WHAT IS 'Valuation Premium'

Valuation premium is a rate set by a life insurance company based on the value of the company's policy reserves. A company’s policy reserve represents the present value of the future cash flows of an insurance policy, and the total liability of the insurer is the sum of the actuarial reserves for every individual policy.

BREAKING DOWN 'Valuation Premium'

Valuation premium is a life insurance calculation that bases charges for premiums on the company's liabilities. At times, an insurance company may opt to set a premium lower than the calculated valuation premium if their experience and statistical records indicate that a lower premium is justified. In the event that a lower premium is charged, the insurance company would be obligated to hold the difference in a deficiency reserve.

When determining the figure of the valuation premium, the company first ensures that it has adequate policy reserves to cover payouts. Once it determines the value of the policy reserves, the insurance company can calculate the valuation premium that will cover its liabilities. In this manner, the insurance company can make sure that it will have the assets necessary to cover all of its policies.

Valuation premiums help ensure an insurance company stays financially solvent and has the necessary means to answer to the claims that may arise from the policies it underwrites. Higher valuation premiums correspond with higher risks and values of covered assets or items.

Putting Valuation Premiums Into Context

Life insurance is a contract between an insurer and a policyholder in which the insurer guarantees payment of a death benefit to named beneficiaries upon the death of the insured. The insurance company promises a death benefit in consideration of the payment of premium by the insured.

The amount of insurance premiums charged by the insurance companies is determined by statistics and mathematical calculations done by the underwriting department of the insurance company. The underwriting process involves investigation into familial diseases, analysis of reports like medical information and motor vehicle reports. Statisticians hired by the insurance company known as actuaries analyze the data, and attempt to predict how likely the insurance applicant will be to make a claim on their policy. The higher the probability of a claim, the higher the premiums usually are.

Regulated insurers are required to offset assets to cover liabilities. The life insurance company’s valuation premium is the amount of premiums paid by policyholders that is set aside for mandated reserves.

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