A premium is the amount paid to an insurer to buy and keep coverage in force. It funds the pool from which claims and expenses are paid. If premiums stop, coverage ends after any grace period (the policy lapses), although cash value life policies have nonforfeiture options.

What drives the premium

Premiums reflect the risk the insurer takes on and the costs of providing coverage:

• Life insurance – mortality (expected deaths, the main factor), interest (expected investment earnings, which lower the premium), and expenses (loading). Age, sex, health, tobacco use, occupation, and hobbies place the applicant in a risk class.
• Health insurance – morbidity (expected sickness and injury) plus expenses and plan design. Under the ACA, individual and small-group major medical premiums may vary only by age, tobacco use, family size, and area.
• Property and casualty – rate × exposure units = premium, with rates based on factors such as construction, location, driving record, and loss history.

Coverage choices matter too: a higher deductible, longer elimination period, or lower limit generally lowers the premium.

Premium mode

The mode is how often the premium is paid: annually, semiannually, quarterly, or monthly. Paying more often costs more in total because of added expense and lost interest to the insurer.

A simple example

Two 40-year-olds buy the same $500,000 term policy. One is a nonsmoker in excellent health and qualifies as preferred; the other smokes and is rated substandard. The second pays a higher premium for the same coverage.

Don't confuse it with…

• The premium is paid to have coverage; a deductible or copay is paid when a claim occurs.
• Policy dividends on participating policies are a return of part of the premium, not investment income.
• The consideration clause of a policy states the premium and how often it is due.

On the exam

Know the life premium factors (mortality, interest, expense) and that higher assumed interest lowers premiums. Remember that more frequent modes cost more, that higher deductibles and elimination periods lower premiums, and that nonpayment leads to lapse after the grace period.