Different types of premiums
Insurance companies transfer the risk on to themselves in exchange for a fixed amount charged from its clients called Premium. Just like sales in a retail company is of paramount importance, premiums are the only way Insurance firms make money. In order for an insurance company to be profitable, the premium collected must be more than the claims it might be giving out. Hence the premium rate is calculated based on extensive research and analysis. However, there are many different ways that an insurance company calculates its profits from the premium. The most commonly used methods are Written Premium and Earned Premium. Apart from them, Gross Written/Earned premium is different from Net Written/Earned premium. But why does Net Earned premium is more important than Gross Earned premium? Let us discuss this in detail.
An insurance company has to face various kinds of risks and to support itself, it sometimes takes the help of a reinsurance company. By doing that, it transfers the risk partly or fully to the reinsurance company. It, however, has to share part of the premium earned from its clients. As a result, if we minus the reinsurance premium from the total premium, we get what is called Net Premium. This is what the insurance company actually earns after giving the share of the reinsurance company.
It refers to the amount of new business that an insurance company gains in a particular time period. In other words, it is the number of sales that an insurance firm makes in exchange for the premium. For example, if a company gets 100 new customers which will pay $100 each in the span of a year, the company’s written premium will be (100*100) $10,000. Hence, the total amount of the premium that will be earned is counted here, regardless of how much portion has been earned.
Gross Written Premium
The total amount of $10,000 that will be earned by the company in a year will be known as Gross Written Premium.
This is counted for a period of time that the premium has been earned by the company at the moment. The $100 that those 100 new customers will give in a year will finally be reflected after the year has passed. However, if the insurance company has to calculate the premium earned in a month, it will be $10,000 divided by 12 = $833 per month. These $833 will be considered as the Earned Premium. Hence this is the money that the insurance company has in its hands. This money is then used to invest or be spent on the expenditure of the company. This is primarily the reason that Earned Premium comes first on any insurance company’s statement and is considered as the most important earnings.
Written Premium vs Earned Premium
The insurance company is entitled to cover the risk only until the said period of time in the policy lasts. If the policy is one year long and only 6 months have passed, it can not be called as Earned Premium until the full year has passed. Thus the above-said premium will be called as Written Premium, as it has been written in the books of the insurance company but if the insurer claims the money the company might be in loss.
However, on the other hand, if the whole year has passed and no claim has been made against the policy, it will be known as Earned Premium. It simply means that the insurance company has earned the premium and no claim can be made against that amount since the time period for which that policy was valid has expired.