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. Classified Insurance

    Insurance coverage provided to a policyholder that is considered ...
  4. Personal Lines Insurance

    Property and casualty insurance products for individuals that ...
  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

    Explaining Insurance

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

    Beginner's Guide To Auto Insurance

    Find the perfect policy that suits both your coverage and budgetary needs.
  5. Insurance

    Do You Need Casualty Insurance?

    Find out how different types of coverages can protect you and which policy is right for you.
  6. 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.
  7. Insurance

    Life Insurance: Putting A Price On Peace Of Mind

    Would your death leave loved ones financially stranded? Find out how to ease your mind and keep them protected.
  8. Insurance

    The Average Cost of Homeowners Insurance

    What factors into the the premiums you pay for homeowners insurance? Much depends on where you live. But there are ways to lower your rates.
  9. Insurance

    7 Mistakes to Avoid When Buying Health Insurance

    Understand the need for health insurance and why some undervalue the need for coverage. Learn about the top seven mistakes to avoid when purchasing insurance.
  10. Insurance

    Insurance Coverage: A Business Necessity

    Don't go to work without this policy in place - especially if your work is in your home.
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. How is my insurance premium calculated?

    An insurance premium is the money charged by insurance companies for coverage. Insurance premiums for services differ from ... Read Answer >>
  5. 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 >>
  6. What is term insurance?

    Term insurance is a type of life insurance policy that provides coverage for a certain period of time, or a specified "term" ... Read Answer >>
Hot Definitions
  1. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  2. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  3. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  4. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  5. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
  6. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
Trading Center