# Net Premiums Explained: Calculations and Differences vs. Gross Premiums

![Net Premium](https://www.investopedia.com/thmb/v3rFiF0VLDMyRW5CjpgrrzXX0NA=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/NetPremium3-2-edit-e963481eb9614c6d9978750f21a3ddb6.jpg)

*— Investopedia / Xiaojie Liu*

## What Is Net Premium?

Net premium is an insurance accounting measure that represents the expected [present value (PV)](https://www.investopedia.com/terms/p/presentvalue.asp) of a policy’s benefits minus the expected PV of future [premiums](https://www.investopedia.com/terms/p/premium.asp). Unlike gross premiums, net premiums exclude expenses tied to maintaining the policy, making them a more focused calculation of pure risk costs.  

Insurers use net premiums to help determine state tax obligations and to distinguish between what portion of premiums goes toward covering claims versus administrative costs.

Understanding the difference between net and gross premiums is important not only for accurate accounting and compliance but also for shaping financial strategy and planning for both insurance companies and policyholders.

### Key Takeaways

*   Net premium is a calculation used in the insurance industry to determine the expected present value of a policy's benefits after subtracting the expected present value of future premiums; it does not consider future expenses for maintaining the policy.
*   Calculating net premiums is crucial for insurance companies to manage their financial obligations, including state tax liabilities, which can vary based on state laws and regulations concerning premiums.
*   The distinction between net premium and gross premium is significant, as gross premiums include future expenses and can influence an insurance company's reported revenue.
*   Insurance policies commonly account for potential future uncertainties, such as less-than-expected investment returns, by building in a margin for contingencies.
*   Tax laws may permit insurance companies to adjust their gross premiums by factoring in expenses and unearned premiums, which impacts their overall tax burden.  
    

## How Net Premium Differs From Gross Premium

The net premium of an [insurance](https://www.investopedia.com/terms/i/insurance.asp) policy excludes future expenses, unlike the gross premium. The difference between net and gross premiums equals the expected PV of expense loadings minus future expenses. Thus, a policy’s gross value will be less than its net value when the value of future expenses is less than the PV of those expense loadings.

> **Important**
>
> Some states' tax laws may allow insurance companies to reduce their gross premium by accounting for expenses and unearned premiums. 

## Navigating Tax Laws on Net Premiums

 Since net premiums exclude expenses, companies must calculate the expenses they can include without incurring a loss. Types of expenses that a company must account for include [commissions](https://www.investopedia.com/terms/c/commission.asp) paid to agents who sell the policies, legal expenses associated with settlements, salaries, taxes, clerical costs, and other general expenses.

Commissions typically vary with the policy’s premium, but general and legal expenses may not be tied to the premium.

## Calculating Permissible Expenses on Net Premiums

Companies can estimate allowable expenses by adding a fixed amount, a percentage, or both to the net premium.

When comparing policies with different net premiums, adding a fixed amount will lead to the same proportion of expenses to premiums as long as expenses do vary by proportion to the premium. Determining which method to use depends on the general and legal expenses associated with the policy, as they relate to commissions on the premium.

Most policies include a margin for unexpected events, like lower-than-expected returns from premium investments.

## Why Net Premiums Matter for Insurers

Net premiums and gross premiums are helpful in figuring out how much an insurance company owes in taxes. State insurance departments often tax insurance companies' income. Tax laws, however, may allow companies to reduce their gross premium by figuring in expenses and unearned premiums. Insurers in the United Kingdom use an [annual premium equivalent (APE)](https://www.investopedia.com/terms/a/annualpremiumequivalentbasis.asp) calculation to determine their premium revenue.

For example, if the state of Ohio imposes a tax on gross premiums written by Ohio insurance companies, but the tax does not apply to amounts deducted for reinsurance, it also won't apply to gross premiums not earned because the insurance company or policyholder canceled a policy before it expired.

## Who Pays Net Premium?

Policyholders pay the insurance premiums. The pricing is based on them being either individuals or [part of a group](https://www.investopedia.com/terms/m/member-month.asp). The premiums paid are the costs associated with purchasing insurance for an individual or business.

## What Is the Difference Between Net Premiums and Net Premiums Earned?

Net premiums include written premiums with commissions and ceded reinsurance deducted. It is a measure of the dollar amount of policies written. Net premiums earned is the measure of actual dollars received from premiums sold.

## What Is a Premium Tax Credit?

A premium tax credit (PTC) is a credit available to families that helps them pay for premiums for health insurance bought through the Health Insurance Marketplace. It is a refundable credit.

## The Bottom Line

Net premium is calculated as the expected present value of the policy's benefits minus the expected present value of future premiums, and it differs from gross premium because it leaves out the costs of maintaining the policy.

This distinction is important for insurers, since both net and gross premiums play a role in managing state tax obligations and ensuring accurate accounting. Using them together helps companies estimate allowable expenses, account for unearned premiums, and stay compliant with tax rules, which can vary by state.

Because of this, precise net premium calculations are essential not only for meeting tax responsibilities but also for optimizing financial planning and expense management.

> **Article Sources**
>
> 1.  Internal Revenue Service. "[The Premium Tax Credit - The Basics](https://www.irs.gov/affordable-care-act/individuals-and-families/the-premium-tax-credit-the-basics)."