Premium

Detailed Definition

In accounting and finance, “premium” can have multiple meanings based on context:

Insurance Premium: This refers to the consideration payable for a contract of insurance or life assurance. It is the amount paid, often periodically, by the policyholder to the insurer for coverage against specific risks.
Share Premium: This is an amount in excess of the nominal (or par) value of a share. When shares are issued at a price higher than their nominal value, the extra amount is considered the premium.
Issue Price Premium: This indicates an amount in excess of the issue price of a share or security. When new shares are issued and start trading in the market, the market price may be higher than the issue price, reflecting a premium.

Examples

Example 1: Insurance Premium

John purchases a life insurance policy, and the insurer charges him an annual premium of $1,200. John agrees to pay this amount every year for the coverage provided by the insurance policy.

A company’s share has a nominal value of $1. However, due to strong market demand and the company’s robust performance, the company issues new shares at $5 each. The $4 difference between the nominal value and the issue price is considered the share premium.

Example 3: Premium Over Issue Price

A startup company issues shares at an initial public offering (IPO) price of $10 per share. After the IPO, the shares begin trading on the open market at $15 per share. The $5 difference is the premium over the issue price.

Frequently Asked Questions

What factors influence the premium for an insurance policy?

Factors include the type of coverage, the policyholder’s personal details (such as age and health), the amount of coverage, and the insurance provider’s underwriting policies.

Share premium is recorded in the equity section of a company’s balance sheet, typically in a separate account called the “Share Premium Account.”

Can the insurance premium change over time?

Yes, insurance premiums can change due to various factors, such as changes in the policyholder’s risk profile, inflation, or changes in underwriting guidelines.

What does it mean when shares are trading at a premium?

It means the market price of the shares is higher than their nominal value or issue price. This can indicate positive market sentiment or strong company performance.

How is the premium calculated for newly issued shares?

The premium is the amount by which the issue price of the new shares exceeds their nominal value. For example, if the nominal value is $2 and the issue price is $10, the premium is $8.

Nominal Value: The face or par value of a financial instrument, such as a share or bond, as stated by the issuer.
Issue Price: The price at which new securities are offered to the public by the issuer during an initial sale.
Stag: An investor who subscribes to a new issue of shares with the intention of selling them quickly to profit from any premium over the issue price.

Online References

Suggested Books for Further Studies

“Insurance and Risk Management” by C. Arthur Williams Jr.
“Corporate Finance” by Stephen A. Ross, Randolph W. Westerfield, and Jeffrey Jaffe
“Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
“Financial Accounting” by Jerry J. Weygandt, Donald E. Kieso, and Paul D. Kimmel
“Essentials of Insurance: A Risk Management Perspective” by Emmett J. Vaughan and Therese Vaughan

Accounting Basics: “Premium” Fundamentals Quiz

### What is an insurance premium? - [ ] A fee charged for issuing a share. - [x] Consideration payable for a contract of insurance. - [ ] An extra bonus paid by the insurer to the insured. - [ ] The nominal value of an insurance policy. > **Explanation:** An insurance premium is the amount paid by the policyholder to the insurer for coverage against specified risks as part of a contract of insurance or life assurance. ### What constitutes a share premium? - [ ] The amount equal to the nominal value of a share. - [x] An amount in excess of the nominal value of a share. - [ ] The cost of insuring the share. - [ ] The market discount on the share. > **Explanation:** A share premium is the amount received by a company issuing shares that is in excess of the nominal value of the shares. ### How can market investors identify a premium over the issue price? - [ ] When shares are trading below the issue price. - [ ] By comparing the nominal values of different shares. - [x] When the market price of shares exceeds the issue price. - [ ] By the year-on-year profitability of the company. > **Explanation:** When the market price of shares is higher than the issue price, it indicates that shares are trading at a premium over the issue price. ### Why might an insurance premium increase? - [x] Changes in policyholder’s risk profile. - [ ] Fixed-rate contracts. - [ ] Decreased coverage benefits. - [ ] Guaranteed renewables. > **Explanation:** Insurance premiums might increase due to changes in the policyholder’s risk profile, inflation, or changes in the insurer's underwriting guidelines. ### On which financial statement is share premium accounted for? - [x] Balance Sheet - [ ] Income Statement - [ ] Cash Flow Statement - [ ] Notes to Financial Accounts > **Explanation:** Share premium is recorded in the equity section of a company's balance sheet, usually in a separate account called the Share Premium Account. ### Who uses the term "insurance premium"? - [ ] Investors purchasing shares. - [x] Policyholders and insurers. - [ ] Tax consultants. - [ ] Real estate agents. > **Explanation:** The term insurance premium is used by policyholders and insurers regarding the amount paid for insurance coverage. ### What does 'trading at a premium' signify about a company's stock? - [ ] It is losing value. - [x] The current market price is above the nominal or issue value. - [ ] The company is issuing more shares. - [ ] The shareholders are receiving dividends. > **Explanation:** 'Trading at a premium' signifies that the company's stock is currently priced above the nominal or issue price, reflecting positive market sentiment. ### What is required for an insurance premium to be paid periodically? - [ ] A lump sum payment agreement. - [ ] Fixed maturity date. - [x] Installment payment schedule. - [ ] Increase in coverage benefits. > **Explanation:** Insurance premiums are often paid periodically according to an installment payment schedule agreed upon by the policyholder and the insurer. ### When can a new issue of shares be at a premium? - [ ] When shares are undervalued. - [ ] When the nominal value exceeds the issue price. - [x] When the market perceives increased value. - [ ] When the company declares bankruptcy. > **Explanation:** A new issue of shares can be at a premium when the market perceives increased value of the company, resulting in a higher market price than the issue price. ### Which part of the balance sheet reflects share premium? - [ ] Current Liabilities section - [ ] Non-current Assets section - [x] Equity section - [ ] Revenue section > **Explanation:** The share premium is reflected in the equity section of the balance sheet, usually under the Share Premium Account.

Thank you for exploring the multi-faceted term “premium” and participating in our quiz on its applications in the field of accounting and finance. Stay knowledgeable and enhance your financial literacy!