How insurance premiums are worked out, including Insurance Premium Tax

Two people can ask the same insurer for the same kind of cover and be quoted very different prices. That is not a mistake: insurers consider a variety of factors when calculating the premium, and the answer varies with the insurer, the individual circumstances of the policyholder and the particular risks the insurer is being asked to cover¹. The price is, at its heart, the insurer's estimate of how likely you are to claim and how much that claim would cost, plus its costs and a margin.

On top of that price comes a government tax. Insurance Premium Tax, usually shortened to IPT, is charged on most general insurance, including motor and household cover, at a standard rate of 12%, with a higher rate of 20% for travel insurance². There is no IPT at all on life insurance or income protection insurance². The tax is usually already included in the price you are quoted, so most people never see it itemised.

How an insurance premium is built up

A premium starts with risk data. Insurers use risk data to calculate the likelihood of the event you are insuring against happening, and the more likely the event, the higher the cost of the premium⁶. An insurer pricing car cover is asking: how often do cars like this, in places like this, driven by people like this, end up in claims, and what do those claims cost? An insurer pricing health cover asks the same questions in medical terms: how likely is it in general terms that someone will need to make a claim, and whether the person taking out the policy is a bigger or smaller risk than the average policyholder, informed by their medical history⁶.

Your own details are then laid over that data. A premium may be increased if the insurer thinks you are more likely to make a claim, which is known as premium loading⁷. Insurers can also charge more or apply special conditions if they believe you are at higher risk of claiming⁸. The outcome of this stage, called underwriting, is not always a price: the insurer may offer the policy at the premium originally quoted, in some cases with an increased premium, may make exclusions to the policy, or may not offer insurance at all⁷.

Finally, the way you pay shapes what you actually hand over. You will pay your premium as a one-off payment, or in monthly or annual instalments, depending on the type of insurance and the term of the policy⁷. Paying monthly often costs more overall, and for some groups markedly more, as covered below. If you change the policy partway through, an additional premium, defined as a further premium payable as a result of a policy amendment that may have increased the risk, can be charged⁹.

The whole structure sits on a legal footing: the tax itself was introduced by Part III of the Finance Act 1994, which created "a tax, to be known as insurance premium tax"⁵.

Risk factors insurers price on

For motor insurance, the factors are wide-ranging. They include the type of vehicle you drive, the area you live in, your occupation, where the car is parked, whether the car is used for work, garage parking, drivers under 25 on the policy, age and driving experience, disabilities, motoring convictions and your accident record³. The more powerful the engine and the more expensive the car is to repair, the more it tends to cost to insure³.

Home insurance is priced on a different set of facts. Insurers use postcodes to determine the risk of an area in terms of crime and flooding, for example, and also look at the age of the home, the type of home (timber framed, thatched or flat roof, listed or in a conservation area) and what the policy covers¹⁰. This is why the same house can cost different amounts to insure on different streets: the postcode carries the area's claims record with it.

Life insurance is priced on three factors: age, health and lifestyle¹¹. Health insurance adds your claims history: claiming may push premiums up at renewal and you may lose any no-claims discount¹². Travel insurers price medical conditions and age, and the details matter. In one mystery shopping exercise, average travel insurance premiums rose 15% after customers declared weight-loss injections¹³.

Where you live can affect the price even when the risk is the same. Research by Fair By Design found that the same driver, in the same car, could still pay at least 15-20% more (£131-156) to get insured in a more deprived area, after removing risk factors such as crime levels, traffic collisions and age¹⁴. The site's page on the poverty premium and low-income pricing covers this in more detail.

Some factors are protected by agreement. Under the ABI Agreement on Age and Insurance, insurers cannot use age alone as the reason for refusing cover, though they can still price it. Disability-related pricing is also constrained: insurers can charge more or apply special conditions if they believe you are at higher risk of claiming, but disability charities advise on what is reasonable⁸. If you are travelling with family or friends, group policies are based on the person the insurer believes is the highest risk⁸.

Telematics, or black box, insurance takes a different route: these policies take into account how the vehicle is used when setting the premium, and premiums may be adjusted at set points during the policy to reflect recently observed driving behaviour, stay the same throughout, or adjust only at renewal, depending on the insurer¹⁵. The rules on these policies are covered in black box policies: curfews, scores and cancellation.

How age and mileage show up in car insurance prices

Age is one of the clearest influences on car insurance prices, and the pattern is not a simple line going up. Insurers generally apply a basic rate to drivers aged 30-49; if you are younger than this, your premium is likely to be higher due to the higher risk posed³. Average premiums in the first quarter of 2025 bore this out: drivers aged 25-34 paid an average of £532 a year, falling to £462 for those aged 35-44, £400 for 45-54 and £338 for 55-64¹⁶.

The averages then rise again in later life. Drivers aged 75-84 paid an average of £417 a year, still almost 10% less than the £462 spent by those aged 35-44, but from 85 and over the average rockets by 78% to £700¹⁶. Independent Age notes the same pattern in guidance: premiums usually start to increase once you are 70 and go up significantly after the age of 80¹⁷.

Mileage matters too. Those driving up to 6,000 miles a year paid an average of £444 for their premiums, compared with £488 paid by those driving up to 10,000 miles¹⁶. The more miles driven, the more time on the road and the greater the chance of a claim, so insurers ask for an annual mileage figure and price it in. Giving a figure that is too low to get a cheaper price is a form of misrepresentation, covered in giving wrong information to an insurer.

How you pay can matter as much as how you drive. Paying monthly for car insurance, rather than in one go, can cost people on low incomes as much as 40% extra, or £384¹⁴. The reasons, and the alternatives, are set out in paying monthly for insurance.

Car insurance groups: 1 to 50

Every car on sale in the UK is placed into an insurance group. There are 50 groups: cars in group 1 have the lowest price rating and cars in group 50 have the highest³. The group reflects what the car is likely to cost an insurer to repair or replace, how powerful it is, and how often that model appears in claims data.

The group is a building block in the premium, not the whole price. A group 10 car insured by a 55-year-old with a clean licence in a low-claims postcode can cost less than a group 5 car insured by a new driver in a city centre, because all the personal and local factors described above are laid on top of the group. That is why two neighbours with the same car can still pay different amounts.

The full guide, car groups 1 to 50: how they affect your premium, explains what puts a car in a particular group and how to find your own car's group. If you are choosing a car and insurance cost matters, the group is one of the few pricing factors you can control directly.

Insurance Premium Tax: 12% standard rate, 20% on travel

Insurance Premium Tax is charged on insurance premiums and covers most general insurance, for example motor and household⁴. The standard rate is 12%, and it is the rate charged on ordinary motor insurance². There is a higher rate of 20% for travel insurance².

The higher rate is not a judgement about travel cover itself: it is set by legislation. A premium received under a taxable insurance contract is liable to tax at the higher rate if it falls within one or more of the paragraphs of Part II of Schedule 6A to the Finance Act 1994⁵. Travel insurance is the example most consumers meet, but the legislation also catches certain other contracts and related fees, described below.

One recent change applies to the Motability Scheme. From 1 July 2026, Insurance Premium Tax is applied at the standard rate of 12% to insurance contracts relating to vehicles on the scheme, for new leases from that date¹⁸. If you lease through the scheme, the change is a tax change, not an insurer repricing, and it applies to new leases from 1 July 2026.

Which policies carry IPT and which do not

The dividing line is between general insurance and long-term protection. There is no IPT on life insurance and income protection insurance². Most general insurance, including motor, household, pet and travel cover, does carry the tax².

The exemption for income protection is worth understanding, because the product itself is often confused with general insurance. Income protection typically pays out a regular income rather than a lump sum, usually covering around 50% to 70% of your salary¹⁹. Because it is exempt, the quoted premium has no tax added, unlike a car or home quote.

Life insurance premiums are also protected in a way general insurance premiums are not. Once a life policy is in place, the premiums cannot be increased after a cancer diagnosis²⁰. With a guaranteed premium on term life insurance, the price you pay each month is set in stone for the entire term of the policy²¹. These protections matter because they mean the price you are quoted for life cover is the price you keep, in a way that a car or home premium, repriced at every renewal, is not.

How IPT is added to the price you pay

IPT is usually included in the price you pay for insurance². You do not pay it separately, and most quotes do not show it as a line of its own. The legislation sets out how the amount is worked out: the chargeable amount is such amount as, with the addition of the tax chargeable, is equal to the amount of the premium⁵. In other words, the tax is baked into the quoted figure.

The tax is payable by the insurer, not by you directly: tax shall be payable by the person who is the insurer in relation to the contract under which the premium is received⁵. Insurers are liable to be registered if they receive premiums as insurer in the course of a taxable business and are not registered⁵. None of this changes what you do: you pay the quoted price, and the insurer accounts for the tax.

Some documents do show the tax. Gap insurance sold at a car dealership is one example: a breakdown of one such premium showed Insurance Premium Tax making up 16.67% of the price, alongside the insurer's share of 22.50%²³. That breakdown is unusual, and it is one reason gap insurance sold at the point of buying a car can be poor value compared with buying it separately, a point covered in GAP cover: what it pays if your car is written off.

Fees around insurance can carry the tax too. A payment in respect of a fee charged by a taxable intermediary in connection with a higher rate contract is treated as a premium received under a taxable insurance contract, chargeable at the higher rate⁵. So an admin fee charged alongside a travel insurance policy can itself attract the 20% rate.

How the IPT rate has risen since it began

IPT is a young tax with a steep history. It came into effect on 1 October 1994, charged at 2.5% on a gross basis⁴. Since 1 April 1997 there have been two rates: a standard rate, initially set at 4%, and a higher rate⁴. The then Chancellor Gordon Brown increased the standard rate to 5% in the 1999 Budget, with effect from 1 July 1999⁴.

The rate then rose to 6% from 4 January 2011⁴. In 2015 the Chancellor announced that the main rate would be increased to 9.5%, effective from November 2015, estimated to raise £530m in 2015/16, rising to £1.46bn in 2016/17⁴. A further 0.5 percentage point increase took the rate to 10% from 1 October 2016, forecast to raise £80m in 2015/16, rising to around £200m a year in subsequent years⁴. The increase to 12% was forecast to raise £520m in 2017/18, rising to £840m in 2018/19⁴. By 2017/18 the tax as a whole was forecast to raise £5.9 billion⁴.

The direction of travel has been one way. A tax that began at 2.5% now stands at 12% on most general insurance, and every rise has been passed into the premiums people pay.

Why a higher premium means more tax

Because IPT is a percentage of the premium, a more expensive policy carries more tax in pounds and pence. On a £400 car insurance premium, the standard 12% rate means the tax element is £48; on a £700 premium it is £84. The tax does not just rise with the insurer's prices, it rises with every factor that pushes your price up: your postcode, your claims history, your car's group.

This also means that anything which reduces your premium reduces the tax too. A higher voluntary excess, for example, lowers the premium and with it the tax, though it raises what you pay towards a claim, as explained in insurance excess explained.

The link between premium and payout runs deeper than the tax. If you underinsure your home, the ombudsman is likely to find the insurer can reduce the claim in line with the proportion of the premium paid: for example, if a consumer paid £400 but should have paid £500, as they have paid 80% of the premium, it is fair for them to receive 80% of the claim value, because the insurer would still have insured them, but at a higher premium²⁵. The same principle appears in the rules on misrepresentation: where a careless misrepresentation means the insurer would have charged a higher premium, the insurer may reduce proportionately the amount to be paid on a claim²⁶. See underinsurance and the average clause and misrepresentation for how these rules work.

Some premiums rise by design. With increasing term insurance, because the payout is guaranteed to increase over the term, either by a set amount each year or in line with the retail prices index (RPI) measure of inflation, your premiums will increase as your cover rises²¹.

Why prices change over time

Premiums rarely stand still, and the reasons are not always obvious. In one ombudsman case study, a customer complained about increases on his policy; the insurer explained it had increased the price gradually over the years to recoup a significant new customer discount, in line with how it priced all policies that received one²⁷. The ombudsman's expectation is that an insurer should be able to explain why there has been an increase and that it has been applied consistently with its customers²⁷.

Claims history feeds directly into renewals. On health insurance, claiming may push premiums up at renewal and you may lose any no-claims discount¹². On car insurance, a fault claim affects your premium for years afterwards, and if a claim was wrongly recorded as your fault, the ombudsman can tell the insurer to change the way the claim was recorded so the current premium can be recalculated and extra money refunded.

Wider prices move too. The official consumer prices index shows transport insurance costs rising 3.7% over the 12 months to August 2026²⁸, so the general level of insurance prices has been climbing alongside everything else.

Rules now constrain some of this. The Financial Conduct Authority's pricing rules ban price walking, where loyal customers are charged more than new ones for the same cover, which is covered in insurance pricing rules. What remains is the renewal cycle itself, explained in insurance renewals and automatic renewal, and the option to shop around, which is where free help comes in.

Where to get help

If you think a price increase is unfair, the first step is to ask the insurer to explain it, in writing. The ombudsman expects an insurer to be able to explain why there has been an increase and that it has been applied consistently²⁷. If the explanation does not satisfy you, you can complain to the insurer and then to the Financial Ombudsman Service, which handles complaints about insurance pricing and renewals¹. The process is set out in complaining about an insurer.

For free help with the cost of insurance in later life, Independent Age publishes guidance on shopping around for insurance, including why premiums rise with age and what to do about it¹⁷. Disability charity Scope advises on insurance and on when an insurer's pricing of disability-related risk is reasonable⁸. For people with mental health conditions, the Mental Health and Money Advice service explains how insurers price mental health risk and what your options are if you are charged more or refused cover⁷, and the ABI publishes guidance on getting health insurance with a mental health history⁶. These are all free and independent of any insurer.

If money is tight, it is worth knowing that the way you pay can cost you more than the cover itself: paying monthly can add as much as 40% for people on low incomes¹⁴. Before accepting monthly payments, check the total cost against the one-off price, and see paying monthly for insurance.