Components of Insurance Premium
An insurance premium is the amount of money that an individual or business must pay for an insurance policy. In an insurance contract, the risk is transferred from the insured to the insurer. For taking this risk, the insurer charges an amount called the premium. The price of an insurance premium for a given insurance policy can vary and depends on a variety of factors. You pay for it by making payments monthly, annually, or semi-annually for the duration of your policy.
The four components of insurance premium are –
Pure premium: It is the most important component of the insurance premiums. Based on actual calculations, it includes the amount needed to cover expected losses & loss adjustment expenses. It is the portion of an insurance premium that reflects the basic costs of loss, not including over-head or profit.
Operating expenses: Operating expenses include the sales commission & other marketing costs, taxes & the cost of handling claims. The size of this component of premium varies from one line to another, largely dependent upon the extent & variety of policyholder services that the insurer provides. Some firms successfully reduce operating expenses to gain a competitive advantage and increase earnings.
Investment and earning margin: It includes an allowance for (a) contingencies & (b) underwriting gain or profit. Contingency funds are needed to meet unexpected increase in the number or size of benefits payments and underwriting gains are needed to provide funds for financing growth. A profit margin percentage is the ratio between some measure of profit and net sales revenues, which are sales revenues after subtracting allowances and returns.