What Does Gross Premium Mean?
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.
When an insured pays their insurance premiums, they are paying a gross premium which includes money to pay for things like commissions to brokers and other selling expenses. After those expenses are accounted for, you end up with a net premium which is what the insurance company actually collects on an insurance policy.
Insuranceopedia Explains Gross Premium
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:
- 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.