Insurance Guide

Understanding Your Insurance Premium and How it is Calculated

Insurance is a valuable product. Insurance provides peace of mind knowing you are protected against insurable losses that can impact your property. It may seem like an unnecessary cost, but when you experience a loss and you're insured for it, it can be a life saver.

That is why insurance is a way of offsetting potentially crippling financial impacts. There is a cost to insurance, which is commonly called a premium. This is the money you pay in order to be insured and is based on factors such as the cost for the insurer to administer your insurance, reinsurance, commission, and quality of the insurance product you purchase.

That is why getting to know how insurance premiums work is important in making the right choices based on individual needs. The following points will help you to learn how insurance premiums work and how you can save money, while ensuring your insurance provides the necessary cover.

What are insurance premiums?

Insurance premiums are the regular payments made by you to an insurance company in exchange for coverage against certain risks. The amount of the premium is determined by various factors, such as the level of coverage, the type of insurance policy, and the likelihood of the insured event occurring.

For example, in car insurance, the premium amount may be determined based on the driver’s age, driving history, the make and model of the car, and the area in which the driver lives. In home insurance factors such as location, the likelihood of natural hazards, and home rebuild costs can influence premiums.

Insurance premiums are typically paid fortnightly, monthly or annually, depending on the policy terms. Failure to pay premiums will result in the cancellation of the policy and the loss of coverage.

How are insurance premiums calculated?

Insurance premiums are calculated based on various factors specific to the type of insurance policy, the individual policyholder and what is being insured. The questions that an insurer may ask when a customer is taking out a new insurance policy can help them to understand various risk factors associated with the insurance. Let’s look at how insurers calculate premiums for insurance policies.

How are home insurance premiums calculated?

Home insurance premiums are calculated based on various factors that assess the risk of insuring a particular property. Some of the main factors that insurance companies consider when calculating home insurance premiums in New Zealand include the following:

The location of the property - Insurance companies consider the property’s location to assess the risk of things like floods and natural hazards such as an earthquake, natural landslide, tsunami, volcanic activity or hydrothermal activity. Properties in high-risk areas may have higher premiums.
The age of the property - Properties built in a certain era may be more prone to damage and may have higher premiums. However, just because your house is older does not always equal higher insurance premiums. There are a number of factors in the building quality over the years that can affect the level of premium you pay.
The rebuild value of the property - The rebuild value of the property is a key factor in determining the premium. Properties with a higher rebuild cost will have higher premiums.
The level of coverage required - The type and amount of coverage required will also impact the premium. There are different levels of cover in the market depending on who you insure with and the insurance policy you take out.
The excess amount - In the event of a claim, the excess is the amount the homeowner must pay out of pocket before the insurance coverage kicks in. If you voluntarily opt for a higher excess, this will result in a lower premium.

How are car insurance premiums calculated?

Car insurance premiums are calculated based on a range of factors. The main factors that insurance companies consider when calculating premiums include the following:

The driver’s experience - For example, less experienced drivers are generally considered at a higher risk of being involved in an accident. They may therefore have to pay higher premiums.
The type of car - The car's make, model, and age can also impact the insurance premium. Cars with higher specifications can be more expensive to repair or replace and may have higher premiums. Similarly, cars with high safety features may attract lower premiums.
The intended use of the car - Insurance companies will also consider how the car will be used. For example, if the car is used for business purposes, the premium may be higher as the car is likely to be driven more often and in more varied conditions.
The level of coverage required - The type and amount of coverage required will also impact the premium. Comprehensive coverage that includes fire, theft, and accidental damage to the car will generally have a higher premium than basic coverage that only covers third-party liability.
Agreed value - agreed-value car insurance is a type of car insurance that covers your vehicle for a fixed, agreed-upon amount in the event of a total loss. This is normally optional and costs more to have.
Location - Where the car is kept overnight can influence premiums as some locations represent a higher risk than others.

Key factors that influence your insurance premium

The following factors greatly impact insurance premiums:

Sum insured - Your sum insured is the overall amount your home is covered for. It is important that your sum insured reflects the cost of rebuilding your home, including costs like demolition, debris removal costs, inflationary pressures, and fees. Setting an accurate sum insured is essential and it should be reviewed each year to check that it’s still accurate. Don’t forget to factor in any renovations, extensions, or other changes to your home as well as increased building costs.

Reinsurance claims - Insurance companies often purchase reinsurance, insurance for insurers, to help manage their risk. However, if there are many reinsurance claims due to natural hazards or other events, this can increase the cost of reinsurance for insurers. These costs will be passed on to you as part of your insurance premiums, resulting in higher insurance costs.

Natural Hazards Insurance Levy (NHI Levy) - The Toka Tū Ake Natural Hazards Commission (NHC) is a government agency that provides natural hazards insurance to New Zealanders up to a specific amount (insurance companies then top up to your sum insured). They provide some cover for:

a) natural hazards including; earthquake, natural landslide, volcanic activity, hydrothermal activity, or tsunami; or
b) fire caused by a natural hazard; or
c) in the case only of residential land, caused by a storm or flood.

The NHI levy, collected through insurance premiums, funds the NHI’s operations and claim payments.

FENZ Levy - Fire and Emergency New Zealand (FENZ) is a government agency that provides fire and emergency services to New Zealanders. FENZ is funded through a levy that is collected through insurance premiums.

Risk-Based Pricing - The goal of risk-based pricing is to help insurance companies accurately assess the likelihood of claims and set premiums that are appropriate for each individual customer. This means if the building or car are considered a higher risk, then you will pay a higher premium for your insurance.

Tax - The Goods and Services Tax (GST) is a value-added tax of 15% that is applied to many goods and services in New Zealand, including insurance premiums.

How can natural hazards influence insurance premiums?

Natural hazards can increase insurance premiums due to the higher likelihood of claims and increased costs for insurers. However, the extent to which premiums are affected will depend on various factors, including the likelihood and potential significance of damage caused during a natural hazard event.

The 2023 January floods in Auckland and Cyclone Gabrielle in February clearly show how insurance plays a key role in protecting families and businesses during natural hazards. There have been tens of thousands of claims lodged and both insurers and reinsurers will be paying towards the costs of repairs to the many impacted homes, businesses, farms and vehicles.

While insurance helps families and businesses recover, how do these events affect insurance premiums? There are three main ways in which natural hazards can affect insurance premiums.

Increase in claims - Natural hazards such as earthquakes or tsunamis can result in many insurance claims for property damage and loss of possessions. Increased claims can result in increased insurance costs, which may lead to higher premiums in the future, especially if the frequency of these events continues.
Increase in reinsurance costs - Insurers purchase reinsurance, essentially insurance for insurers, to protect themselves against large-scale losses. After a natural hazard, reinsurance costs may increase dues to the same factors as insurers.
Changes in risk assessment - Insurers may re-evaluate their risk assessment of certain areas. For example, if an area experiences repeated flooding insurers may increase their premiums for policies to reflect the increased risk.

The2023 flooding and cyclone demonstrates the importance of having effective financial reserves and reinsurance protection that can cover these widespread natural hazard claims.

What do insurers do with premiums?

When insurers collect premiums, they use the money to cover the cost of claims, pay administrative and distribution expenses, and pay for reinsurance. Insurers often use premiums they collect in the following ways:

When a policyholder makes a claim, the insurer uses the premiums it has collected to pay for the costs of the claim. Claims can include paying for repairing, replacing damaged property or compensating third parties for damages or injuries.
Insurers incur a range of administrative expenses, including the cost of underwriting policies and processing claims. They use premiums to cover these expenses and to ensure they can continue to operate as a business.
Insurers also need to maintain a financial solvency margin. This is a Government requirement and provides assurance that the insurers have the necessary financial reserves and structures to pay claims, even when there is a large-scale event such as the Canterbury Earthquakes, Auckland Floods or Cyclone Gabrielle.

How can you reduce insurance premiums?

You should review your insurance policies periodically and adjust as necessary to ensure you get the best coverage at the best price. The following strategies can help reduce insurance premiums:

Optional add-ons - check optional add-ons on your policy before it renews to make sure the optional add-ons are still relevant to your current situation.
Increase home security - Installing smoke detectors, burglar alarms, and deadbolt locks may qualify for discounts on home insurance premiums.
Risk assessment - Understanding risk plays a key role in keeping home insurance premiums down. For example, avoiding buying houses in high-risk areas for natural hazards can help homeowners save on their premiums.
Insuring cars for the right amount - When insuring vehicles, it is important to know its current value. Adjusting a vehicle’s value as it depreciates can help keep car insurance premiums in check.
Opting for an annual premium payment - Paying your premium annually can be less expensive.
Looking at higher excess options - A higher excess may work for you and reduce your premium spend. Make sure you are able to afford to pay the excess if a claim occurs.

Have questions about your insurance premium?

If you've got questions about insurance premiums, we can answer them. Contact us today at 0800 267 263 for a quote or get a home, contents, or car insurance quote online.