier. In addition to everyday costs, these funds might be pooled to cover eligible claims or other overhead expenses.

Still have questions?

Want to learn even more about insurance premiums and how they work? Here are some commonly asked questions to consider.

What’s the difference between insurance rate and premium?

An insurance rate is a carrier’s cost for a specific level of coverage calculated by actuaries within the company generally approved by the state. These rates are then used as a baseline for determining a specific customer’s individual premium, or cost of coverage, according to that person’s own risk factors, coverage levels, and preferences. While rates and premiums aren’t exactly the same, they are both used to calculate your out-of-pocket cost as an insurance policyholder.

How often do you pay an insurance premium?

Insurance premiums for coverage are generally paid in advance, so you’ll need to make a payment for your coverage when it’s first purchased. In many cases, this might mean making one lump sum payment at the time your policy is first activated. However, many carriers may also agree to allow you to make installment payments over time; depending on the insurance policy term you choose, these payments can be made semi-annually, quarterly, or even monthly. 

How do insurance companies calculate premiums?

The process of calculating insurance premiums for specific customers is called underwriting. This process involves the use of risk tables developed by mathematicians (called actuaries) whose job it is to calculate risk and expenses. These tables are then used as a baseline for each individual policyholder, allowing carriers to personalize premiums according to each customer’s own policy preferences, coverage limits, claims history, and risk factors. 

How much does an insurance premium cost?

Insurance premiums vary widely according to the type of insurance policy, the value of the asset being protected, the coverage limits chosen, and the individual carrier the policy is being purchased from. Additionally, premiums are affected by each policyholder’s individual factors, such as their claims history, location, and even credit score. With that said, the average HO-3 homeowners insurance policy premium countrywide was $1,411 in 2021, according to data from the National Association of Insurance Commissioners (NAIC).

Is an insurance premium paid monthly or yearly?

If you are purchasing an annual homeowners insurance policy, for example, your premiums will be due on an annual basis. Many carriers will allow you to either pay these premiums upfront when coverage is activated, though, or spread these payments out over the course of the policy. Depending on the coverage term you choose and what that carrier allows, this may mean being able to make premium payments on a semi-annually, quarterly, or even monthly basis.