Loading the player...

What is a 'Premium'

Premium has multiple meanings in finance: (1) it's the total cost to buy an option, which gives the holder the right but not the obligation to buy or sell the underlying financial instrument at a specified strike price; (2) it's the difference between the higher price paid for a fixed-income security and the security's face amount at issue, which reflects changes in interest rates or risk profile since the issuance date; and (3) the specified amount of payment required periodically by an insurer to provide coverage under a given insurance plan for a defined period of time. The premium compensates the insurer for bearing the risk of a payout should an event occur that triggers coverage. The most common types of coverage are auto, health, and homeowners insurance.

BREAKING DOWN 'Premium'

The three usages of the term premium all involve payment for something that is perceived to have value.

Option Premium

The buyer of an option has the right but not the obligation to buy (with a call) or sell (with a put) the underlying instrument at a given strike price for a given period of time. The premium that is paid is its intrinsic value plus its time value; an option with a longer maturity always costs more than the same structure with a shorter maturity. The volatility of the market and how close the strike price is to the then-current market price also affect the premium.

Sophisticated investors sometimes sell one option (also known as writing an option) and use the premium received to cover the cost of buying the underlying instrument or another option. Buying multiple options can either increase or reduce the risk profile of the position, depending on how it is structured.

Bond Price Premium

The concept of a bond price premium is directly related to the principle that the price of a bond is inversely related to interest rates; if a fixed-income security is purchased at a premium, this means that then-current interest rates are lower than the coupon rate of the bond. The investor thus pays a premium for an investment that will return an amount greater than existing interest rates.

Insurance Premium

Premiums are paid for many types of insurance, including health insurance, homeowners and rental insurance. A common example of an insurance premium comes from auto insurance. A vehicle owner can insure the value of his or her vehicle against loss resulting from accident, theft, fire and other potential problems. The owner usually pays a fixed premium amount in exchange for the insurance company's guarantee to cover any economic losses incurred under the scope of the agreement.

Premiums are based on both the risk associated with the insured and the amount of coverage desired.

RELATED TERMS
  1. Insurance Premium

    The amount of money that an individual or business must pay for ...
  2. Premium Income

    1. In investing, income that is earned through the sale of an ...
  3. Personal Lines Insurance

    Property and casualty insurance products for individuals that ...
  4. Classified Insurance

    Insurance coverage provided to a policyholder that is considered ...
  5. Earned Premium

    The amount of total premiums collected by an insurance company ...
  6. Insurance Coverage

    The amount of risk or liability covered for an individual or ...
Related Articles
  1. Insurance

    Explaining Premiums

    Premium has a few different meanings in the financial world.
  2. Financial Advisor

    Understanding Life Insurance Premiums

    When buying permanent life insurance, what amount of premium should you pay for the coverage?
  3. Insurance

    Homeowner's Insurance Guide: A Beginner's Overview

    Everything new homeowners need to know about insurance to protect their residence.
  4. Insurance

    Insurance: A Common Personal Finance Pitfall

    Making decisions about insurance can be challenging. But declining coverage altogether comes with it's own risks, and costs.
  5. Insurance

    Term Life Insurance: Everything You Need to Know

    Term life insurance is an affordable way to financially protect your loved ones after your death. Here's what you need to know before purchasing a policy.
  6. Insurance

    Explaining Insurance

    Insurance is a form of contract between an individual and an insurance company that spreads risk in exchange for premium payments.
  7. Insurance

    Do You Need Casualty Insurance?

    Find out how different types of coverages can protect you and which policy is right for you.
  8. Investing

    Methods of Handling Risk: A Quick Guide

    Discover the five methods to manage pure risk, and learn how they can be implemented to mitigate risk with health and life insurance.
  9. Insurance

    How to Find the Right Car Insurance

    Finding the right car insurance can be difficult. However with these strategies, you can get the most for your money, protect your assets and your health.
  10. Insurance

    Understanding Taxes on Life Insurance Premiums

    Learn about the tax implications of life insurance premiums, including when they might be taxable and whether they are tax deductible.
RELATED FAQS
  1. Why is my insurance premium so high/low?

    Insurance premiums can be affected by many factors including: type and amount of risk size of deductible amount of coverage ... Read Answer >>
  2. What caused the European / Eurozone debt crisis?

    Understand how insurance companies price insurance premiums, and learn the importance of data and statistics in the insurance ... Read Answer >>
  3. What are some examples of industries that practice price discrimination?

    Understand the various types of insurance coverage offered in the insurance marketplace, and learn why each policy should ... Read Answer >>
  4. What is the average return on total revenue for the insurance sector?

    Learn about the three main segments of the insurance industry, and find out what the average return on revenues is for the ... Read Answer >>
  5. What is the main business model for insurance companies?

    Read about the most important components of an insurance company business model, such as risk pricing, float investing and ... Read Answer >>
Hot Definitions
  1. Smart Home

    A convenient home setup where appliances and devices can be automatically controlled remotely from anywhere in the world ...
  2. Efficient Frontier

    A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a ...
  3. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  4. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the ...
  5. Border Adjustment Tax

    A tax levied on goods based on where they are sold – exported goods are exempt from tax; those imported and sold in the ...
  6. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
Trading Center