What are net written premiums?
The net premiums written are the sum of the premiums written by an insurance company during a given period, less the premiums ceded to reinsurance companies, plus any reinsurance assumed. The net premiums written represent the part of the premiums that the company must keep to assume the risk.
Explanation of net written premiums
Examining changes in net premiums written from year to year is one way to assess the health of an insurance company.
The health of an insurance company depends on the types of policies and the risks associated with these policies. An increase in net premiums written represents an increase in new insurance policies purchased, while a decrease indicates fewer policies purchased. Decreases in net written premiums could be the result of competitors entering the market and gaining market share, or it could be due to the fact that the premiums are not competitive compared to others companies offer. Companies that offer policies to a larger pool of people can reduce the risk of decline.
Insurance companies can receive premiums in a single payment in advance, but they can also offer payment plans to policyholders. Installment plans provide the insurance company with premiums during the year, which are recognized differently when determining the amount of income the insurance company earns. Since policyholders using installment plans make payments, a company classifies them as earned premiums. When determining the tax liability of an insurance company, a state may authorize discounts for premiums ceded to reinsurance companies or premiums due but not yet received.
The adjustment of liabilities associated with unearned premiums in a year is called net earned premiums. If a business is able to write more premiums during the year, its written premiums will exceed its earned premiums. To adapt to this, the company is setting up new bonuses representing unexpired terms.
Calculation of the net premium
Since the calculation of the net premium does not take expenses into account, companies must determine the amount of expenses that can be added without causing a loss. The types of expenses that a business should consider include commissions paid to agents selling policies, legal fees associated with settlements, salaries, taxes, office expenses and other overheads. Commissions generally vary based on the contract premium, while general and legal fees may not be related to the premium.
The calculated difference between the net premium and the gross premium is equal to the expected present value of expenses, less the expected present value of future expenses. Thus, the gross value of a policy will be less than its net value when the value of future expenses is lower than the present value of these expenses.