What is Insurance Premium? Definition and What premium must Cover

What is Insurance Premium?

An insurance premium is a monetary payment that is allotted to the insurer by the insured in protecting or covering his risk.

In most contractual, business, or any physical work agreement, wages or salaries which is a fixed regular payment earned for work or services, typically paid on a daily or weekly basis normally play the same role as premium though won’t be classified as same with premium.

But the similarities that both shares in common are the fact that they are geared toward a settlement for the work done.

However, an insurance premium is a monetary consideration from the insured to the insurer for their agreement to pay the sum insured in the event of risk insured against the happening of the insured event.

Premium is a necessary element in the formulation of an insurance contract, this is because many people consider what insurance premium is all about before buying an insurance plan.

The majority of insurers have a table of related premiums charged by them for each class of risk underwritten.

In preparing these tables they are guided by experience or knowledge acquired so far in the field.

Therefore, the premium can be paid periodically, annually, monthly, or daily depending on the agreement between the insurer and the insured.

Who fixes the premium?

It is the duty of the insurer to fix the premium which is agreed to by the insured before the commencement of the contract.

When is the premium payable?

An insurance premium is due for payment at the beginning of the contract, but in some cases, policies are issued before payment.

In a legal consideration, the payment of premium is in line with the genuine agreement between the parties to insurance.

However, policies sometimes state that the insurer is not bound by terms of the contract until the premium has been paid, but in the event where this provision is not obtained, the insured may sue for a loss covered by the policy even though he has made no payment to the insurer.

Also, section 41 {1} of insurance Decree, 1997, states: ” Where an insurance business is transacted through an insurance broker, he shall, not later than 30 days of collecting the premium, pay to the insurer any premium collected by him,”

How is the premium payable?

Basically, a premium is payable in cash, in advance. the fact that payment is due at the beginning, rather than at the end of policy terms has an important bearing on the rate of premium since interest earnings can be taken into account in keeping the premium as low as possible.

The procedure for payments is usually annually, although agreements are sometimes made for payments in two or three installments.

However, in life assurance contracts payments are made half-yearly, quarterly, or monthly installments attract slight extra cost.

With industrial life assurance, the whole basis of premium payments is always different being collected from the insured home on a weekly or monthly basis.

What the premium must cover

Proper calculation of premium must be carried out as accurately as possible because it will enable the parties to insurance business to carry out their transaction in a more reliable way, as it has to cover the following:

a. Claims: Premium must be adequate enough to cover the cost of all claims since this is the very foundation and function of insurance. It is on the claim service of an insurer that his reputation mostly depends. that is to say without insurance claims, there would be no insurance.

b. Profit: Most commercial insurance is in the business for profit and cant be attributed to a philanthropic institution.

However, it is an unarguable fact that insurance is in the business of providing help to some persons in diverse casualties, but the insurer is in business for profit.

c. Reserve: This entails the specific amount of premium set aside for a defined purpose.

Besides the provision for unexpectedly large claims, all prudent businesses will set aside reserves. this also must come from premiums.

d. Administrative cost: In every organization, there’s always an avenue for incurring expenses such as staff salaries, cost building, printing cost, transportation requirements, and many other examples combine to produce a considerable expense ratio for the insurers. this ratio could be in the region of 20:30 percent, or even more, and this must be provided for in the premium received.

What do insurance companies do with insurance premiums:

The insurance company has to gather the premiums from many individuals, organizations and ensure they save enough of that money in liquid assets which will enable them in the payment of claims when the need arises.

The insurance company takes the premium sets them as a reserve, thereby investing them in some fixed asset, and letting it multiply or appreciate in value every year one doesn’t have a claim. When the amount of money realized from the premium invested is higher than the amount invested, a premium is said to be on profit.