- Insurance companies charge premiums to provide people with insurance coverage. Premiums are the payments that the insured (the person who is covered under an insurance policy) pays to the insurance companies in return for insurance coverage, such as auto insurance or life insurance. Premiums are due on insurance policies on a regular basis, such as monthly, semi-annually or annually. Failure to pay insurance premiums can result in the termination of the insurance policy.
- Insurance companies try to charge enough money in insurance premiums to cover the amount of money that they will have to pay out to their insureds under all of the insurance policies that they have issued. Insurance companies make an educated guess about how likely they will have to pay out on the insurance policies that they issue. In order to make an educated guess, they request information from applicants that help them determine how much risk is involved in issuing insurance policies to each applicant.
- When insurance companies receive an application for insurance, an insurance agent reviews variables that affect how likely the insurance companies will have to pay out under the insurance policies. A person called an actuary runs a statistical analysis to determine which risk factors are more likely to result in having to pay out under insurance policies. For life insurance, the actuary evaluates factors such as age and the state of the applicant's health. For auto insurance, the actuary considers factors such as level of driving experience and history of traffic violations.
- After insurance companies have evaluated the level of risk involved in providing insurance coverage, then the insurance agent establishes premiums by calculating how much the insurance premiums need to be to cover the risk. The greater the risk of having to pay out under an insurance policy, the higher the insurance premiums are likely to be. When insurance companies believe that an applicant is a poor risk (very likely to require insurance companies to pay out under the insurance policies), then they might decline to offer insurance coverage altogether.
- Insurance premiums are likely to change over time as variables change. For example, premiums for comprehensive automobile insurance coverage generally decreases over time as the value of the automobile decreases. Premiums for automobile collision insurance often decrease once a driver turns age 25 due to the change in the driver's level of experience. However, other factors can result in an increase in insurance premiums, such as filing a claim under an automobile insurance policy after causing a collision or suffering from a serious health condition when renewing a life insurance policy.
