Earned Premium

Earned Premium
See also
Aggregate deductible Automatic Premium Loan Cafeteria system Price risk Unearned Premium General reserve Cash earnings Actuarial Value Composite Rate

Earned premium is the policyholder's liability to the insurer for the insurance cover granted during the contractual period called the insurance period (A. Pallaria, N. Savelli 2019, p. 72). It constitutes for the policyholder the price of the insurance service. From the economic point of view of the financial insurance undertaking earned premium represents the policyholder's share of the cover future benefits and indemnities (A. Pallaria, N. Savelli 2019, p. 72). The amount of the earned premium is determined on the basis of the premium rate, which is the price of the insurance cover of the unit of value of the insurance (A. Pallaria, N. Savelli 2019, p. 72).

Rules on the setting of earned premium

The calculation of earned premium should take into account the three gold insurance rules (D.R. Clark 2104, pp.3-8):

• The premium and benefit balance rule - called the basic financial equilibrium rule insurance undertaking, means that the balance between the fund and the insurance undertaking must be guaranteed on the one hand, and the payment of benefits and compensation on the other. Rule this, however, does not prejudge the nature of the distribution of burdens on individual members of the community the risk (D.R. Clark 2104, pp.3-8).Proportionality rule for earned premium and benefits - means that there must be an appropriate relationship between premium earned and expected insurance benefit. In practice, this means that earned premium is a function of the sum insured. The higher the ceteris paribus sum insured, the earned premium level should be higher (D.R. Clark 2104, pp.3-8).
• The earned premium and benefit equivalence rule (also known as the fair premium rule) means that an appropriate relationship must be ensured between the financial burden of the individual members of the risk community and the size of the risk they contribute to the insurance community. It therefore implies the need to apply the principle of the individualisation of charges in the form of earned premium. Full individualisation of earned premium income takes place using the differentiated premium method, which presupposes a strict classification of insured risks (D.R. Clark 2104, pp.3-8).

Methods for determining earned premium

Differentiated, individualised rate method.

It is rarely used, due to high technical costs, most often for risks which have no of mass character. Prevents the phenomenon of anti-selection (concentration of high risks in the portfolio) risk, escape from a wallet of better risks. Usually it concerns voluntary insurance (H. Marufu, 2014., pp.12).

Average rate method

Earned premium is calculated at the same level for all types of risks, regardless of their size, which guarantees technical simplicity of calculation. The consequence of simplicity is the possibility of risk antiseparation. It is usually used for compulsory insurance (due to its mass nature) (H. Marufu, 2014., pp.13).

The method of limited individualisation of the premium by manipulating bonuses and males

The method was created as a result of an attempt to combine the advantages of the methods mentioned above. It consists of the division of risks into smaller classes within which the average premium method is applied. Bonuses (rebates) that reduce the premium are related to a reduced risk of a specified risk (object) (H. Marufu, 2014., pp.14-15). The adoption of a defined contribution rate decides on two very important issues:

1. the size of the policyholder's fund,
2. the distribution of insurance charges between policyholders (H. Marufu, 2014., pp.14-15).

Premium earned schemes

Pay-as-you-go system (bottom-up premium system).

The pay-as-you-go system, known as the 'pay-you-go' premium scheme, is based on actual demand caused by random events over a period of time, known as the 'insurance period', usually one year (T. Struppeck, 2016 pp.89-97 ). Advantage: precise distribution of the insurance burden, there is no risk of overpayment. Disadvantage: it is impossible to determine the price of insurance cover at the time of purchase. It is most often used in mutual insurance companies, life insurance companies (K.J. Murphy, M. C. Jensen 2011, pp.21-22).

Premium earned system

The prepayment scheme, known as the fixed premium scheme, bases the calculation of insurance premiums not on actual but probable demand. It is based on the probable course of random events in the insurance period (K.J. Murphy, M. C. Jensen 2011, pp.21-22) . Advantage: The price of insurance is known at the time of its conclusion. Disadvantages: the distribution of the burden of insurance may be inadequate to the actual events, there is a risk of overpayment or underpayment (T. Struppeck, 2016 pp.89-97 ).

Earned premium structure

The basic part of earned premium is pure premium, often referred to as net premium. It represents the policyholder's share of the distribution of claims, and the sum of these premiums creates an insurance fund for the payment of benefits and indemnities (GP. Clemente, N. Savelli, D. Zappa. 2015, pp.164–182). A clean premium plus various allowances and adjustments is called a total premium or a gross premium. Basic supplements increasing the pure premium include (F. Eijkenaar 2013., pp.8-9):

• administrative expenses allowance of an insurance organisation,
• allowance for insurance acquisition costs, acquisition costs,
• the security allowance, the risk allowance,
• profit allowance.

Calculation of earned premium

Calculation of the pure premium in insurance. short-term, property and other personal insurance is determined on the basis of the sum of pure premiums for a given insurance period. a specific set of risks and the expected amount of compensation (F. Eijkenaar 2013., pp.8-9). The calculation of premium earned is based on the average insured death risk over the life of the policyholder, the expected rate of return on investments made by the insurer over the life of the insurance contract and the expected amount of cover. The death risk is determined by age, gender and health status on the basis of mortality tables for specific populations (GP. Clemente, N. Savelli, D. Zappa. 2015, pp.164–182).

References

• Clark D.R., (2014), Basics of Reinsurance Pricing, Actuarial Study Note,
• Clemente GP., Savelli N., Zappa D., (2015), The impact of Reinsurance Strategies on Capital Requirements for Premium Risk in Insurance
• Eijkenaar F., (2013), Pay-for-performance for healthcare providers. Design, performance measurement, and (unintended) effects, Optima Grafische Communicatie, Rotterdam, the Netherlands,
• Marufu, H., (2014), Reinsurance and dividend management. University of Cape Town,
• Murphy K.J. Jensen M. C., (2011), CEO Bonus Plans: And How To Fix Them, Harvard Business School Nom Unit Working Paper No.
• Pallaria A., Savelli N., (2019), Premium Risk Net of Reinsurance: From Short-Term to Medium-Term Assessment
• Struppeck, T., (2016), Premium Earning Patterns for Multi-year Policies with Aggregate Deductibles, New York, NY (212)

Author: Marzena Rusin