CandleFocus Glossary Editor
Net Premium in Insurance: What it is and How it is Calculated
Net premium is an accounting term used in the insurance industry to determine the value of a policy's benefits over its lifespan. The calculation for net premium is based on the expected present value (PV) of an insurance policy's benefits minus the expected PV of future premiums. By subtracting the future premiums from the policy’s expected value over its lifespan, the insurer can determine the true net value of the policy.
The most common example of this is finding the net premium of an auto insurance policy. Automobile insurance policies generally cover three broad categories of incident: comprehensive coverage, collision coverage, and liability coverage. For each of these coverage types, the expected PV of future premiums is known, and the expected value of the actual benefit, in the form of medical payments, property damage, etc., is also known. By subtracting the future premiums from the expected value of the policy's benefits, an insurance company can calculate the net premium of the policy.
Net premium and gross premium are both useful in calculating the amount of state taxes an insurance company needs to pay. Some states’ tax laws allow insurance companies to reduce the amount of their taxable gross premium by adding back expenses. Net premiums are also used in pricing decisions and in deciding what policy benefits are worth adding to a policy.
To summarize, net premium is an accounting term used to calculate the net value of a policy. It is calculated by subtracting the expected PV of future premiums from the expected PV of the policy’s benefits over its lifespan. Net premium and gross premium are both useful in calculating state taxes and in pricing decisions.
Net premium is an accounting term used in the insurance industry to determine the value of a policy's benefits over its lifespan. The calculation for net premium is based on the expected present value (PV) of an insurance policy's benefits minus the expected PV of future premiums. By subtracting the future premiums from the policy’s expected value over its lifespan, the insurer can determine the true net value of the policy.
The most common example of this is finding the net premium of an auto insurance policy. Automobile insurance policies generally cover three broad categories of incident: comprehensive coverage, collision coverage, and liability coverage. For each of these coverage types, the expected PV of future premiums is known, and the expected value of the actual benefit, in the form of medical payments, property damage, etc., is also known. By subtracting the future premiums from the expected value of the policy's benefits, an insurance company can calculate the net premium of the policy.
Net premium and gross premium are both useful in calculating the amount of state taxes an insurance company needs to pay. Some states’ tax laws allow insurance companies to reduce the amount of their taxable gross premium by adding back expenses. Net premiums are also used in pricing decisions and in deciding what policy benefits are worth adding to a policy.
To summarize, net premium is an accounting term used to calculate the net value of a policy. It is calculated by subtracting the expected PV of future premiums from the expected PV of the policy’s benefits over its lifespan. Net premium and gross premium are both useful in calculating state taxes and in pricing decisions.