by Premium is the amount paid by the policyholder to the insurance company in consideration for the insurance protection provided by the insurer. It is the price of the insurance contract and represents the primary source of income for life insurance companies. Premiums enable insurers to pay claims, meet operating expenses, create reserves, and earn profits.
Meaning of Premium
Premium is the amount that the insured agrees to pay periodically or in a lump sum to obtain insurance coverage under a life insurance policy.
Definition
Premium is the consideration paid by the policyholder to the insurance company for undertaking the risk covered by the insurance policy.
Objectives of Collecting Premiums
- To Provide Funds for Settlement of Claims
The primary objective of collecting premiums is to create a fund for paying claims arising under insurance policies. Insurance companies receive premiums from a large number of policyholders and use these funds to compensate insured persons or their beneficiaries when the insured event occurs. Timely payment of claims is essential for maintaining public confidence in insurance companies. Therefore, collecting premiums ensures that sufficient financial resources are available to meet present and future claim obligations.
- To Meet Operating and Administrative Expenses
Insurance companies incur various operating expenses such as employee salaries, office rent, advertising costs, commissions to agents, and administrative expenses. Premium income provides the necessary funds to meet these expenditures and enables the company to conduct its business efficiently. Without adequate premium collection, an insurer may face financial difficulties in managing its day-to-day operations. Therefore, one of the important objectives of collecting premiums is to cover operating and administrative costs.
- To Create Reserves for Future Liabilities
Insurance companies are required to maintain reserves to meet future obligations arising from insurance contracts. A portion of the premium collected is set aside to create policy reserves and contingency funds. These reserves ensure that the insurer can meet future claims and unexpected losses without affecting its financial stability. Therefore, an important objective of collecting premiums is to create adequate reserves for future liabilities and maintain the long-term solvency of the company.
- To Maintain Financial Stability and Solvency
Premium collection helps insurance companies maintain financial strength and solvency. A steady flow of premium income enables insurers to meet their obligations, manage risks, and maintain adequate capital. Financial stability is essential for gaining the confidence of policyholders, investors, and regulators. Therefore, one of the major objectives of collecting premiums is to ensure the financial soundness and stability of the insurance company.
- To Generate Profit and Ensure Business Growth
Insurance companies operate as business organizations and aim to earn reasonable profits while providing insurance protection. Premium income, after meeting claims and expenses, contributes to the company’s profits and supports future expansion. Profits enable insurers to introduce new products, invest in technology, and improve customer services. Therefore, one of the significant objectives of collecting premiums is to generate profits and ensure the growth and development of the insurance business.
- To Facilitate Investment Activities
Insurance companies invest a significant portion of the premium collected in government securities, bonds, shares, and other financial instruments. These investments generate additional income and strengthen the financial position of the insurer. Investment income also helps companies meet long-term obligations and improve profitability. Therefore, one of the important objectives of collecting premiums is to provide funds for investment activities and wealth creation.
- To Fulfill Contractual Obligations
By collecting premiums, insurance companies acquire the financial resources necessary to fulfill their contractual obligations toward policyholders. The insurer promises to provide financial compensation when specified events occur, and premium income enables it to honor these commitments. Failure to collect adequate premiums may impair the company’s ability to meet its obligations. Therefore, one of the fundamental objectives of collecting premiums is to ensure the fulfillment of contractual responsibilities.
- To Protect the Interests of Policyholders
The collection of premiums helps protect the interests of policyholders by ensuring that sufficient funds are available to settle claims and provide policy benefits. Adequate premium income contributes to the financial security and stability of the insurance company, thereby safeguarding the interests of insured persons and beneficiaries. Therefore, one of the important objectives of collecting premiums is to protect policyholders and maintain confidence in the insurance system.
Features of Premiums
- Primary Source of Income
Premiums are the main source of income for life insurance companies. The funds collected from policyholders are used to pay claims, meet operating expenses, create reserves, and generate profits. The financial stability and growth of an insurance company largely depend on the amount of premium collected. Without premium income, insurers would be unable to fulfill their obligations to policyholders. Therefore, one of the most important features of premiums is that they constitute the primary source of revenue for insurance companies.
- Paid as Consideration for Insurance Protection
A premium is paid by the policyholder in exchange for the insurance protection provided by the insurer. By paying the premium, the insured obtains financial security against specified risks covered under the policy. The insurer assumes the risk only after receiving the premium or a promise to pay it. Thus, premiums form the basis of the contractual relationship between the insurer and the insured. Therefore, one of the fundamental features of premiums is that they are paid as consideration for insurance coverage.
- Usually Paid in Advance
Premiums are generally paid before the insurance coverage begins. The insurer assumes responsibility for the risk only after receiving the premium payment. Advance payment ensures that the insurance company has adequate funds to meet future claims and expenses. It also reduces the risk of default and strengthens the financial position of the insurer. Therefore, one of the significant features of premiums is that they are usually collected in advance of the insurance coverage period.
- Amount Depends on Risk Factors
The amount of premium varies according to the degree of risk involved. Factors such as age, health, occupation, lifestyle, and the sum assured influence the premium payable by the policyholder. Higher risks generally attract higher premiums, while lower risks require lower premiums. Insurance companies use actuarial principles and risk assessments to determine premium rates. Therefore, one of the important features of premiums is that their amount depends upon the level of risk undertaken by the insurer.
- May Be Paid in Different Modes
Insurance companies offer various modes of premium payment to provide convenience to policyholders. Premiums may be paid annually, half-yearly, quarterly, monthly, or even as a single lump-sum payment. This flexibility enables individuals with different income levels and financial capacities to purchase insurance policies. Therefore, one of the important features of premiums is that they can be paid through different methods and at different intervals.
- Forms an Important Item of Revenue
Premium income is one of the most significant items in the Revenue Account of a life insurance company. The profitability and financial performance of the insurer largely depend on the amount of premium earned during the accounting period. Proper accounting and recognition of premium income are essential for preparing accurate financial statements. Therefore, one of the notable features of premiums is that they form an important component of the revenue of insurance companies.
- Non-Payment May Lead to Policy Lapse
The continuation of an insurance policy depends upon the regular payment of premiums. If the policyholder fails to pay the premium within the prescribed period, the policy may lapse and the insurance coverage may cease. Although some policies provide a grace period or revival facility, continuous non-payment results in the termination of benefits. Therefore, one of the significant features of premiums is that their non-payment may lead to the lapse of the insurance policy.
- Helps in Creating Reserves and Meeting Future Obligations
A portion of the premium collected by insurance companies is set aside to create reserves for future claims and liabilities. These reserves ensure that insurers can meet their obligations even during periods of high claims or unexpected losses. The creation of reserves contributes to the financial stability and solvency of insurance companies. Therefore, one of the essential features of premiums is that they help in creating reserves and meeting future obligations toward policyholders.
Types of Premiums in Life Insurance
1. Single Premium
A single premium is a type of premium in which the entire premium amount is paid in one lump sum at the beginning of the insurance contract. After making this one-time payment, the policyholder is not required to pay any further premiums during the policy term. Single premium policies are generally preferred by individuals who have surplus funds and wish to obtain insurance coverage without the burden of regular premium payments.
The premium amount in such policies is usually high because it covers the entire cost of insurance for the policy period. Single premium policies are commonly used for investment-linked insurance plans, annuity plans, and certain endowment policies. Since the insurer receives the entire premium at once, it can invest the amount and generate returns over the policy term.
Example: Mr. A purchases a life insurance policy with a sum assured of ₹10,00,000 by paying a one-time premium of ₹2,50,000. He is not required to make any future premium payments. This ₹2,50,000 is known as a single premium.
Single premium policies are suitable for individuals seeking long-term insurance protection and investment opportunities without the obligation of periodic premium payments.
2. Regular Premium
A regular premium is a premium that is paid periodically throughout the policy term. The policyholder may pay the premium annually, half-yearly, quarterly, or monthly according to the terms of the insurance contract. This is the most common method of premium payment in life insurance.
Regular premium policies are popular because they make insurance affordable by allowing policyholders to spread the cost over several years. These policies encourage disciplined savings and provide continuous insurance protection as long as the premiums are paid regularly.
Failure to pay regular premiums within the prescribed time may result in the policy lapsing, although insurers generally provide a grace period for payment.
Example: Mrs. B purchases a life insurance policy with a sum assured of ₹20,00,000 and agrees to pay an annual premium of ₹30,000 for twenty years. The yearly payment of ₹30,000 is called a regular premium.
Regular premium policies are ideal for individuals with regular income because they provide flexibility and reduce the burden of making a large one-time payment.
3. First-Year Premium
The first-year premium is the premium received by the insurance company from newly issued policies during the first year of the insurance contract. It represents the initial premium paid by the policyholder when the policy is purchased and constitutes an important source of new business income for the insurer.
Insurance companies pay special attention to first-year premium income because it reflects the company’s ability to attract new customers and expand its business operations. Agents and intermediaries often receive higher commissions on first-year premiums because acquiring new customers involves significant efforts and expenses.
The first-year premium may be paid as a single amount or according to the chosen mode of payment.
Example: Mr. C purchases a new life insurance policy and pays the first annual premium of ₹40,000. This initial payment of ₹40,000 is known as the first-year premium.
The first-year premium is an important indicator of business growth and the market performance of life insurance companies.
4. Renewal Premium
Renewal premium refers to the premium received from existing policyholders after the first year of the policy. It represents the continuing income of the insurance company and is essential for maintaining long-term financial stability.
Renewal premiums are generally more predictable than first-year premiums because they come from policies that are already in force. A large volume of renewal premiums indicates customer satisfaction and policy persistence. Insurance companies rely heavily on renewal premiums to meet claims, expenses, and reserve requirements.
Regular payment of renewal premiums ensures uninterrupted insurance protection and helps policyholders continue to enjoy the benefits of their policies.
Example: Mrs. D purchased a life insurance policy five years ago and pays an annual premium of ₹25,000 every year. The premium of ₹25,000 paid after the first year is called a renewal premium.
Renewal premiums provide stability to insurance companies and contribute significantly to their long-term profitability and growth.
5. Bonus Premium or Additional Premium
A bonus premium, also known as an additional premium, is an extra amount paid by the policyholder to obtain additional benefits or riders under a life insurance policy. Such riders may include accidental death benefits, critical illness coverage, disability benefits, or waiver of premium benefits.
The additional premium increases the scope of insurance protection and provides enhanced financial security to the policyholder and beneficiaries. The amount of additional premium depends on the type of rider and the degree of additional risk undertaken by the insurer.
Bonus premiums allow policyholders to customize their insurance coverage according to their specific needs and financial objectives.
Example: Mr. E purchases a life insurance policy and chooses an accidental death benefit rider by paying an additional premium of ₹5,000 per year. This extra payment of ₹5,000 is called a bonus or additional premium.
Additional premiums help policyholders obtain comprehensive insurance protection beyond the basic benefits provided under the original life insurance policy.
Calculation of Premium Income for Life Insurance Companies with Illustration
Premium income is the total amount of premiums earned by a life insurance company during an accounting period. It is the primary source of revenue for the insurer and includes premiums received during the year as well as outstanding premiums relating to the current year.
Premium income is shown on the income side of the Revenue Account of a life insurance company and is used to meet claims, operating expenses, and reserve requirements.
Formula for Calculation of Premium Income
The premium income of a life insurance company is calculated as follows:
Premium Income = Premium Received during the Year + Outstanding Premium at the End of the Year − Outstanding Premium at the Beginning of the Year
This formula ensures that only the premiums relating to the current accounting period are recognized as income.
Format for Calculation of Premium Income
| Particulars | Amount (₹) |
|---|---|
| Premium Received during the Year | XXX |
| Add: Outstanding Premium at the End of the Year | XXX |
| XXX | |
| Less: Outstanding Premium at the Beginning of the Year | (XXX) |
| Premium Income | XXX |
Illustration 1
The following information is available from the books of ABC Life Insurance Company:
- Premium received during the year = ₹1,50,00,000
- Outstanding premium on 1 April 2025 = ₹4,00,000
- Outstanding premium on 31 March 2026 = ₹6,00,000
Calculation
| Particulars | Amount (₹) |
|---|---|
| Premium Received during the Year | 1,50,00,000 |
| Add: Outstanding Premium at the End | 6,00,000 |
| 1,56,00,000 | |
| Less: Outstanding Premium at the Beginning | (4,00,000) |
| Premium Income | 1,52,00,000 |
Therefore, the premium income for the year is ₹1,52,00,000.
Illustration 2
The following information relates to XYZ Life Insurance Company:
- Premium received during the year = ₹2,20,00,000
- Outstanding premium at the beginning = ₹8,00,000
- Outstanding premium at the end = ₹10,00,000
Calculation
| Particulars | Amount (₹) |
|---|---|
| Premium Received during the Year | 2,20,00,000 |
| Add: Outstanding Premium at the End | 10,00,000 |
| 2,30,00,000 | |
| Less: Outstanding Premium at the Beginning | (8,00,000) |
| Premium Income | 2,22,00,000 |
Therefore, the premium income of XYZ Life Insurance Company is ₹2,22,00,000.
Calculation of Profit for Life Insurance Companies
In life insurance companies, profit is generally known as surplus. It represents the excess of income over expenditure after considering claims, operating expenses, commissions, and actuarial liabilities. Since life insurance is a long-term business, profit is not determined solely by comparing income and expenses; it also depends upon actuarial valuation and changes in the Life Assurance Fund.
The surplus determined after actuarial valuation may be distributed as bonuses to policyholders and dividends to shareholders.
Sources of Income of Life Insurance Companies
- Premium Income
- Interest, Dividend, and Rent
- Profit on Sale of Investments
- Fees and Other Income
Items of Expenditure
- Claims by Death and Maturity
- Surrenders
- Annuities
- Commission Expenses
- Management Expenses
- Taxes and Other Charges
- Increase in Actuarial Liability
Methods of Calculating Profit
1. Revenue Account Method
Under this method, profit is calculated by deducting all expenses and claims from the total income.
Formula: Profit (Surplus) = Total Income − Total Expenditure
2. Valuation Surplus Method
The actual profit of a life insurance company is determined through actuarial valuation.
Formula: Valuation Surplus = Life Assurance Fund − Actuarial Liability
The surplus obtained is the profit available for distribution.
Calculation of Profit Using Revenue Account Method
Formula
Profit = Premium Income
Illustration 1
The following information relates to ABC Life Insurance Company:
| Particulars | Amount (₹) |
|---|---|
| Premium Income | 2,50,00,000 |
| Interest, Dividend and Rent | 40,00,000 |
| Other Income | 10,00,000 |
| Claims by Death and Maturity | 1,50,00,000 |
| Commission Expenses | 20,00,000 |
| Management Expenses | 30,00,000 |
Calculation
Total Income
| Particulars | Amount (₹) |
|---|---|
| Premium Income | 2,50,00,000 |
| Interest, Dividend and Rent | 40,00,000 |
| Other Income | 10,00,000 |
| Total Income | 3,00,00,000 |
Total Expenditure
| Particulars | Amount (₹) |
|---|---|
| Claims | 1,50,00,000 |
| Commission | 20,00,000 |
| Management Expenses | 30,00,000 |
| Total Expenditure | 2,00,00,000 |
Profit (Surplus)
Profit = ₹3,00,00,000 − ₹2,00,00,000
Profit = ₹1,00,00,000
Therefore, the profit earned by the company is ₹1,00,00,000.
Calculation of Profit Using Valuation Surplus Method
Formula: Profit (Valuation Surplus) = Life Assurance Fund − Actuarial Liability
Illustration 2
The following information is available:
- Life Assurance Fund = ₹15,00,00,000
- Actuarial Liability = ₹13,20,00,000
Calculation
| Particulars | Amount (₹) |
|---|---|
| Life Assurance Fund | 15,00,00,000 |
| Less: Actuarial Liability | (13,20,00,000) |
| Valuation Surplus (Profit) | 1,80,00,000 |
Therefore, the valuation surplus or profit amounts to ₹1,80,00,000.
