Insurance Premiums - What Are You Really Paying For?

Almost everyone in the United States has insurance in one form or another, but are you aware of what you're paying for? The insurance premium that you pay for when you purchase a plan has a few elements to it that you should be aware of as a buyer.

First of all we need to establish that when you buy insurance and pay that premium, you are effectively minimizing your cost of whatever risk you are trying to avoid albeit a car accident, property damage, medical problems, etc. This is important to be aware of. Many people believe buying insurance will somehow lower their chance of something happening to them. This is not true; insurance simply lowers the cost when an accident does occur.

With that established, we now need to look at the components of insurance premiums themselves, which is the upfront cost and continued periodic payment to an insurance company for the plan you purchased. In exchange for you paying them, they are essentially taking on X amount of your risk, where X is equal to the amount of coverage you purchased.

So how are insurance premiums calculated? Without going into too much detail because the math is a headache, the premium is calculated by taking the insurers expected claims costs plus the premium loading.

What are expected claims costs? Expected claims costs are values based on carefully calculated probabilities by statisticians that work for insurance companies and demographics surveys, which essentially provide an average cost for specific insurance related to personal traits about you, such as age, type of car driven, medical history, smoking and drinking habits, etc. This value is what the insurer can be expected to pay if an accident occurs.

The insurance premium loading is the additional compensation the insurer requires you to pay if they see you as a heavy risk. This is also their profit margin so to speak, so you can expect to always be paying more than you actually should in regards to your level of risk. Which is perfectly fine, without these premium loadings insurance companies couldn't exist and we'd all be forced to pay 100% of our incurred liabilities out of pocket.

Short summary, this is basically how insurance companies go about charging insurance premiums to their customers. They calculate the level of risk for the individual and what they expect it will cost them given the general probability of the specific demographic then they tack on a premium loading which acts as their profit margin and also compensates for additional probability of risk.

Also keep in mind, the more coverage you buy, the more likely these costs are to increase.

Can you lower your costs? Sure. The most obvious choice is buying less insurance coverage. Surprisingly enough this is normally instinctive. If people believe their chances of incurring a loss are low, they most likely won't bother buying insurance for said loss in the first place.

Another obvious way to lower your costs is to shop around. Different companies offer different rates and premiums and it shouldn't be hard to realize some savings after doing some research.

Hopefully this has helped you gain a stronger grasp on insurance premiums and what you are paying for. These days, knowing how things such as this work will be to your benefit if money is an issue as it is for most of us.