Net premium is a crucial term in the insurance industry, defining the expected present value (PV) of an insurance policy’s benefits minus the expected PV of future premiums. This calculation excludes future maintenance expenses associated with the policy.
Net premiums and gross premiums serve as critical metrics for insurance companies, particularly useful in determining the taxes owed to the state.
Key Takeaways
- Net premium is a principal accounting term within the insurance sector.
- The formula to determine net premium is the expected present value (PV) of an insurance policy’s benefits less the expected PV of future premiums.
- Both net and gross premiums are pivotal in computing state taxes for an insurance company.
- Certain state tax laws permit insurance companies to adjust their taxable gross premiums by incorporating expenses.
Delving Deeper into Net Premium
An insurance policy’s net premium significantly differs from its gross premium, with the latter considering future expenses. The difference calculated between net and gross premium represents the expected PV of expense loadings subtracted by the PV of future expenses. Consequently, a policy’s gross value is typically less than its net value if future expenses are less than the PV of those expense loadings.
Net Premium and Tax Laws
Given that net premium excludes consideration for expenses, companies must carefully ascertain how much expense can be added without incurring a loss. These expenses typically encompass commissions, legal settlements, salaries, taxes, clerical costs, and other general expenditures.
Notably, commissions often vary with the policy premium, whereas general and legal expenses may not be directly correlated to the premium.
Estimating Allowable Expenses
To accurately estimate allowed expenses, a company may apply fixed expenses to the net premium (flat loading), a percentage of the premium, or a hybrid of both. The choice depends on the correlation of general and legal expenses to the policy’s commissions.
Policy computations often include a margin for contingencies, addressing scenarios where investment returns on premiums may be lower than anticipated.
Importance of Net Premium
Net and gross premiums are instrumental in determining the taxes an insurance company owes. State insurance departments calculate taxes based on the income generated by insurance companies. However, tax legislation allows companies to reduce their gross premiums by taking into account expenses and unearned premiums.
For instance, the state of Ohio may impose taxes on gross premiums written by Ohio-based insurance companies, but taxes would not be applicable to amounts deducted for reinsurance or gross premiums canceled prior to policy expiration.
Understanding Policyholders’ Contributions
Insurance premiums are paid by policyholders, whether individuals or group members. These premiums represent the cost of obtaining insurance coverage for personal or business purposes.
Differentiating Net Premiums and Net Premiums Earned
Net premiums involve written premiums deducting commissions and ceded reinsurance. It quantifies the dollar amounts of policies underwritten. Conversely, net premiums earned measure actual money received from sold premiums.
What Is a Premium Tax Credit?
A Premium Tax Credit (PTC) is a refundable credit aiding families in covering the cost of health insurance purchased through the Health Insurance Marketplace.
Conclusion
Net premiums form a fundamental metric for insurance companies, aiding in accurate tax calculations and legal compliance. The distinction between net and gross premiums also contributes to effective financial management within the industry.
Related Terms: gross premium, premium tax credit, insurance policy, commission, present value.
References
- Internal Revenue Service. “The Premium Tax Credit - The Basics”.
