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Everyone understands that insurance costs money, but one phrase that may be unfamiliar when you first begin looking for insurance is “premium.” The premium is typically the amount paid by an individual (or a firm) for plans that cover auto, house, health, or life insurance. Before learning What is the difference between gross premium and net premium and earned premium, some key concepts need to be addressed. They are discussed in the paragraphs given below.
What Are Insurance Premiums?
Simply put, the insurance premium is the amount of money that the insurance company will charge you for the insurance policy that you are purchasing. The cost of your insurance is referred to as the insurance premium.
A basic calculation is typically used for calculating insurance rates. Then, depending on your details and region, discounts may be applied to the base premium, lowering your cost. Additional information is utilised to obtain preferred rates, more competitive or lower insurance prices. Insurance premiums can be paid annually, semi-annually, or monthly. If the insurance company decides that the insurance premium should be paid in advance, it may also require that. This is frequently the case when a person’s insurance coverage has been cancelled in the past due to non-payment.
The basis of your insurance payment is the premium. In some instances, an insurance premium may be deemed taxable income. Depending on the local insurance rules and the issuer of your contract, service fees may be imposed. If you have a question concerning fees or charges on your premium, the National Association of Insurance Commissioners Guidelines or your State Insurance Commissioners’ office can provide you with more information on your local rules. Extra charges, such as issuance fees or other service charges, are not regarded as premiums and will appear on your premium or account statement separately.
The amount of your insurance premium will vary depending on the sort of coverage you choose and the risk involved. This is why it is always a good idea to shop for insurance or consult with an insurance professional who can compare premiums from several different insurance providers on your behalf. When people look for insurance, they may notice that different insurance companies charge different premiums for the same coverage, and they may be able to save a lot of money on insurance premiums just by selecting a firm that is more interested in “writing the risk.”
Factors Determining Insurance Premium
Four major elements normally affect an insurance premium:
- Coverage Type: When purchasing an insurance policy, insurance companies provide a variety of possibilities. The greater your insurance payment is, the more coverage you get or the more comprehensive coverage you choose. When it comes to home insurance premiums, for example, open peril or all-risk coverage policy will cost more than a named perils policy that just covers the essentials.
- The Amount of Coverage and the Cost of Your Insurance Premium: You will always pay a larger premium (more money) for larger amounts of coverage, whether you are purchasing life insurance, vehicle insurance, health insurance, or any other type of insurance. This can be accomplished in two ways. The first method is simple, while the second method is a little more complex but still a fantastic approach to saving money on your insurance costs. The dollar value you want on whatever you’re insuring can change the amount of coverage you get. It’s simple: the higher the dollar worth of the item you wish to insure, the higher the premium. If you choose insurance with a higher deductible, you will pay less for the same level of coverage. Higher deductibles or policies with alternative options, such as higher co-pays or longer waiting periods, are available in the case of health insurance or supplemental health insurance.
- Personal Information of the Applicant for an Insurance Policy: Your insurance history, where you reside, and other aspects of your life are all key factors in determining the insurance premium you will be charged. Different rating factors will be used by each insurance provider. Some businesses employ insurance ratings, which are based on a variety of personal criteria ranging from credit scores to the frequency of automobile accidents, personal claims history, and even vocation. These characteristics frequently result in insurance policy premium decreases. Other risk variables particular to the person being covered, such as age and health issues, will also be considered for life insurance. Insurance firms, like any other business, have target clients. Insurance firms will evaluate what type of client they want to recruit to stay competitive, and they will establish programmes or discounts to help them attract those clients. One insurance business may opt to target seniors or retirees as customers, while another may price rates to appeal to young families or millennials.
- The Insurance Industry’s Competition and the Target Market: If an insurance firm decides to pursue a market sector aggressively, it may adjust rates to attract new business. This is an intriguing aspect of insurance premiums since it has the potential to radically change rates on a temporary or long-term basis if the insurance firm is successful and achieves strong outcomes in the market.
What Does the Insurance Company Do with Insurance Premiums?
The insurance firm must receive premiums from a large number of people and ensure that enough of that money is saved in liquid assets to cover claims from a small number of people. The insurance company will take your premium and set it aside for each year that you do not file a claim, allowing it to grow. The company will be profitable if it receives more money than it pays out in claim costs, operational costs, and other expenses.
What is the Difference between Gross Premium and Net Premium and Earned Premium?
To have a better understanding of the word “premium,” we will divide it into parts.
Gross Premium is the amount of new business acquired by an insurance firm in a given year. This is the amount a company earns in a year as a new business. Written Premium is another name for Gross Premium.
An insurance firm decreases its overall risk exposure by shifting some risks to a reinsurer when it engages in a reinsurance agreement. The reinsurer is entitled to a part of the insurer’s premiums in exchange for taking on these risks. The amount of premiums to which the reinsurer is entitled is set by a fixed rate under a non-proportional reinsurance arrangement. This rate is multiplied by a base premium, which is the dollar amount of premiums that the reinsurer is entitled to from an insurer.
The reinsurance contract specifies the method for calculating the subject premium. The parties agree on the reinsurance rate premium percentage that will be applied to the base premium, as well as whether the base premium will be computed using earned or written premiums. If earned premiums are selected, the computation starts with GNEPI (gross net earned premium income). For excess loss reinsurance, this is the most typical rating basis. The GNWPI is employed if the agreement includes written premiums. The ceding insurer’s premium income, rather than premium receipts, is used to determine gross net written premium income. The premiums are “net” because cancellations, refunds, and reinsurance premiums are subtracted, but “gross” because expenses are not deducted. Written premium income will be larger than earned premium income if the amount of risk taken on by the reinsurer increases with time.
Gross net written premium income is a useful indicator of an insurer’s performance, although it excludes earnings from investments such as stocks and bonds. It also disregards any assets that the insurer may possess. As a result, many businesses are more concerned with trading gross income, which includes these figures. While the GNWPI is a good indicator, it cannot be used to determine an insurer’s financial health purely based on it.
Insurance is a high-risk venture. In exchange for a predetermined payment, an insurance company assumes the risk of its insured (premium). Nobody can guarantee that the insured will follow the policy’s rules and file a claim. As a result, an insurance firm is exposed to a variety of risks. These insurance companies use the services of a reinsurance company to reduce their risk. These reinsurance companies collect a portion of the premium from insurance companies and assume a portion of the risk. If the insured makes a claim, both the reinsurance and insurance firms are responsible for paying the benefits according to a predetermined percentage.
The net premium value of an insurance policy differs from the gross premium value, which includes future expenses. The estimated PV of expense loadings less the expected PV of future expenses is the computed difference between net and gross premium. When the value of future expenses is less than the PV of those expense loadings, a policy’s gross value is less than its net value.
Because expenses are not factored into the net premium calculation, businesses must evaluate how much expense they may add without incurring a loss. Commissions given to agents who sell insurance, legal fees related to settlements, salaries, taxes, secretarial costs, and other miscellaneous expenses are all expenses that a corporation must account for. Commissions are usually connected to the policy’s premium, but general and legal expenses aren’t always.
A company can add a fixed number of expenses to the net premium (called flat loading), a percentage of the premium, or a mix of a fixed sum and a percentage of the premium to estimate permissible expenses. When comparing policies with differing net premiums, adding a fixed sum to the premiums will result in the same percentage of expenses to premiums, as long as expenses change in proportion to the premium. The general and legal expenses related to the policy, as they relate to premium commissions, determine which approach to adopt. Most insurance calculations include a contingency factor, such as when the money earned by investing premiums turns out to be less than predicted.
The difference between net and gross premiums might assist determine how much a corporation owes in taxes. The income of insurance businesses is frequently taxed by state insurance authorities. Companies may, however, be able to reduce their gross premium by factoring in expenses and unearned premiums under tax laws.
It indicates premiums earned on a portion of a cancelled insurance policy. Unearned premiums are those that are collected for a portion of an insurance policy that is in use. While earned premiums can be used to cover expenses, unearned premiums carry the risk of the insuree filing a claim. As a result, the earned premium becomes a critical indicator.
In the insurance industry, an earned insurance premium is often utilised. Insurers do not immediately count premiums paid for an insurance contract as earnings because policyholders pay premiums in advance. While the policyholder fulfils their financial obligations and receives benefits, the insurer’s responsibility begins when the premium is received. It is an unearned premium, not a profit, that is paid when the premium is paid. Because, as previously said, the insurance company still has a responsibility to fulfil. Only when the entire premium is considered profit can the insurer alter the status of the premium from unearned to earned. Assume the premium is recorded as a profit by the insurer, and the period hasn’t passed. During that time, however, the insured party makes a claim. To unravel the transaction listing the premium as an earning, the insurance firm will have to reconcile its records. In the case that a claim is lodged, it makes more sense to defer recording it as an earned.
The accounting technique and the exposure method are the two methods for calculating earned premiums. The accounting method is by far the most popular. On the majority of insurers’ corporate income statements, this method is utilised to display earned premium. This method entails dividing the total premium by 365 and multiplying the result by the number of days that have elapsed. The date a premium is booked is not taken into consideration by the exposure approach. Rather, it examines how premiums are exposed to losses over a certain period. It’s a difficult procedure that entails looking at the portion of unearned premium that was exposed to loss throughout the calculation period. The exposure approach examines various risk scenarios based on historical data that could occur over time—from high-risk to low-risk scenarios—and applies the resulting exposure to premiums generated.
The above article has discussed all the important factors that need to be considered when discussing “What is the difference between gross premium and net premium and earned premium”. Download the entri app to get coaching to ace the banking awareness section in bank exams.