The Difference: Unpacking Premiums
Direct Written Premium vs. Earned Premium vs. Net Premium Earned
Different types of premiums will impact operations and financial reporting. The terms Direct Written Premium (DWP), Earned Premium, and Net Premium each represent distinct aspects of the premium cycle. Let’s break down these terms and their implications.
Direct Written Premium (DWP)
Direct written premium refers to the total premiums an insurance company collects from policyholders, without adjustments for amounts ceded to reinsurers. It includes all premiums recorded within a year, minus any returned premiums. This figure reflects the gross income an insurance company generates from its policies before any reinsurance. In short, direct written premiums are the total amounts insurance companies charge for their policies. These do not account for any amounts transferred to other insurers (reinsurers). A high amount of direct premiums written generally indicates a strong financial position for the insurance company, assuming the pricing is adequate. Understanding DWP helps gauge an insurance company’s financial stability, which is useful when choosing an insurer.
Earned Premium
Earned premium is the portion of insurance premiums that an insurer has earned over time, based on the coverage period that has passed. It represents the amount the insurer can keep for the time the policy has been in effect. Once earned, the amount is non-refundable, even if the policy is canceled. Earned premiums contribute to an insurer’s profit by reducing their potential payout obligations. Insurers aim to maximize profits by managing risks and minimizing claims payments. Conversely, unearned premiums are those that an insurer has collected but not yet earned, often returned if the policy is canceled early.
Net Premium Earned
Net premium earned represents the adjusted amount of premiums an insurance company recognizes as earned over a specific period, accounting for changes in unearned premiums. This adjustment reflects the premiums earned throughout the year, after accounting for any premiums that are unearned at the start or end of the year. Net premium earned is calculated by subtracting unearned premium from written premium, reflecting the revenue earned during the accounting period. Insurance companies often use reinsurance to manage risk, which affects the calculation of net premiums. Gross premiums written represent the total premiums expected over the policy’s life, while net premiums written are the gross premiums minus reinsurance costs.
According to the National Association of Insurance Commissioners (NAIC):
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The Difference
The Difference is an ongoing educational series from ProAssurance designed to compare common terms in medical professional liability insurance.