There’s more than one definition for a premium when it comes to the financial industry. Primarily, it is the total cost that is paid to purchase an option. This is a transaction form where two parties agree to a premium price before its release.
Premium also refers to the price for fixed-cost security, such as a stock or a bond. Here, it represents the amount paid at purchase and its face value when it’s issued.
There are other terms related to premiums in the financial world.
In the insurance industry, an unearned premium is an amount that remains on a policy. Its value hasn’t been earned by the time the policy ends or when it’s canceled by the insured. This is normally something that occurs in pre-paid policies.
A consumer might purchase a 10-year policy in which they annually pay $2,000. At the end of the first full year, the policy would have $18,000 of unearned premiums left. In some cases, the insured might be entitled to a refund if they cancel before the policy’s end. In other circumstances, they can receive the unearned premiums if a covered item is deemed a complete loss.
This type of premium is also applied to insurance policies. Here, the insurer can make the premium lower or higher depending on what was agreed with the insured. The adjustment takes place when the insurer decides to assess the policy’s total cost.
They do this by calculation from the creation of the contract to the payout of a claim. Next, they divide the total by the number of years it’s expected to be used. The result is how much the insured will be charged to maintain the policy.
Adjusted premiums are normally used for insurance policies in the health and auto industries. For the latter, premiums are increased or decreased depending on market issues and how safe the driver has been. Should the driver cause an accident or need to use the insurance to pay for damages, the premium is usually adjusted higher.
Health insurance can also go up and down due to its use. However, in most cases premiums are adjusted due to the market. They calculate increases and decreases in services and technology. Next, they add that number into the potential payouts the insured might receive. The final cost is factored into an increase or decrease in premiums.
Other premium definitions include:
- Risk Premium: The minimum return expected on a risky asset that urges the holder to maintain its ownership.
- Earned Premium: A value earned at the time an insurance policy is in effect. Insurers are permitted to record earned premiums as revenue once the coverage expires.
- Vanishing Premium: Permits the holder of a whole life insurance policy to utilize earned dividends to pay premiums. This causes the policy’s cash value to grow to the point where both the dividend and premium are equal.