When it is used in relation to an insurance contract, definition of the word “premium” is different than its use in a normal conversation to mean superior or additional amount to be paid due to high demand. In that sense, Premium is the price of a car insurance policy. In other words, it is an income for the auto insurer who has underwritten the contract and promised to pay the claims made according to the terms of coverage.
A premium for automobile insurance is the amount of money you need to pay to be insured against risks associated with driving a vehicle. A carrier quotes a fixed price for promising to indemnify you if your car is damaged by any of the perils listed on your policy and also protect you against third party liability claims. An insurance policy can only start protecting after the price quoted is paid (or a payment plan put in place).
A policy is a contract to transfer the risks to a carrier for a fee. In case of vehicle insurance, policyholders transfer the risks involving with driving a car. There is always a risk that they can cause an accident in which they injure people and cause them financial losses. A liability policy covers this risk. Also, there is a risk that policyholders’ own automobile is damaged, totaled or stolen. A full coverage policy covers both types of losses.
An insurance company agrees to indemnify policyholders in case they suffer such financial losses and they receive a fee in exchange that is known as premium. The whole concept is based on pooling resources to pay for the less fortunate and goes back to Roman times. Today, this system is operated by mostly profit seeking commercial entities.
They need to collect enough money to pay for future claims, their overheads including employees and still make profits for their shareholders. So, they need to be good at underwriting and especially pricing risks.
Theoretically, insurance premiums are payable before the coverage starts. However, most companies allow their customers pay in installments. However, your coverage can be cancelled if you don’t make the payments.
Most companies sell auto insurance policies for 6 months although you can still buy coverage for a year. At the end the agreed term, you are offered a new renewal quote that can be cheaper or more expensive than what you paid last time, depending on claims and other factors. Your rates should normally come down at each renewal if there is no change in your details or history.
How Is an Auto Insurance Policy Priced?
Usually, the higher the chance of an accident or other losses and damages the higher the vehicle insurance cost. This makes sure that careful drivers and people who look after their vehicles get rewarded for their efforts by being charged less than the risk takers.
Insurers take a few factors into account when they calculate your car insurance premium. These are your age, gender, driving history, credit score, coverage required, type of car you want to insure, other listed drivers, where you live, how many miles you drive, where you keep your car and so on. They use varying levels of rates for each type of applicants and apply further discounts or surcharges on them.
So, if you are a good driver you get charged preferred rates and get discounts for not making claims and having a clean driving record. High risk drivers get higher rates and may face surcharges for traffic tickets and recent accidents.
Every state sets rules as to how insurers can use premiums they collect. Usually, they are allowed to invest some of the money and they do invest on properties with rental income and other fixed assets. And the rest must be kept in cash or easily convertible assets like bonds so that companies have no liquidity problem when it comes to paying claims.