Net premiums and gross premiums are terms used to describe the income a company receives in exchange for the risks the insurer incurs under the policy. A premium is the amount that a policyholder pays for insurance to protect them from financial losses. However, there is a difference between gross premiums and net premiums.
The total premium is the amount that the insurance company is expected to receive during the duration of the contract. This affects how much the insurance buyer will pay for the insurance under the insurance policy. For example, if the insurance buyer pays $1,000 for a six-month auto insurance policy, the total premium for that period is $1,000.
Net premium is the income that the insurance company will receive when assuming the risk under the policy, minus the costs associated with the provision of insurance under the insurance policy. Insurance companies often buy reinsurance, paying for claims on a certain amount. This helps protect the insurance company from having to pay for large, catastrophic losses. The amount paid for the reinsurance of a policy is deducted from the total premium.
Insurance policies paid under the installment plan can also affect net premiums. In the installment program, the policyholder does not pay for the entire duration of the contract at the start or at the renewal.
Instead, the policyholder makes installment payments, usually every month or every two months. The net premium obtained reflects the portion of the premium paid by the policyholder and the insurance company that paid for it.
Total premiums and net premiums are important for calculating the taxes that the insurance company owes. State insurance departments often tax the income that insurance companies receive. However, tax laws can reduce allowances for total premiums due to unrealized costs or premiums. For example, the Pennsylvania Department of Revenue taxes total premiums written by Pennsylvania insurers, but this tax does not apply to the amount deductible for reinsurance. It also does not apply to the total premiums not earned by the insurance company or the insurance buyer who canceled the policy before the expiration of the contract term.