In this instance the premium is charged as a percentage of the loan amount. Now loans attract interest and charges which are included as part of the repayment figure, and it is common of this calculation to include loan charges such as interest.
For instance if the loan was £9,000 and the charges £1,000 and the premium rate 15%, then the calculation would be (£9,000 + £1,000) x 15% = £1,500.
This method is used to calculate a single premium which if the arrangement is made through the lender, may be added to the loan amount. If the premium is added to the loan amount, then it also attracts an interest charge.
In the event of a claim the loan repayments for both the original loan and the premium charge are covered, assuming always that the sum insured was set at an adequate level.
This method is common when calculating mortgage payment protection premiums (single premium polices) and those for personal loans, hire purchase and secured loans. For single premium mortgage payment protection polices the period of cover may be arranged for only the first three or five years of the loan, when the repayment burden may be considered more difficult.
However many mortgage payment protection polices are taken out using a monthly premium basis with the insurance continuing to run as long as the monthly premium payment is maintained.
A more complicated method of arriving at the premium figure is to base the calculation on the total amount repayable, known as TAR. In this case the calculation is loan amount + loan charges + insurance premium + interest on the premium. Special calculators or computers are used for these types of calculation, where the formula can be done automatically.