When it is used in relation to auto coverage, definition of the word 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 company who has underwritten the contract and promised to pay the claims made according to the terms.
A premium 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 the car is damaged by any of the perils listed and also protect you against third party liability claims. A policy can only start protecting after the price quoted is paid (or a plan put in place).
A policy is a contract to transfer the risks to a carrier for a fee. In other words, motorists transfer the risks involving with driving. There is always a risk that they can cause an accident in which they injure people and cause them financial losses. Also, there is a risk that own automobile is damaged, totaled or stolen. Full coverage compensates both types of losses.
A 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 take care of 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 meet 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, they are payable before the coverage starts. However, most companies allow their customers arrange installments. However, coverage can be cancelled if you don’t keep up.
Most companies sell auto insurance for 6 months although you can still buy it 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. Rates should normally come down at each renewal if there is no change in details or history.
How Is Auto Insurance Priced?
Usually, the higher the chance of an accident or other losses and damages are the higher the rates. 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.
Underwriters take a few factors into account in their pricing. These are age, gender, history, credit score, coverage required, type of car you want to insure, other listed drivers, where you live, how many miles you travel, where you park it 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 record. High risk applicants spend more and may face surcharges for traffic tickets and recent accidents.
Every state sets rules as to how carriers can use the funds collected. 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 they have no liquidity problem when it comes to settling claims.