Getting to grips with net written premium is actually pretty straightforward. The concept is, thankfully, simple. The Net Written Premium of an insurance company is simply the total value of the premiums that will be retained by an insurance business.
Calculating Net Written Premium
Premiums Written + Reinsurance Assumed – Reinsurance Ceded = Net Written Premium
In essence this is, hopefully, an obvious idea. The cash value of all premiums that have been written is added to the value of any reinsurance that the insurer is covering and then you subtract the cash value of any reinsurance that the insurer has take out to reduce their risk profile. The final value f net written premium represents a cash in the bank figure.
Insurers and Brokers – Net Written Premiums
I’ve found it a little more difficult to come to a conclusion for brokers. If we assume the commonly held calculation for net written premiums is correct for insurers. Then it would appear that the equation for brokers would be:
Premiums Written = Net Written Premium
Though I suspect it’s more likely to be:
Premiums Written – Payments to the Insurer = Net Written Premium
We’d be interested in hearing from brokers on this, what formula do you use to calculate net written premium in your brokerage? Or is this simply a restatement of Gross Broking Income?
The Purpose of Net Written Premium
The purpose of the calculation is to uncover how much of the premiums paid are kept by the insurer or the broker.
This figure is of value because it enables a rough measure of the “financial health” of an insurer or broker. If net written premium rises over time – it suggests that the business is growing, though it does not offer an opinion on the validity of risk controls.
It would be, theoretically, possible for a ponzi scheme approach to insurance (e.g. taking premiums at too low a value and using them to pay out on claims based on the idea that under-valuing insurance products would create a large growth in sales – though that growth would ultimately be unsustainable and collapse under the weight of claims over time) that would show large growth in net written premium but the insurer would be destined for failure nonetheless.
A decline in net written premiums is an indicator of a lower level of custom at that insurer or a decrease in the profitability of policies underwritten. This may show a failure to compete in the market or simply a market which has become overly price competitive.
Partial Payments and Net Written Premium
Given that insurance policies may be paid weekly, monthly, annually, etc. it’s important to take into account the payment schedule when calculating net written premium. As it is a measure of cash flow, it seems reasonable to assume that only premiums collected may be taken into account as part of the calculation. Again, we’d like to hear from brokers and see how that works in practice – please leave a comment at the bottom or send us an e-mail if you’d like to add something on this.