What is Insurance Expense?
Insurance expense, also known as insurance premium, is the cost one pays to insurance companies to cover their risk from any unexpected catastrophe. It is calculated as a set percentage of the sum insured and is paid at a regular pre-specified period.
Insurance Expense Formula
1 – For Life Insurance
Insurance Expense (Premium) = sum insured * % of the premium to be paid
2- For insurance other than Life Insurance
Insurance Expense (Premium) = Value of asset * % of the premium to be paid
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For eg:
Source: Insurance Expense (wallstreetmojo.com)
Examples of Insurance Expense
Example #1
Generally, a manufacturing concern must pay 2.89% of the asset value as an insurance cost. From the below value of the assets, calculate the insurance expense to be paid by XYZ Ltd.:
- Machinery: $9,000,000
- Industrial shed: $1,23,100
- Spares: $45,000
- Forklift: $32,000
- Safety equipment: $18,500
- Total: $9,218,600
Solution:
Calculation showing insurance cost to be paid for machinery-
- =9,000,000*2.89%
- =260,100.00
Similarly, we can calculate insurance expenses for other assets, which are shown below:
Total will be –
Thus, XYZ Ltd. would have to pay $2,66,417.54 as an insurance premium for the given year.
Example #2
Anthony has a habit of smoking. He is presently pursuing a master’s from Boston University. His father is interested in taking the insurance of Anthony’s health due to his bad habit of smoking. Therefore, he consulted the PQR insurance company for medical insurance. They provided the following details related to the mediclaim plan:
| Age | 0-15 | 16-24 | 25-50 | 51-70 | 70 and above |
|---|---|---|---|---|---|
| Base Premium Rate for Mediclaim | 1.30% | 2.01% | 2.19% | 2.70% | 3.50% |
| Additional premium to cover a specific illness | 1% | 1.20% | 1.50% | 1.70% | 2% |
| Additional premium if smoking | 0.50% | 0.65% | 0.80% | 1% | 1.20% |
Calculate the insurance expense for the mediclaim plan, including coverage of a specific illness of $500,000, needed to be paid by Anthony’s father.
Solution:
Anthony is 23-years old. Hence, all the premium rates will apply to the slab of 16-24 years.
Calculation showing insurance expense to be paid
Similarly, we can calculate insurance expense which is shown below:
Total Premium to be Paid will be –
- =10,050+6,000+3,250
- =19,300
Thus, the total insurance expense to be paid is $19,300 for the sum insured of $500,000.
Advantages
- Ensures Security – It protects the insured from future wrongdoings in their lives or their businesses. It will ensure security and give mental calmness in their life.
- Long-term financial safety – It will provide long-term financial safety to the insured person and safeguard the personal interest of individuals. One can obtain these benefits in life insurance.
- Source of collecting funds – It gives the opportunity of creating a pool of funds that can be parked at a proper place and create a steady flow of income, which can help cover the catastrophe of the insured person.
- Creates a habit of saving – It nurtures a practice of insurance among individuals that will ensure good cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more over a long time.
Disadvantages
- Reimbursement is not equal to loss – Insurance expense does not guarantee that one will get a refund from an insurance company equivalent to the loss incurred. Reimbursement of claims is always dependent on various factors. As a result, the majority of times, the loss amount is not fully recovered from insurance companies.
- Complexity in schemes and clauses – Scheme documents of insurances are highly complex. Moreover, they will put various provisions that laypeople are unaware of. As a result, an insured person will not be fully aware of all the terms and conditions of the insurance contracts.
- Lack of trust – Insurance companies have often behaved recklessly in the past. As a result, there always exists a somewhat low level of trust over them.
- Limit in the claim – All the insurance policies will have a fixed sum insured. As a result, if the coverage is $1 million, and even if an individual incurs the loss of $2 million, the insured person will get reimbursement of $1 million only. This sum insured often gets wrongly estimated, and as a result, has to bear the risk.
Conclusion
Thus, insurance contracts are almost inevitable for a smooth life and business nowadays. If anyone misses taking the insurance, they are prone to a huge risk. As a result, they will face severe mental and financial loss. Therefore, it is always advisable to incur the insurance expense considering the danger one faces and requirements against the same.
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