How are insurance premiums calculated?

When you get an insurance policy, the company charges you a certain amount of money against the coverage. This money that you pay to the company is called the insurance premium. You might pay the premium every month or on a semi-annual basis, depending on your insurance policy.

While purchasing any policy, we do not have much control over the insurance premium amount as it is determined by the insurance firms. However, the question- how are insurance premiums calculated and what are its key deciding factors might have crossed your mind.

Well, we have an answer for that! Let’s understand the cost of the premium and how it is calculated.

How much does an insurance premium cost?

Insurance premiums have no set cost. Various insurance policies have different insured sum and coverage and hence can have varied premiums. For instance- a 5 lakh health insurance policy will have a lower premium as compared to a 50-lakh health insurance policy. But this doesn’t mean that you opt for insurance with the lowest premium. Assess your need and financial condition before opting for insurance.

How are insurance premiums calculated?

Insurance companies consider different factors while calculating premiums. Here are a few of them:

1. Age

Age is a major factor while deciding insurance premiums. People below the age of 40 generally have lesser health problems and generally get the best premiums. People above the age of 40 have more health issues like diabetes, arthritis, cancer, etc, and pose a higher risk to insurers. Hence these people are usually charged higher premiums by the insurer.

2. Type of coverage

You are offered several add-on coverages like zero depreciation, maternity cover, critical illness covers, etc. on specific insurance policies. The more comprehensive coverage you opt for, the more expensive the premium will be. For instance- if you have a car insurance policy that covers liability only, it will have a cheaper premium. If the same car policy accounts for comprehensive coverage, liability, and medical payments the premium will automatically be higher.

3. Amount of coverage

The sum insured under the insurance coverage is a key factor in deciding premiums. If your total insured amount is less, the premiums for that insurance will generally be lower and vice versa. For instance- if you purchase a home loan of Rs 60 lakh, it will have a high premium than a Rs 25 lakh home loan.

4. Actuarial tables

Actuaries are business professionals that assess the risk of financial loss using mathematics and statistics. Insurance companies hire these actuaries to predict the likelihood of an insurance claim. After the assessment of the possible losses, actuaries produce something called an actuarial table that is provided to an insurance company that uses it to set policy premiums.

5. Whole life vs Term life insurance

An insurance policy that provides coverage until the death of the insured is called a whole-of-life policy. A term insurance policy offers cover only for a fixed number of years. Whereas, a whole life policy offers coverage generally across the expected life span of the individual.

For whole life insurance, the premium is paid generally for the first 10-15 years while the coverage is offered for the entire life of the policyholder. The payment of premium is limited to a specific period and therefore the premium charged for whole life insurance is on the higher side. On the other hand, term life insurance provides coverage for a specified period like 5 years or 10 years wherein the premium amount to be paid is fixed. This results in the premium charges being lower.

6. Number of dependents on the insured

Children and parents are dependent on the earning member of the family who is also the policyholder. The number of family members dependent on the insured plays a role in calculating the premium amount. A higher number of dependents means more protection is needed which translates to a higher premium.

7. Occupation

Your occupation might play a role in calculating the premiums if you decide to purchase an insurance policy. Some occupations such as pilots, soldiers, offshore oil or gas industry workers are deemed riskier than others by the insurance companies. If you are a professional working in the above-mentioned fields, you can expect higher premiums compared to those working in a comparatively safer environment.

8. Income

One of the vital factors to determine the amount of premium is the sum an individual earns. Premiums are to be paid regularly to the insurer without any defaults. Insurers evaluate your income to determine if you will be able to afford regular premium payments.

9. Debts

If you have ongoing loans, mortgages, or have unpaid credit card bills, the insurance institutions consider these things as debts against the insured. These debts might have a direct impact on the premium you pay for the policy. There might be situations, where you might even be denied to avail a policy because of these debts. It’s therefore suggested to clear them in order to get a policy as per your requirement.

10. Operating cost of the firm

Insurance companies spend a huge amount of money to maintain an online presence through ads on various websites and social media. The insurance companies promote their product i.e. the policies through these channels. The money spent on this comes under marketing expenses. The insurance company also bears non-marketing expenses like maintenance, rent, salaries, legal fees, agent’s commission, etc. These marketing and non-marketing expenses make up the total operational costs of the insurance firm. This operational cost affects the insurance premiums the company charges to the policyholders.

11. Interest on investments

As an added investment, insurance firms invest the policyholders’ premiums in bonds, stocks, real estate, etc. The insurance company earns a specific rate of interest on the invested funds. This interest earned on these investments may vary as per the fluctuations in the market. It is yet another important factor that is considered while deciding the insurance premium.

These factors affecting the insurance premiums vary from policy to policy. Understanding how insurance premiums are calculated will help you immensely when you are looking for your next insurance policy. To get the best coverage for you and your family at affordable prices, you must take the time and effort to do online as well as offline research.