Gross/Net Premium Methods

Discussion in 'Practice modules' started by dee22, Jun 19, 2011.

  1. dee22

    dee22 Member

    (P0 - Unit 4 - Page 5 - Section 1.4.1.3 Liabilities)

    "Regulatory basis life firms must use a net premium method for valuing non unitised with profits business. Realistic basis life firms have the option to use a gross premium method."

    Presumably these are different methods for capitalising expected future outgoings net of expected future premium income, but really I'm drawing a blank here.

    Would someone mind explaining what these methods are, and what the key difference(s) between the methods is(are)?
     
  2. Mike Lewry

    Mike Lewry Member

    The net premium and gross premium methods are prospective methods for placing a value on life insurance policies. In this context, it's for reserving purposes. They are covered in Subject ST2.

    The gross premium method is essentially the present value of all future cashflows associated with a policy:

    GP value = PV(Benefits) + PV(Expenses) - PV(Premiums)

    Since the value of actual expected premiums is deducted, this method capitalises the profit loadings in future premiums. This can be overcome by using a suitably prudent basis.

    Alternatively, a net premium method can be used, which values net premiums instead of actual premiums. The net premium is that premium which is sufficient, on the valuation assumptions, to provide the benefits guaranteed at outset. So:

    NP value = PV(Benefits) - PV(Net Premiums)

    Since the net premiums are re-calculated whenever there is a change in basis, this method is relatively insensitive to basis changes when used for regular premium policies.
     

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