What Is an Earned Premium?
Let me explain what an earned premium is. It's the premium that an insurance company has collected for the part of a policy that has already expired. This is the amount you've paid as the insured for the time the policy was active but has now passed. During that period, the company covered the risk, so they initially see those payments as unearned. Once that time is up, they can record it as earned or as profit.
Understanding Earned Premiums
You need to know that earned premiums are a standard term in the insurance world. Since policyholders like you pay premiums upfront, insurers don't count them as earnings right away. Your payment meets your obligation and gives you benefits, but the insurer's duty starts when they get the premium.
When you pay the premium, it's labeled as unearned—not profit yet. That's because the company still has to provide coverage. They can only shift it to earned status once the full premium turns into profit.
Important Note
Here's something key: for a full-year policy paid upfront and in effect for 90 days, the earned premium covers just those 90 days.
If the company records the premium as earnings before the period ends and you file a claim, they'll have to adjust their books to reverse it. It makes sense to wait on recording it as earnings in case a claim comes in.
Key Takeaways
- An earned premium is the premium for the time the insurance policy was in effect.
- Insurers record earned premiums as revenue after the coverage period expires.
- You can calculate earned premiums using the accounting method or the exposure method.
Special Considerations
There are two ways to calculate earned premiums: the accounting method and the exposure method.
The accounting method is the most common one, used to show earned premiums on most insurers' income statements. You calculate it by dividing the total premium by 365 and multiplying by the number of days elapsed. For instance, if an insurer gets a $1,000 premium for a policy in effect for 100 days, the earned premium is $273.97 ($1,000 ÷ 365 x 100).
The exposure method ignores when the premium is booked and focuses on how premiums are exposed to losses over time. It's more complex, involving the portion of unearned premium at risk during the period. This method examines various risk scenarios from historical data, from high-risk to low-risk, and applies that exposure to the earned premiums.
Earned vs. Unearned Premiums
Earned premiums are those paid in advance that the insurer has now earned and can keep, while unearned premiums are different. These are premiums collected upfront that the company must return to you if coverage ends before the paid period.
For example, if you buy auto insurance and prepay for six months, but you total your car in the second month, the company keeps the premiums for the first two months as earned. They return the remaining four months' worth as unearned. Or, if you pay $200 monthly for a 12-month policy and cancel after three months, the insurer keeps $600 as earned and refunds $1,800 as unearned.
