Earned Premium
What Does Earned Premium Mean?
The earned premium refers to the portion of an insurance policy’s premium that applies to the expired portion of the policy. Policyholders typically pay their premiums in advance. However, insurance companies do not immediately recognize these premiums as income. Instead, they earn the premium at a consistent rate over the policy’s term. As a result, the portion of the premium that applies to the expired period becomes the earned premium. Conversely, the portion of the premium that applies to the remaining term of the policy is recognized as the unearned premium reserve.
Insuranceopedia Explains Earned Premium
Insurance companies do not immediately treat the premium paid by policyholders as income upon receipt. Instead, they view the payment as fulfillment of the policyholder’s obligations. However, the insurer recognizes that they still have duties to fulfill toward the policyholders. As a result, premiums are initially treated as unearned premiums.
Over time, the insurer gradually shifts the premium status from ‘unearned’ to ‘earned’. This transition occurs at a consistent rate throughout the policy term. The insurer’s obligations end when the policy expires, and at that point, the entire premium is recognized as part of their profits.
Insurers typically calculate earned premiums in the following ways:
- The Accounting Method: In this method, insurers divide the total premium by 365 and multiply the result by the number of days that have passed. For example, if the premium is $365 for a year’s coverage, the earned premium for 100 days would be $100 (i.e., $365 ÷ 365 × 100 = $100).
- The Exposure Method: This method focuses on the premium’s exposure to losses over a specific period. It calculates the portion of the unearned premium exposed to loss during that time. Insurers typically assess various risk scenarios (ranging from high to low risk) based on historical data and apply the resulting exposure to the earned premiums.
