RISK MANAGEMENT AND INSURANCE

Life Insurance Premium

INTRODUCTION

 Life Insurance - Meaning

Life Insurance can be defined as a contract between an insurance policy holder and an
insurance company, where the insurer promises to pay a sum of money in exchange for a
premium, upon the death of an insured person or after a set period.
Life insurance is a social and economic devise by which a group of persons may cooperate to
ameliorate the loss resulting from the premature death of members of the group. The insuring
organization collect contributions from each member, invest this contribution, grants both their
safety and a minimum interest return and distribute benefits to the estates of the members who
die.
Life insurers are generally engaged in the provision of both protection and saving. The protection
is against financial loss difficulty and is acquired for a consideration called premium, which is
the price that keeps the policy in force. The protection given by the insurer is death benefits to
the beneficiary of the insured, or in the case of survival of the insured, other financial benefits in
accordance with the policy contract.
 Simply put, “premium” means a payment. It's the amount of money you pay your life
insurance company in exchange for your coverage. The payout itself (called a death
benefit) is the amount of money the life insurance company would pay your beneficiaries
if you, the policy owner, died unexpectedly.

 What is a life insurance premium?

A life insurance premium is the payment you make as your portion of the cost of an insurance
policy. You can usually pay your life insurance premium monthly, quarterly, semi-annually, or
annually.
At its simplest, your life insurance premium is the amount you pay to your insurance provider for
your life insurance policy. It’s the same as your car insurance premium or your home owners
insurance premium. Your life insurance premium is the cost of your coverage.

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Together with your life insurance provider you’ll come up with a plan for when your life
insurance premiums are due. You might owe them money every month or each quarter, or you
might need to pay your life insurance premium in full once a year.
You need to know your premium because if you can’t pay it, your policy will lapse. That means
that if you pass away, your beneficiaries won’t get any of the death benefit. And even if you do
realize you missed a premium payment and move to pay it right away, it might be too late – even
just one missed payment is grounds for your provider to cancel your coverage.

 How are life insurance premiums used?

Now that you know what a life insurance premium is, you might be wondering where that money
goes once you hand it over to your insurer. Generally, insurance providers can do three things
with your life insurance premium:
 Use it to cover their liabilities. Insurance providers have to be ready to pay out on
claims. For a life insurance company, that means that if one of their insureds passes
away, they need to pay out the death benefit — plus any other policy perks — to the
policyholder’s beneficiaries. They keep some of their life insurance premiums payment
money on hand to make good on the agreements they have with their insureds.
 Use it for business expenses. Like any other company, an insurance organization costs
money to run. Your insurance provider can use your life insurance premium to pay for
salaries, office space and more.
 Invest it. Some insurance providers invest a portion of the money they receive. Good
returns on those investments allow them to keep the cost of their insurance products as
low as possible. But don’t worry – insurers are subject to liquidity ratio requirements
that ensure they have sufficient liquid assets on hand to cover claims as they need to be
paid out.

 How are life insurance premiums determined?

Premiums on life insurance policies vary from person to person. Why? Before they issue you a
life insurance policy, insurance providers evaluate you to determine how risky you are to insure.
In life insurance, a higher risk level means you’re more likely to pass away soon and that means

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that your insurer is more likely to have to pay out your death benefit. So younger, healthier
people generally see lower premiums on life insurance policies.
Here are some of the main factors an insurance company considers when determining your life
insurance premium:
 Type of coverage
You can choose between two main types of life insurance: term and permanent policies.
Term policies cost less, but they expire after a certain period (the term). Permanent policies stay
in force for the duration of your lifetime, but you get a higher life insurance premium for that
longevity.
1. Age
The earlier you buy life insurance, the less you’ll pay for it. To get a feel for how much lower
your life insurance premium could be if you buy a policy now, check out our breakdown of
policy cost by age. The take away? A healthy 50-year-old will pay three times as much (or more)
for a policy as a healthy 25-year-old.
2. Sex
Since women tend to live longer, they are less likely to die while the policy is in force which
means the insurer is less likely to have to pay out the benefit. As such, women usually get
cheaper premiums on life insurance.
3. Health
Most life insurance policies require a medical exam. This is your insurance provider’s way of
making sure a preexisting condition won’t drastically shorten your life.
The healthier you are, the less you’ll pay for your life insurance premium. And you can control
your health, at least to an extent. So if you want lower premiums on life insurance, maintain a
healthy diet, exercise regularly and definitely quit or avoid smoking.
Types of life insurance premium
There are two types of life insurance premiums these are;-.
1. Net premium
2. Gross Premium

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1. What Is Net Premium?

 Net premium, an insurance industry accounting term, is calculated as the expected

present value (PV) of an insurance policy’s benefits, minus the expected PV of future
premiums. The net premium calculation does not take into account future expenses
associated with maintaining the insurance policy.
 Net premiums, along with gross premiums, help an insurance company to determine how
much it owes in state taxes.
 The determination of net premium considers only the mortality rate and rate of interest. It
ignores operating costs charged by the insurer. N.B. Net premium provides the insurer
only with the amount of money required to pay death claims. The net premium to be paid
could be single or level premium. Net single premium is the net premium to be paid as a
single sum at the beginning of the contract while a net level premium is a premium
charge that doesn't change from year to year throughout the term of the policy.
Important - Some states' tax laws may allow insurance companies to reduce their
gross premium by accounting for expenses and unearned premiums.

 Net Premium Explained

 An insurance policy's net premium value differs from the policy’s gross premium value,
which does take into account future expenses. The calculated difference between net
premium and gross premium equals the expected PV of expense loadings, minus the
expected PV of future expenses. Thus, a policy’s gross value will be less than its net
value when the value of future expenses is less than the PV of those expense loadings.

 Net Premium Tax Laws

 Because the net premium calculation does not take into account expenses, companies
must determine how much expense they can add without causing a loss. Types of
expenses that a company must account for include commissions paid to agents who sell
the policies, legal expenses associated with settlements, salaries, taxes, clerical costs, and
other general expenses.

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Commissions typically vary with the policy’s premium, but general and legal expenses may not
be tied to the premium.
 Importance of Net Premium
 Net premiums and gross premiums are helpful in figuring out how much an insurance
company owes in taxes. State insurance departments often tax insurance companies'
income. Tax laws, however, may allow companies to reduce their gross premium by
figuring in expenses and unearned premiums.
For example, if the state of Ohio imposes a tax on gross premiums written by Ohio insurance
companies, but the tax does not apply to amounts deducted for reinsurance, it also won't apply to
gross premiums not earned because the insurance company or policyholder canceled a policy
before it expired.

2. What is Gross Premium?

 Gross Premium, if you have purchased an insurance policy before, you would have paid
a premium. Premium is the term used in the insurance industry to refer to the cost or
price of an insurance policy.
The term dates back to the early days of insurance where lenders who financed an ocean
voyage to faraway lands would forgive the loan if the ship was lost at sea due to weather,
piracy, or a variety of other disasters for an additional fee—a premium—that they put on
top of the original loan amount.
Most insurance these days is sold through intermediaries like brokers and advisors.
These people and organizations are compensated with a commission that is typically a
percentage of the premiums paid by the insured.
 The insurer's costs of operating the business are added to the net premium, which is
called loading. Loading is the act of adding costs of running business to the net premium
costs including operating expenses, commissions, advertisement expenses, etc
 The gross premium is the amount the insured pays for an insurance policy that is not the
amount the insurance company actually earns for writing the policy. Gross premiums are
typically adjusted upwards to account for commissions, selling expenses like discounts,
and other insurer expenses.
This number is generally made up of two main parts:

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 The commissions paid to intermediaries in the insurance transaction are typically a

percentage of the gross premium paid by the client.

 The net premium is what is actually collected by the insurance company that they use to
pay for administration and other expenses needed to operate the business, held in reserve
to pay claims, invest to earn additional profits, and ultimately generate a profit for
shareholders and owners.
 Insurance companies need to know both the net and gross premium since the latter allows
them to understand how much money they are earning from their policies. Net premiums,
however, allow them to know how much they will actually get to keep, which gives them
a sense of their profitability.
 In many jurisdictions, gross premiums also come with serious tax implications. Many
areas of the world tax insurance companies based on the gross premiums of the business
they write rather than income or net premiums. Of course, certain deductions are allowed.
 In cases where insurers choose to use reinsurance to shift some of their liabilities off
books to increase their capacity to write more business, they pay reinsurance premiums
based on some percentage of gross premiums received for that particular piece of
business being reinsured.
 What is a gross premium tax?
 Premium Tax — a tax, imposed by each state, on gross premium written by insurers
allocable to risks located in that state. Gross written premium (GWP) means before
reinsurance ceded but after salvage and subrogation.
What is the difference between net premium and gross premium?
 An insurance policy's net premium value differs from the policy's gross premium value,
which does take into account future expenses. The calculated difference between net
premium and gross premium equals the expected PV of expense loadings, minus the
expected PV of future expenses.

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