What's an Insurance Premium?
Your insurance premium is the amount of money you pay for a car, home, life, or health insurance policy. Depending on your home insurance company, you may pay the premium every month, per quarter, or annually. If you invest in homeowners insurance, you can expect an insurance premium.
What is a Homeowners Insurance Premium?
When you purchase a homeowners insurance policy, the premium is your purchase price for the policy. You typically pay for it through monthly payments, just like a monthly subscription fee for your telephone. In return, your insurance company pays to fix or replace damages to your home and personal property, and they pay for lawsuits and medical care should anyone get injured on your property.
Mortgage lenders typically require homeowners insurance to protect their financial interests.
Insurers charge premiums to cover the claims you make, which they expect when insuring you. While insurance companies make multiple investments in other assets, state insurance commissioners require that companies maintain liquidity in some of those assets. Insurance premiums paid in by customers assure compliance with the liquidity requirement.
How Do Insurance Premiums Work?
You pay the premium to guarantee coverage. Failure to make payments as agreed to in your policy results in cancellation and losing coverage for theft, home damage, personal liability, etc.
When you apply for a policy, an insurance agent determines your risk and matches you with an appropriate policy, your contract. At that time, they give you a quote for your personalized premium, which depends on their risk of insuring you. First-time homebuyers, customers with previous claim history, poor credit score or a low insurance score, or down payments of less than five percent at purchase are examples of risks that lead to higher premiums.
Factors That Affect Home Insurance Rates
The primary factors affecting home insurance rates include the amount and type of coverage you buy and your insurance score. Your insurance score determines how often the insurer thinks you will file a claim.
Cost of Coverage
Insurance costs depend on the type and amount of coverage you buy. There are eight coverage types for owner-occupied homeowners, each having unique pricing. You can choose from HO1, HO2, HO3, HO4, HO5, HO6, HO7, and HO8. Eighty percent of homeowners in the US have an HO3 policy.
Once you choose the type of insurance coverage you want, you must select your desired coverage amount. For example, you may purchase $300,000 for your dwelling, $100,000 for personal property, and $100,000 for personal liability. Your premium amount fluctuates as you increase or decrease your coverage amounts.
The deductible amount you pick also impacts your premium amount. We explained deductibles and how to choose deductible amounts below.
Insurance Score (Your Risk Level)
The underwriting step determines your home insurance rate based on your insurance score. Underwriters review your risks and set premium amounts based on them. If you present several risks, you will pay more for homeowners insurance than those considered low risk.
Some of the risk factors affecting your insurance score and ultimately your premium payment include:
- Replacement cost. The RCV factor is the cost to replace your home. A 1,000-square foot ranch will cost less to replace than a 4,500 square-foot high-end suburban dwelling, so the smaller home's premium will cost less than the larger one. Replacement cost also includes personal belongings.
- Depending on your insurance company, coverage limits on personal property replacement ranges from 50 to 75 percent of your dwelling coverage.
- For example, if your 1,000-square foot house structure has coverage of $200,000, your personal property coverage is $100,000 to $150,000. If you own antiques or expensive jewelry, you require additional riders to protect those unique items, and those add-on riders increase your premium.
- Age and construction of a home. Older homes are more costly to insure because there is more to repair and a greater chance of catastrophic issues. Newer homes have a reduced chance of falling apart but are often made of modern materials that resist fire and other named perils.
- Material costs fall into this, too; for example, brick houses cost more to insure than frame homes. Even if you have an older home, you can replace roofs with fire-retardant asphalt shingles and lower your premium.
- Household size. A household of seven attracts a larger premium than a household of one. More people mean a need for higher liability coverage.
- Fire protection services. Homes near a fire station or several working fire hydrants yield lower premiums. This factor is a new development that allows insurance underwriters to assess fire risk. If you buy a home in a vibrant suburb with access to emergency services, including fire, police, and ambulance, you face a lower premium than if you live in the middle of nowhere with few services.
- Animals. Home and renters insurance policies started placing dog breed restrictions. While they may still insure your home if you own an aggressive breed, you will pay a higher premium, especially if the dog has a bite history. Sakes, horses, and other exotic animals raise policy premiums, or they might require farm or ranch coverage or other riders.
- Credit score. Low credit scores do not always render you uninsurable, but they raise your premium. Research reveals that people with low credit scores file more claims, so the insurance company considers this when setting your rates.
- Claims history. The Comprehensive Loss Underwriting Exchange report reveals your past insurance claims and those filed on your property by previous owners. Companies review seven years of history to see if you or your property attract risk.
- Security and crime. Homes in high-crime areas cost more to insure than those in safer areas. However, home security systems and deadbolt locks reduce property crime likelihood, and installing them can lower your premium or introduce new discounts.
- Attractive nuisances. If you keep a pool, hot tub, fish pond, trampoline, playground equipment, or anything else that may appeal to trespassers, you maintain an attractive nuisance. Considered hidden hazards, homes with these features cost more to insure. You might be able to lower your home insurance premium if you install secure fencing, locks, and other things.
- Personal information. Things like your age, where you live, the value of your home, your family member's credit scores, and the number of people in your household matter.
An underwriter takes these factors together. For example, you may have an excellent credit score and no claim history. These circumstances work in your favor.
However, if you breed guard dogs and build a playground structure, these factors are high-risk and will raise your premium. But the lack of claim history may balance this out. It usually depends on the insurance company and your insurance deductible choice.
The algorithms used to determine your insurance score are proprietary to each insurance company, so it is worth shopping for the best coverage that offers the lowest premium.
Deductible vs. Premium
Premiums are payments you make to keep your insurance policy. Deductibles are the amounts you pay when you file a claim. It is the money you pay before your insurance company pays their share of the claim.
Deductibles are popular with health insurance policies, but they also arise with homeowners insurance.
Insurance policies include deductibles to assign some risk to you, so you do not intentionally damage your home or leave the property vulnerable. An example of this behavior includes leaving your door unlocked because insurance will cover lost personal property anyway. Insurers call this a moral hazard. By adding a deductible, you must pay for part of the loss.
For example, you have $100,000 of personal property coverage with a $1,500 deductible. One day, a random thief takes your lawnmower. It has a replacement cost of $950. Since the lawnmower's replacement cost is below $1,500, you pay the entire $950 out-of-pocket.
However, if the thief breaks into your garage and takes the lawnmower, snowblower, three boxes of tools, and a box fan, that loss exceeded the $1,500 deductible. Your insurance agent determines the replacement cost of these items, subtracts the $1,500 for the deductible, and gives you the rest to replace your property.
Like premiums, deductibles are a payment but only arise when you file a claim.
Policies with a higher deductible charge a lower premium since you are less likely to have an effective claim unless you face a disaster. However, if you choose a lower deductible, you have more coverage for a loss but pay more per month for your premium. Your decision depends on your risk aversion and the service level you demand from your insurance company.
What Deductible Amount Should I Choose?
The industry rule of thumb is to choose a deductible that you can afford to pay if you ever file a claim. Affording your deductible allows you the ability to fix or replace whatever gets damaged vs. not filing a claim because you cannot pay the deductible and getting stuck with the damaged or destroyed property. If you do not file claims, you get no value from the product you bought your insurance policy.
On the other hand, if a policyholder only wants home insurance for a catastrophic event, like your house burning down, a low premium and high deductible strategy will accomplish that. This strategy is like buying catastrophic health insurance when saving money is essential. You plan to pay out of pocket for medication and yearly exams, but your health insurance kicks in if you are in a car accident.
When Do You Pay the Insurance Premium?
Paying the premium depends on your agreement with the insurance company and lender. You may need to pay the premium every year, or your mortgage payment may include it. Some customers choose monthly or quarterly payment plans, as well.
If you bundle homeowners and car insurance with your company, it will likely put your homeowners premium on the same schedule. When you choose a policy, ask about their payment terms and make sure you can work them into your budget.
Homeowners insurance is a competitive market. Take advantage of that situation by shopping around and finding the best policy for your needs. We are ready to help you search 40+ insurers to find the ideal policy.
Hope that helps!
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