Only few things are more unclear to people than how insurance premiums are calculated. Some think each insurance company sets its rates arbitrarily. Some think the rates depend on the insurance policy being purchased. And some think the rates are the standard prices set by insurance regulatory bodies.

And worse, many insurance agents and brokers have no idea how the premiums are calculated. To them, they are in the business for the commissions, not to teach!

Now every customer has the right to know how the money she’s being charged for a product or service came about. But insurance companies do very little to enlighten their customers about how insurance premiums are calculated. And even the few who try, leave the customers more confused than enlightened.

Whether you are an insurance policy holder or you plan to buy an insurance policy in the future, you need to understand how insurance premiums are calculated. Granted, going into too much of technical detail can drive anyone crazy. But there’s a way to explain things in very simple terms that you can still enjoy and understand. And that’s what this article is all about.

The amount of insurance premiums charged by an insurance company is determined by statistics and mathematical calculations done by the underwriting department of the insurance company. As an insurance customer, the premium you will be charged depends on statistical data that exists about your life history, age, and health.

For example, if you are a 50-year-old man who drives a four-door sedan car, you are very likely to pay less auto insurance premium than an 18-year-old man who drives a red sports car. This is because your car is less expensive and your chances of getting involved in accidents are slim because younger people have been found to be careless drivers.

When you apply for insurance, you will be made to go through the underwriting process. This process involves investigation into factors related to the type of insurance policy you apply for, such as familial diseases, analysis of reports like medical information bureau, and motor vehicle reports. All the pieces information are gathered and analyzed by statisticians, called actuaries, hired by insurance companies to calculated insurance premiums based on risk.

How Insurance Premiums are Calculated Based on Product Specification

The specific factors used to calculate your insurance premiums depend on the type of policy you are applying for. For auto insurance, here are the factors that will be considered:

  • Where you live: If you live in a bustling city where there are many cases of accidents and vehicle theft, your insurance premiums will be higher than that of someone who lives in the country area.
  • The type of vehicle you drive: The make and model of your car also determine what risk factors will be associated with it. For example, certain car makes and models are so strong they fare better in collisions than others. If such cars get involved in collisions, injury to the occupants and damage to the car itself will be less severe. So, such cars will be less expensive to insure.
  • The cost of the vehicle: Newer, more expensive vehicles cost more to replace. So, they are more expensive to insure than old, expensive vehicles.
  • How you use your car: The more time your car spends on the road, the higher the chances of having it involved in an accident. So, if you drive a lot, you will have to pay higher premiums. Same runs true if you drive long distances or you drive to work every day.
  • Your driving record: This is one of the major factors that determine how much you will pay as premium on your auto insurance. If you have a long driving history of no accidents, your premiums will be less than you will pay if you have been involved in some accidents in which you were at fault.
  • Your statistical group: Your insurance company may look into the claims history of the group you belong as a driver to determine your premium. For example, if you fall within an age group that is notorious for auto accidents in your geographical location, your premiums will most likely be higher.
  • Other factors: Market forces, government regulations, taxes, discounts, and other factors also determine the rate of insurance premiums.

Having looked in detail into how auto insurance premiums are calculated, let’s briefly look at the factors considered for other types of insurance policies.

For home insurance, your premiums will be determined by the crime rate in your neighborhood, how close you live to a fire station and fire hydrant, the value of your personal property, your home insurance history, the claims history of your property, how prone your neighborhood is to sewer backup and so on.

For life insurance, your premiums will be calculated based on your age, familial diseases you are prone to, how risky your occupation is, and other factors.

Ajaero Tony Martins