Understanding Unearned Premiums
Unearned premiums represent the portion of an insurance policy premium that has not yet been “earned” by the insurance company, as the policy still has time remaining before expiration.
These unearned premiums are recorded as liabilities on the insurer’s balance sheet since they would need to be refunded if the policy is canceled.
For instance, with a five-year insurance policy that requires $2,000 in premiums annually, at the end of the first year, the insurer has earned $2,000 and holds $8,000 as unearned premiums.
Key Takeaways
- Unearned premiums are the yet-to-be “earned” portion of a policy premium as the policy is still in effect.
- Insurance contract provisions dictate the treatment of unearned premiums.
- Under specific circumstances, insurers may not be obligated to refund unearned premiums.
Understanding Unearned Premiums
Unearned premiums refer to the portion of an insurance company’s total premiums collected in advance, which may be refunded if coverage ends earlier than the premium period.
For example, if a client who prepaid a year of auto insurance has their vehicle declared a total loss after four months, the insurer retains one-third of the premium and returns the remainder as unearned.
Insurance contract provisions, in compliance with relevant regulations, outline the terms for unearned premiums and may specify calculation methods.
In cases like policy termination without cause, insurers might not have to refund unearned premiums, emphasizing the importance of understanding policy terms before switching providers.
However, if the insurer breaches contract terms, the unused premium portion should be refunded.
Unearned Premium vs. Earned Premium
Unearned premiums contrast with earned premiums, which constitute the portion of premiums already “earned” by the insurer for coverage provided.
Earned premiums reflect the payments covering a past policy period, acknowledging the insurer’s coverage during that time.
Example of Unearned Premium
Unearned premiums, considering potential refunds, are listed as liabilities on an insurer’s balance sheet.
For instance, if an insurance company receives $600 for coverage starting February 1 but $600 remains unearned by January 31, it’s marked as a liability until it’s recognized as earned revenue.