Net Premium

Net premium is an accounting term commonly used in the insurance industry to describe the amount of money the insurance company will receive in exchange for the risk it takes to offer the insurance contract. Yet, it does not include the coverage cost under the policy. 

Insurance net premium is calculated by taking the expected present value of an insurance policy and subtracting it from the expected value of future premiums. It shields the insurer from paying a hefty amount. It is also called a benefit premium. Its primary purpose is to work along with the gross premium to track the state or federal taxes owed by an insurer.

Net premium denotes the money an insurance company receives on the risk of offering an insurance contract. When an insurer offers an individual a policy, they pay a premium to the company. These premiums are subject to federal and state tax laws, allowing a company to track how much it owes to the tax authorities. At the same time, from a business perspective, it safeguards the company from payments in catastrophic loss. 

Furthermore, it does not include account expenses. An insurance company incurs several types of expenses, such as clerical costs, salaries, taxes, legal expenses, and agent commissions. It must calculate how much it can add without losing money in the business.

Annualized net premium refers to the total amount paid by an insured person to the insurer to keep the policy in force. At the same time, the net premium has multiple meanings, such as it reflects the premium portion required to pay for future losses. In addition, it showcases the actuarial variation, which simultaneously signifies the expected value of policy benefits minus the expected value of all future premiums. 

After subtracting the agent's commission from the gross premium, the net premium reflects the resulting amount. An insurance company often uses an allowed flat loading percentage and multiple fixed expense combinations to the net premium. When coupled with other ratios like rider premium, gross premium, earned premium, or risk premium, it has several uses.

To calculate net premium, the present value of anticipated benefits (premiums collected) is subtracted from the expected future value of premiums (expenses such as commissions, claims, and administrative costs).

Net premium = Policy's expected present value - Expected future value of premiums (expenses).

Below are two examples to help you understand the concept better: 

Example #1

Suppose an insurance company XYZ has offered an insurance policy with a net present value of $90000 and incurs a projected future premium/expenses value of $9000. 

The net premium can be easily calculated by implying the formula = Present value benefits - Expected present value of future premiums.

90000 - 9000 = $81000.

Every year, an insurance company declares its financial reports and mentions the rise or decline in its net premium for the general public, business analysts, and investors to help them understand the company's financial health and performance. 

Example #2

Let’s examine Berkshire Hathaway's recent financial performance to understand the significance of net premiums. Berkshire Hathaway reported a record quarterly profit in the first quarter, mostly due to higher revenue from insurance underwriting. Operating profit for the first quarter of the year increased by 39% to $11.22 billion from $8.07 billion in the previous year.

This increase in profit emphasizes how essential it is to manage net premiums well. Profitability is directly impacted by net premiums or the money received from insuring policies after reinsurance expenses. Berkshire's performance illustrates how this financial metric used in the insurance industry can be effectively managed to produce significant financial rewards.

Its importance is listed below: 

• It helps insurers to track the amount they owe in taxes. 
• It protects the company from paying a catastrophic loss amount. 
• It mainly works and favors the insurance company based on the premium paid by the policyholders. 
• This financial metric used in the insurance industry is often coupled with gross premiums to understand the sales tax on an insurance product. 
• It is the amount of money an insurance company charges for the risk of providing policy and coverage.

All three play a key role in insurance accounting, but there are significant differences among them.