What is an Insurance Premium and What Does It Cover?

An insurance premium is the amount you pay to an insurance company to keep your insurance policy active. Think of it as a fee you pay regularly-monthly, quarterly, or yearly-to ensure you're protected against specific risks, like accidents, medical emergencies, or property damage. In simple terms, it's the cost of your insurance coverage. For example, if you have health insurance, the premium is what you pay to ensure the insurance company covers your medical bills when needed.

In India, insurance premiums are a standard part of life for millions who buy policies for health, vehicles, homes, or life insurance. Paying the premium on time ensures your policy remains valid, and the insurance company will support you during a claim. If you stop paying, the policy may lapse, leaving you unprotected.

Components of an Insurance Premium

After understanding the insurance premium meaning, let's explore its components. An insurance premium consists of the following components:

1. Net Premium or Risk Premium

This forms the base premium and accounts for the most significant part of the premium. It covers the cost of insured losses and is calculated based on the insured's risk profile. The higher the risk, the higher the net premium.

2. Operating Expenses

This includes the insurer's business expenses, such as administrative costs, sales and marketing expenses, etc. A portion of the premium covers these costs.

3. Profit Margin

Insurance companies incorporate a profit margin into the premium. This margin allows them to earn profits and grow their capital.

4. Taxes and Levies

Premiums are also subject to certain taxes and levies as mandated by regulatory authorities. For instance, GST is charged on general insurance premiums. The relative proportion of these components varies with the type of insurance product. Term life insurance premiums primarily consist of only the net premium, as they have low operating expenses. On the other hand, unit-linked or investment-oriented products have higher operating and profit margins built into them.*

Factors That Influence Premium Amount

The premium charged for an insurance policy depends on a variety of factors such as:

1. Age

As the ages pass, there are higher chances of illness, hospitalisation and death. Hence, aged individuals pose a higher risk for insurers. This risk gets translated into higher premiums charged, especially for insurance products like life, health and disability, which are directly correlated to age.

For every year of increase in age, premiums may rise depending on the product and the insurance company.

2. Gender

Statistically, women have longer life expectancies than men. Hence, for life insurance, the mortality charges levied on women's premiums are lower. However, for health insurance policies, differential pricing based on gender has been deemed illegal by regulatory interventions. So men and women now pay identical health premiums.

3. Health and Lifestyle

An individual's health condition and lifestyle habits directly impact the level of risk faced. People with pre-existing illnesses or chronic disorders like diabetes pose a higher risk. Similarly, habits like smoking, alcoholism or adventure sports increase chances of untimely death or hospitalisation.

To factor in such risks, insurers incorporate medical tests and seek health declarations. Substandard health or high-risk lifestyles can inflate premiums by 50% to 100%.

4. Family Medical History

Certain diseases like cancer, heart problems, etc., can have a hereditary prevalence. If close family members have suffered from such issues, the chances of occurrence are higher for the individual, too.

Insurers consider such genetic predispositions while underwriting, as it is indicative of higher future claims. The presence of genetic risks can load premiums substantially.

5. Policy Term

Longer policy terms allow greater discounting of future costs and risks for the insurer. This enables them to offer cheaper premium rates for long-term life insurance policies vis-a-vis short-term ones. Hence, premiums are lower when policy terms are higher, often reducing by 30-40% when policy tenure doubles.

6. Coverage Amount

Naturally, when insured amounts for life, health or assets are higher, the risk covered is larger for insurers. This entails higher claims settlements in case of adverse events. Correspondingly, higher coverage translates into higher premium outgo. However, the premium will increase proportionally as per the term and conditions of the product.

7. Claims History

Frequent minor claims under existing policies lead insurers to perceive policyholders as higher risk. Even if the claims were legitimate, a history of claims can cause insurers to inflate premiums upon renewal as the likelihood of repeat claims is high.

Tips to Manage and Optimise Premiums

Here are some tips to manage premium outflow and also optimise it through informed choices:

1. Compare Premium Rates: Before buying any insurance, always compare premium quotes from different companies. This allows you to find the most cost-effective policy as premium rates vary across insurers. Do not just renew your existing policy without cross-checking premiums.

2. Choose Riders Wisely: Insurance riders provide additional coverage but increase overall premiums. Hence, pick riders thoughtfully based on current life stage needs instead of opting for too many. For instance, a critical illness rider is more useful once you cross 50 years of age.

3. Pay Annually: Paying a premium annually or half-yearly rather than monthly saves service charge costs levied on more frequent installments. This significantly reduces the overall outgo towards premiums over the policy term.

4. Review and Revise Covers: Review inflation, income, dependents, loans, lifestyle periodically, and alter insurance covers accordingly. Reduce over-insurance and avoid under-insurance. Buying adequate covers as per changing needs curtails unnecessary premium outgo.

5. Stay Healthy: Poor health results in higher premiums. Hence, undergo regular health check-ups and make lifestyle changes to manage weight, quit smoking, etc. to minimise chances of illness and keep premiums in check.

6. Avoid Minor Claims: Even legitimate minor claims lead to higher premium loadings at renewal, as insurers see you as a high risk. Hence, avoid claiming for small amounts and use the cover only for significant hospitalisation/accident expenses to avoid premium hikes.

Frequently Asked Questions (FAQs)

1. What happens to my premium if I file a claim mid-term?

Filing a life insurance claim mid-term does not affect the premiums you've already paid. The claim process will determine if your beneficiary receives the death benefit, but it doesn't change the premium payments made prior to the claim.

2. Can I change my premium payment mode after policy issuance?

Yes, most insurers allow policyholders to modify premium payment modes even after policy issuance. So you can shift from annual payments to half-yearly or quarterly instalments and vice versa by informing the insurer through the proper channels.

3. Do premiums cover pre-existing diseases immediately?

For health insurance, most companies have an initial waiting period for covering pre-existing diseases. Some chronic ailments may have even more extended exclusion periods. For life insurance, however, premiums generally cover deaths from any cause unless specifically excluded contractually.