What Are Unearned Premiums?
An unearned premium is the portion of an insurance premium corresponding to the remaining time period on an insurance policy. In simpler terms, it is the part of the premium that the insurance company has yet to earn because the policy is still active.
Unearned premiums are listed as a liability on the insurer’s balance sheet as they may need to be refunded if the policy is canceled before its term ends.
For instance, if at the end of the first year of a fully prepaid five-year insurance policy with premiums of $2,000 annually, the insurer has earned $2,000 and owes $8,000 as an unearned premium.
Key Insights
- Unearned premium signifies the portion of the premium not yet earned by the insurance company due to the policy’s active status.
- Terms governing unearned premiums are outlined in the insurance contract.
- Under some conditions, such as policy fraud, insurers may not need to refund the unearned premium.
Understanding Unearned Premiums
An unearned premium is the segment of an insurer’s total premiums paid upfront by the client, which may need to be refunded if the coverage cancels before the term ends. For example, if a client paid a one-year auto insurance premium but their vehicle gets totaled four months into the policy, the insurer would keep one-third of the premium and return the remaining two-thirds as unearned premium.
Additionally, provisions within the insurance contract dictate the terms for unearned premiums. These must comply with local regulations and may require specific formulas for calculation.
An insurance premium paid is not immediately considered income by the insurer. There are instances, such as misrepresentation in the policy application, where the insurer isn’t obliged to refund the unearned portion.
Insurance providers might also withhold unearned premiums if the cancellation arises from capricious reasons or the wish to transfer to another provider. Policyholders are generally advised to wait till the end of the current policy term before switching providers.
However, if insurers violate the contractual terms, policyholders are entitled to a refund of the unused premium.
Unearned Premium vs. Earned Premium
Unearned premiums differ from earned premiums, with the latter representing the pro-rated portion of paid-in-advance premiums now considered earned due to the insurer providing coverage during that time. In contrast, unearned premiums represent future coverage periods yet served.
For example, the premium earned for coverage provided up to today is reported as income, as opposed to the liability represented by premiums for forthcoming coverage periods.
Example of Unearned Premium
Suppose an insurance provider receives $600 on January 27th for coverage spanning February 1st to July 31st. By January 31st, these $600 hasn’t been earned as the coverage hasn’t begun. Consequently, the insurer logs $600 in its cash account and displays $600 as a liability in its unearned premium revenue account, moving funds from the liability to a revenue account as they provide coverage over time.
Related Terms: earned premium, insurance contracts, balance sheet, liability, provisions, auto insurance, total loss
