Understanding Insurance Premium and Its Calculation in India

Published on: Thu Jun 15 2023

Insurance is a crucial part of risk management in our daily lives, providing a protective shield against unforeseen circumstances that may lead to financial distress. One of the pivotal components of insurance is the 'Insurance Premium'. This article will walk you through the understanding of Insurance Premium and the comprehensive process of its calculation in India.

What is Insurance Premium?

Insurance premium is a specified amount paid by the policyholder to the insurance company at regular intervals, usually monthly, quarterly, half-yearly, or annually. It is essentially the cost of purchasing the insurance policy, which offers protection against various risks. The insurance company, in turn, promises to compensate for the losses or damages as per the terms of the policy.

It's worth noting that the terms 'insurance premium' and 'insurance policy' are not interchangeable. An insurance policy refers to the contract between the insurer and the insured. In contrast, the premium is the cost the insured party pays to maintain the insurance coverage.

Types of Insurance Premium

Insurance premiums can be classified into two types:

Single Premium: In this case, the policyholder pays the entire premium in a single lump sum at the beginning of the policy period.

Regular Premium: The premium amount is paid at regular intervals throughout the policy period.

Factors Affecting Insurance Premium in India

The calculation of insurance premium involves considering various factors, including:

Type of Policy: Different types of policies like term insurance, health insurance, car insurance, or endowment plans have different premium rates. The risk associated with each policy type also significantly affects the premium.

Age: Age is a major factor in premium calculation. Younger individuals are typically charged lower premiums as they are perceived to be at lower risk of illness or accidents.

Gender: Gender plays a role, particularly in health and life insurance premiums. As per statistical data, women live longer than men, so they may pay lower premiums for life insurance.

Occupation: Certain professions carry more risk than others, affecting the premium. For instance, a commercial pilot may pay a higher premium for life insurance than an office worker.

Health History: Health insurance providers consider the applicant's medical history. Pre-existing conditions might lead to a higher premium.

Lifestyle Habits: Habits like smoking or drinking can lead to higher premiums due to associated health risks.

Policy Term: The duration of the policy also affects the premium. Longer policy terms often mean higher premiums.

Calculating Insurance Premium in India

The calculation of insurance premium in India is a meticulous process involving the consideration of multiple variables. Actuaries, who are specialists in financial risk assessment, usually carry out this complex task. They use statistical models and historical data to assess the probability of a claim being made.

Let’s take a simplified example of how life insurance premium is calculated:

Suppose a 30-year-old non-smoker male wants to purchase a term life insurance policy with a sum assured of INR 1 Crore and a policy term of 30 years.

Insurance companies use mortality tables, which show the statistical death probability of individuals at each age. Suppose the mortality rate for such an individual is 0.001. The insurer also considers other factors like administrative costs, profit margins, and a risk premium for uncertainty.

Assuming the combined additional factors amount to INR 2000 annually, the premium will be:

(0.001 * 1,00,00,000) + 2000 = INR 12,000 annually

Why Timely Payment of Premium is Essential

Timely premium payment is crucial to keep the policy active. Failure to pay within the grace period (usually 15 to 30 days from the due date) may lead to policy lapse. A lapsed policy means you lose your insurance coverage, and the insurer isn’t obliged to pay any benefits.

Understanding the concept and calculation of insurance premium is important while purchasing an insurance policy. It not only helps in making an informed choice but also assists in foreseeing the financial commitment towards the policy. In India, multiple factors influence the premium amount, and understanding these will help ensure that you get the best possible coverage at the most affordable rate. Insurance is a significant financial decision, hence always research, compare and evaluate before you invest in a policy.

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