What Is an Insurance Premium?

An insurance premium is the amount you pay to an insurer in exchange for cover. It can be paid monthly, annually, or sometimes as a one-off. Whether you're insuring your car, home, health, business or anything else, the premium is what keeps the policy in force.

Understanding how premiums are calculated, what influences the cost, and how they relate to taxes like Insurance Premium Tax (IPT) helps you make better decisions when choosing a policy.

What Does Insurance Premium Mean?

The term "premium" simply refers to the price you pay for insurance. In return for paying the premium, the insurer agrees to cover certain risks set out in your policy. If an event happens that’s covered – like a car accident, theft, or flood – the insurer pays out, subject to any excess and policy limits.

You might be quoted a monthly premium (for direct debit payments) or an annual premium (usually slightly cheaper overall).

Why Is It Called an Insurance Premium?

The word "premium" has its roots in finance, where it refers to a payment for a service or added value. In insurance, it’s the price of risk transfer. By paying a premium, you pass the financial risk of certain losses to the insurer.

How Does an Insurance Premium Work?

Once you've agreed to the cover and the insurer has accepted your application, you pay the premium either up front or in instalments. If you stop paying, your policy could be cancelled, and you won’t be covered.

Premiums aren’t just about paying for potential claims. They also cover administrative costs, commissions, and in some cases, profit margins. In business insurance, premiums may also include additional policy-specific levies and charges.

How Are Insurance Premiums Calculated?

Premiums are calculated using a process called underwriting, where the insurer assesses how likely you are to make a claim and what that claim might cost. This process is supported by actuaries, who use data, statistics and risk models to help insurers set appropriate pricing.

The more likely a claim is, or the more expensive it could be, the higher your premium will be. If your circumstances suggest you’re a lower risk, you’ll usually pay less.

Factors That Can Affect the Price of Insurance Premiums

Several things influence your premium, depending on the type of cover:

• Age: Especially relevant for car, life, and health insurance.

• Location: Areas with high crime or flood risk may attract higher home or car premiums.

• Type of business: For commercial policies, riskier industries tend to pay more.

• Claims history: A track record of claims may result in higher premiums.

• Policy details: Higher sums insured or broader cover generally lead to higher premiums.

• Excess amount: Agreeing to a higher voluntary excess can lower your premium.

Premiums are usually reviewed and recalculated at renewal, based on updated risk assessments and market trends.

What About Insurance Premium Tax (IPT)?

In the UK, most insurance policies are subject to Insurance Premium Tax (IPT). This is a government tax charged on premiums and is included in the price you pay.

The standard IPT rate is 12%, but some types of insurance – like travel cover – are taxed at a higher rate of 20%. Life insurance is one of the few areas that is exempt from IPT.

Your policy documents should show the IPT amount as a separate line. Insurers collect this tax and pass it on to HMRC.

Premiums and Business Insurance – Things to Consider

If you run a business, understanding premiums becomes even more important. Business insurance often includes multiple elements – like public liability, employer’s liability, professional indemnity, and contents cover – all priced individually and then bundled together into a total premium.

When reviewing or comparing policies, business owners should consider not just price, but also what’s included, what’s excluded, and whether the level of cover matches the actual risks the business faces. Underinsuring to keep premiums low can be a costly mistake if you ever need to claim.

Also factor in whether the insurer offers flexible payment terms, no-claims discounts, and the ability to adjust cover as your business grows.

Final Thoughts

An insurance premium is the cost of transferring financial risk from you to your insurer. It’s calculated based on the likelihood and potential size of a claim, influenced by your personal or business risk factors. While you can’t control everything that affects your premium, you can take steps to keep costs reasonable by understanding how it works, choosing cover wisely, and reviewing policies regularly.

Before you buy, always compare cover as well as cost, check for hidden fees or charges, and make sure you understand what’s included in your premium – including Insurance Premium Tax.