Net Premium

Net Premium: Definition and Importance

Net premium is an insurance accounting measure equal to the expected present value (PV) of a policy’s benefits minus the expected PV of future premiums. It represents the pure cost of risk assumed under a policy and intentionally excludes expense loadings for administering and maintaining the policy. Insurers use net premiums for actuarial valuation, tax reporting, and to separate the portion of premiums that funds claims from the portion that funds expenses.

Key Takeaways

• Net premium = PV of expected benefits − PV of expected future premiums; it excludes future administrative and acquisition expenses.
• Gross premium includes expense loadings; net premium does not.
• Net and gross premiums both affect tax liabilities because some tax rules allow adjustments for expenses and unearned premiums.
• Insurers estimate allowable expenses by adding a fixed amount, a percentage, or both to the net premium, depending on how expenses vary with the policy.

Net Premium vs. Gross Premium

• Gross premium = net premium + expense loadings (the PV of future expenses tied to the policy).
• Net premium excludes those expense loadings, so it isolates the risk-bearing component of premium pricing.
• When expense loadings exceed expected future expenses, gross and net values diverge accordingly.

Tax and Expense Considerations

Tax rules vary by jurisdiction. Many state and national tax systems tax insurers’ premium-related income but permit adjustments to gross premium for certain items, such as:

• Commissions to agents (often proportional to premium)
• Legal and settlement costs
• Salaries, clerical costs, and other general overhead
• Taxes and regulatory fees
• Unearned premiums (amounts returned or not earned if a policy is canceled)

Because net premiums exclude expense loadings, insurers must determine which expenses are permissible when calculating taxable premium bases so they do not understate tax liabilities.

Calculating Allowable Expenses

Insurers commonly estimate permissible expense loadings using one of these methods:

• Fixed amount added to the net premium — appropriate when some costs don’t vary with premium size.
• Percentage of the net premium — appropriate when expenses scale with premium (e.g., commissions).
• Combination of fixed amount plus percentage — to capture both fixed overhead and variable costs.

Insurers also build margins for contingencies into expense assumptions to cover uncertainties, such as lower-than-expected investment returns.

Why Net Premiums Matter for Insurers

Net and gross premiums together inform several operational and regulatory needs:

• Tax compliance — tax bases can be affected by whether expenses and unearned premiums are deductible or excluded.
• Financial reporting — separating risk costs from expense loadings clarifies profitability and claims funding.
• Pricing and reserving — net premium drives actuarial reserve calculations and helps ensure solvency.
• International practice — some markets use standardized measures (for example, annual premium equivalent or APE) to compare premium revenue.

Example: A jurisdiction that taxes gross premiums but allows deductions for reinsurance or unearned premium will reduce the taxable gross amount accordingly.

Other Terms Explained

• Who pays net premium: Policyholders pay the premiums; pricing depends on whether they are individuals or members of a group.
• Net premiums vs. net premiums earned:
• Net premiums (written) = premiums written minus commissions and ceded reinsurance; a measure of policies issued.
• Net premiums earned = the portion of those premiums recognized as revenue for the period (earned over the policy term).
• Premium tax credit (PTC): A refundable tax credit available to eligible families to help pay premiums for health insurance purchased through a marketplace.

Bottom Line

Net premium isolates the expected cost of claims by excluding expense loadings. This distinction from gross premium is critical for actuarial valuation, pricing, reserve setting, and tax compliance. Insurers must carefully estimate allowable expense adjustments and account for unearned premiums to meet regulatory and tax requirements while maintaining accurate financial reporting.