Premium refers to money paid to an insurance company to purchase insurance coverage. This can be life, health, homeowners, automobile, or other types of insurance; but for the purpose of this article, we will refer to life insurance. Premium can also refer to purchase payments to retirement planning products such as annuities.
The amount of premium that an insurance company will charge a policyholder depends on the level of coverage and the amount of risk an insured person presents to an insurer.
Generally, the younger and healthier a person is, the less expensive their insurance premium will be. Younger people have less expensive premiums because they have a longer time period over which the insurance companies can collect premium payments from them. Being healthy also results in lower premiums, because a person in good health is less likely to die while the policy is in force and cause the insurance company to pay a death benefit.
Single vs. Periodic Premium
Life insurance policies may be funded by single premiums or a series of periodic premiums.
The most common way to fund a life insurance company is with periodic premiums that are sent to the insurance company on a regular basis such as monthly, quarterly, or annually. In these policies, premiums are paid as long as the policy is in force. Failure to make premium payments may eventually result in the policy being canceled.
As the name suggests, single-premium insurance policies are funded with a single payment at the time the policy is issued. This payment keeps the policy in force permanently or for a specific term, with no further financial obligations for the policyholder.
Other Types of Life Insurance Costs
On certain variable life insurance products, there are costs in addition to premium payments. These policies may incur separate cost of insurance and administrative charges in order to compensate the insurance company for their cost of maintaining these complicated policies.
Variable insurance policies hold their cash values in “subaccounts”, which function in a similar way to mutual funds. These accounts are managed by fund companies that may be unaffiliated with the insurance company. Fund companies typically charge a management expense that is expressed as a percentage of the money in the subaccount.
What do Life Insurance Companies do with Premiums?
Insurance companies don’t make money by simply hoping they collect more money in premiums than they pay out in death benefits. They take premiums collected from their life insurance and retirement planning products and invest them in order to produce income.
Insurance company investment portfolios are regulated heavily, so there are some restrictions on in what they can invest. They also want to maintain liquidity so they can pay out those death benefits as needed, so insurers usually hold very conservative investments.
High-quality corporate and government bonds usually make up a large portion of insurance investment portfolios. They may also hold some stocks, although probably not many. Some insurers have additional ways of making money with their premiums, such as issuing commercial mortgages.