How do excesses and premiums work?

If you have ever bought an insurance policy, you will have come across the words premium and excess. They appear on quotes, policy documents and renewal notices, and most people have a general idea of what they mean.

What is not always as clear is the relationship between the two. Changing your excess can affect the price you pay for your insurance, but choosing the cheapest premium does not necessarily mean you have found the right balance.

Understanding how both work can make it easier to compare policies and know what you would actually have to pay if you needed to make a claim.

What is an insurance premium?

A premium is the amount you pay for your insurance cover. Depending on the policy and provider, this might be paid annually or spread across monthly payments. The amount you pay is based on a range of factors, including the insurer's assessment of the risk involved in providing your cover. Exactly what they consider depends on the type of insurance.

With car insurance, factors can include your age, driving history, the car you drive and where it is kept. Life insurance premiums can be influenced by your age, health, lifestyle and the amount and type of cover you apply for. With home insurance, the property, its location and rebuild cost are among the factors an insurer may consider.

This is why two people looking for similar cover can receive very different quotes. The premium reflects more than the policy itself. It also reflects the circumstances of the person, property or vehicle being insured.

What is an insurance excess?

An excess is the amount you are responsible for paying towards a claim. If you make an eligible claim for £1,000 and the total excess is £250, for example, you would usually cover the first £250 and the insurer would pay the remaining £750, subject to the terms of the policy.

You may see two different types of excess when comparing insurance. A compulsory excess is set by the insurer, while a voluntary excess is an additional amount you choose to pay if you make a claim.

Increasing the voluntary excess can sometimes reduce the premium because you are agreeing to take on more of the cost yourself. However, it is important to look at the total excess you would actually have to pay, not just the voluntary figure.

This becomes particularly relevant with smaller claims. If the value of a claim is close to the total excess, the amount you receive from the insurer could be relatively small. Depending on the policy, making a claim may also have implications for a no-claims discount or future premiums.

How do excesses and premiums affect each other?

Generally, agreeing to a higher voluntary excess can result in a lower insurance premium. By accepting responsibility for a larger part of a potential claim, you reduce some of the financial risk being taken by the insurer.

The trade-off is fairly simple: you may pay less for the policy, but you could have to find more money if you need to claim. That does not mean that choosing the highest possible excess is automatically the cheapest option overall. The reduction in premium needs to be weighed against the additional amount you would have to pay following a claim. For example, imagine increasing your voluntary excess by £200 reduces your annual premium by £50. If everything else remained the same, it would take four claim-free years for those premium savings to equal the additional £200 you have agreed to contribute towards a claim.

Of course, nobody knows when they are going to need their insurance. A more practical consideration is whether you could comfortably afford the total excess at short notice. A lower annual premium may offer little benefit if the excess would be difficult to pay when you actually need the policy.

How are premiums calculated for protection insurance?

Protection insurance works differently from general insurance in several important ways. With policies such as life insurance, the premium structure is normally agreed when the cover is arranged. Some policies have guaranteed premiums, meaning the way the premium is determined is set at the outset, although the amount payable can still change in some types of cover, such as where benefits are designed to increase over time.

Other policies use reviewable premiums. These can be reviewed by the insurer at specified points and may increase over the life of the policy.

Age, health, lifestyle, occupation, the amount of cover and how long you want the protection to last can all influence the premium offered when you apply. This is one reason the cost of taking out new protection can change as you get older or your circumstances change.

Understanding whether premiums are guaranteed, reviewable or otherwise able to change is therefore an important part of comparing protection policies. A lower starting premium does not tell you everything about what a policy could cost over the longer term.

What can affect your insurance premium over time?

General insurance premiums are usually recalculated when a policy comes up for renewal, and there are several reasons why the price you are offered may be different from the previous year.

Your claims history can play a part, particularly where a claim affects a no-claims discount. However, insurers also take wider factors into account when setting their prices. Rising repair and replacement costs, inflation and changes in claims across the market can all influence the cost of providing cover, which means premiums can increase even if you personally have not made a claim.

Changes in your own circumstances can make a difference as well. A different car, improvements to your home or a change in how a property is used could alter the risk being insured and, as a result, the price you are quoted.

This is why an increase at renewal does not necessarily mean something specific has changed with your policy. The price can reflect a combination of your circumstances, your claims history and what is happening across the wider insurance market.

Frequently asked questions

Should I always choose the highest excess to reduce my premium?

Not necessarily. A higher voluntary excess may reduce the premium, but it also increases the amount you could have to contribute if you make a claim.

The more useful question is whether you could comfortably afford the total excess if something happened tomorrow. If paying it would cause financial difficulty, the saving on the premium may not be worthwhile.

Why has my premium increased even though I have not made a claim?

Insurance prices are influenced by more than an individual's claims history. Changes in repair and replacement costs, inflation, claims across the wider market and an insurer's pricing or risk assessment can all affect renewal premiums.

Changes to your own circumstances can also make a difference. If your renewal price has increased, comparing the cover and cost available elsewhere can help you understand your options.

What is a no-claims discount and how does it work?

A no-claims discount, sometimes called a no-claims bonus, is a discount offered by some insurers based on the number of years you have gone without making certain claims.

How the discount works varies between insurers. Making a claim may reduce the number of no-claims years recognised, although some policies offer the option to protect a no-claims discount, usually at an additional cost and subject to conditions.

Does paying monthly rather than annually affect the total cost?

It can. When insurance premiums are paid monthly, the arrangement may effectively involve credit, with interest or other charges added to the cost.

As a result, the total amount paid over 12 months can be higher than paying the annual premium in one payment. When comparing the two options, look at the total amount payable rather than the monthly figure alone.

Can I negotiate my insurance premium?

With some types of general insurance, you may be able to discuss the renewal price with your insurer. It can also be useful to compare quotes from other providers so you have a clearer idea of what similar cover costs elsewhere.

Protection insurance works differently. Premiums are generally based on underwriting and the terms offered by the insurer, rather than being a price that can simply be negotiated at renewal.

What should you consider when comparing premiums and excesses?

When comparing insurance, it can be tempting to focus on the premium first. However, the cheapest policy may come with a higher excess, different exclusions or a level of cover that does not meet your needs.

The excess is particularly important because it determines how much you may need to contribute if you make a claim. Choosing a higher voluntary excess could reduce the price of your insurance, but that saving needs to make sense alongside the amount you would have to find at short notice if something went wrong.

Looking at the premium and excess together gives you a much clearer idea of what a policy could actually cost you. From there, you can consider the level of cover, exclusions and other policy terms before deciding which option is appropriate for your circumstances.

Ultimately, insurance is there to provide financial protection when you need it. The aim is not necessarily to find the lowest premium or excess, but a balance that gives you suitable cover at a cost you can manage.