Premium Income

  

Categories: Credit, Bonds

In certain financial situations, “premium” just stands in as a fancy word for “payment.” Just like "masticate" is a fancy word for "chew," and "Congress" is a fancy word for "disorganized assemblage of blowhards."

Premium, in this sense, comes up in two key situations: insurance and options trading.

For insurance, it represents the money you pay to have an insurance policy. You have car insurance that costs $100 a month. That $100 represents the premium.

For option trading, the premium is the amount spent to purchase an option. Or, if you happen to be selling the contract, the premium is the amount you receive. If it costs $2 to buy a call for 100 shares of MSFT with a strike price of $140, then that $2 represents the premium.

Premium income equals the amount a company or individual brings in through these activities. From the insurance company's perspective, the $100 you send each month contributes to premium income. And if you are selling that MSFT call, the $2 proceeds from the sale provides your premium income from the transaction.

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Finance: What is insurance: deductibles,...8 Views

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and finance Allah shmoop What is insurance Shmoop All right

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people This is you nervous Nellie You're worried about your

00:10

house and well here is your house Your house and

00:13

Lynn carry a book value I eat what you paid

00:15

for it last year of $300,000 You realise that some

00:19

night you may hear it rumbling and it won't be

00:21

from your stomach And you'll come fully awake surfing on

00:23

your chimney at 90 miles an hour down the road

00:26

If this happens you're home will become duck Disneyland And

00:29

well it's 300,000 Dollar value will likely be worth something

00:32

close Teo zero You can stomach paying $10,000 from these

00:37

damages out of your own piggy bank to go find

00:39

a new home But you want someone else to pay

00:41

the $290,000 gap to go buy an equivalent place somewhere

00:45

else with a you know nice view of the valley

00:48

Good thing you bought term real estate insurance That is

00:51

You pay 800 bucks a month What's called a premium

00:54

in return for a Sam Schmucks insurance company being willing

00:57

to pay for a new home for you showed your

00:59

old home B You know damn well that $800 premium

01:02

you pay every month is a bet that the insurance

01:04

company is betting your house will be fine and trust

01:07

us They want your house to be fine because well

01:09

then they can keep collecting your monthly premiums almost 10

01:11

grand a year and sit on their hands In the

01:14

meantime an update their Facebook pages and the economics makes

01:17

sense Sam Schmuck insures 49 other homes just like yours

01:20

collecting 10 grand a year from each for total revenues

01:23

Sam Schmucks of 500,000 bucks a year if they had

01:25

to replace an entire home at a cost of 290,000

01:29

every year Well Sam schmuck is still profiting handsomely from

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the engagement You're on the other end of the bed

01:34

Your bed in your house will not be fine Otherwise

01:37

you probably would not have gotten the insurance in the

01:39

first place You wanted to have that safety net for

01:42

your worry Well this is the stuff of insurance reducing

01:45

risk by entering a contract where one party agrees to

01:48

compensate another party in the case of specific damage or

01:51

losses in exchange for premium payments Yeah that's insurance You

01:55

pay the insurance company premiums every month and they pay

01:57

you well when you need it If you're home isn't

02:00

washed away this month well then you lose all 800

02:03

bucks premium that you've paid And Sam Schmucks Insurance Company

02:06

keeps it so you can do the math if 10

02:08

years go by and your house still hasn't been washed

02:11

away While Sam Schmuck has collected 10 years of a

02:13

10 grand per year from you and since that money

02:16

is reinvested in bonds and stocks and other investments while

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Sam Schmucks earnings are compounding that is Sam's rolling in

02:24

all that premium payment money and the interest he's earning

02:26

on it invested collectively after 10 years Well if it

02:30

follows a roughly with the markets do thereabouts it'll double

02:33

or more to clarify That is 10 years of 10

02:36

grand and payments is only 100 grand Yet your home

02:38

has financial exposure to Sam Schmuck of 290 grand So

02:42

how is it that 10 years of payments totaling 100

02:44

grand can be worth 290 Well when Sam receives your

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money he invested in some form of the stock and

02:50

or bond market and that money then earns a financial

02:53

return such that it grows at a nice clip And

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he's presuming that your home will last at least 10

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years before it gets Ah washed away to the sea

03:00

And remember he has dozens of homes He's ensuring and

03:02

all those will likely not get washed away Right So

03:05

yes we're guessing on the numbers But it's pretty reasonable

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to think about numbers doubling in and changing or so

03:10

like that in every decade and change But what if

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your house did wash away well After all it's in

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an obviously precarious position and you just couldn't say no

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to the view Could you worth the risk You told

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yourself if you woke up one day to beavers as

03:22

your new neighbors Well you'd be looking to Sam Schmuck

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to pay acclaim and get that insurance dough to go

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buy another home But First Mister Schmuck reminds you that

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you must pay the $10,000 deductible deductible is the dough

03:34

you pay first before the insurance company's money kicks in

03:37

Well this means that in a calamity you must pay

03:39

for the 1st 10,000 bucks before you see any dollars

03:42

from Sam Schmucks Insurance Company Sam Schmucks Insurance Company and

03:45

deals and all kinds of shmoop O R Insurance You've

03:48

got health insurance betting on your health continuing its life

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insurance betting on you living another month car insurance button

03:54

on your car's life homeowner's insurance betting on your home's

03:57

life like that property insurance betting on your possessions and

04:00

someone when the risk makes you feel uncomfortable enough while

04:03

so much so that you're willing to pay to reduce

04:05

that risk Well somewhere out there and insurance agents Spidey

04:08

senses become engaged and they'll find you Well okay maybe

04:12

I'll type it into Google first Then they'll find you

04:14

Insurance companies stay afloat because while they're working with a

04:16

lot of data to help them make smart bets remember

04:20

every insurance policy is filled with tons of fine print

04:23

Like if you break your pinky toe it's totally covered

04:25

But the tone next to your pinky toe well that

04:27

one's eso Well insurance companies take all of that data

04:30

and crunch the numbers to make policies that are attractive

04:32

enough to get people to buy them But our waited

04:34

enough toward the insurance company is that it's worth it

04:37

for them to take that risk Ideally they'll make few

04:39

payouts and keep the premium payments rolling in But don't

04:42

worry Even insurance companies have insurance like usually other insurance

04:46

companies in a magical dance of risk sharing called reinsurance

04:50

That's why the insurance market doesn't crack into bits when

04:52

an entire city pulls in Atlantis and goes underwater Now

04:56

put your poker face on or some snorkel gear and

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ask yourself What's worth the risk Is it worth it

05:01

to go skydiving without health insurance Is it worth the

05:04

risk to own a house next to a forest without

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fire insurance What's worth those monthly premium payments that go

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down You're draining into Sam schmucks pockets Yeah well only 00:05:13.449 --> [endTime] you can say good luck

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