Noun
earned·pre·mi·um | ˈər-nəd ˈprē-mē-əm
Definition: The portion of payment for an insurance policy representing the duration of the policy term that has elapsed.
Ron cancelled his insurance policy and received a full refund less the earned premium.
When you buy an insurance policy, the price you pay is known as the premium.
You’ll usually pay premiums in advance, to cover the whole duration of your policy term. That term is normally one year. Most providers (like Square One) offer monthly payment options, but you might also choose to pay for the full term up front.
When you pay in advance, the insurance provider hasn’t actually earned all of that money until the year has passed. Since you’re exchanging the money for a year of insurance coverage, the insurer must provide that year of coverage before they’ve earned the premiums—that’s when we call it earned premium. When you’ve paid, but the coverage time hasn’t elapsed, it’s called unearned premium.
Insurers don’t earn premiums all at once; they earn them progressively over the life of the policy:
Mathilde bought a new tenant insurance policy with a term of one year. She paid $240 for the full year of coverage.
At the moment she bought the policy, all $240 were unearned premiums, because her insurer hadn’t spent any time insuring anything. After one month, or one-twelfth of the policy term, her insurer had earned one-twelfth of the $240—or $20. The remaining $220 in premiums were still unearned.
At the end of the year, there were no longer any unearned premiums. The insurer had held up their end of the deal, offering coverage for the full year, so they’d earned the full $200.
Based on this example, you can see how an insurer earns premiums over time. But why does the difference between earned and unearned premiums matter?
Insurance companies care about earned and unearned premiums because only earned premiums represent actual revenue. That’s mainly because they may have to return unearned premiums to their customers.
When an insurance customer cancels their policy before the term ends, they’ll receive a refund of any unearned premiums:
Mathilde needs to cancel her $200/year tenant insurance policy after only six months, because she’s moving to a new province.
Since only half the policy term has elapsed, her insurer only earned half the premiums ($100). When she cancels her policy, her insurer refunds her the unearned $100.
Insurers need to hold on to unearned premiums just in case they need to issue refunds. That’s the main reason a customer might care about this topic: unearned premiums are what they’d normally receive if they cancel.
You can calculate earned premium the most basic way with this equation:
(total premium / days in policy term) * days elapsed = earned premium
That’s assuming your insurer calculates earned premiums daily, of course.
Some insurers may also use the exposure method to calculate earned premiums. This method is more complex, involving a calculation of how premiums relate to loss exposure over a given period of time—but don’t worry about it.
The simpler (and more common) method of calculating earned premiums is called the accounting method. After all, from the insurer’s perspective, earned and unearned premiums are an accounting issue.
Unearned premiums are unearned revenue. Unearned revenue is still money, and the insurer can use that money to pay claims or salaries or heating bills. But, unearned revenue is recorded as a liability on the company’s balance sheet—they can’t report it as income until they’ve earned it.
That’s not important unless you’re an accountant working with an insurance company, of course. If you’re buying insurance, unearned premiums matter only if you cancel your policy. Which brings us to one final point:
At the moment your new insurance policy comes into effect, the insurer hasn’t earned any premiums, right?
Not quite.
Most of the time, a policy will feature a minimum earned premium, also known as a minimum retained premium. This is the amount that the insurer earns simply by issuing the policy. After all, there is an administrative cost associated with selling any policy. Agents spend their time, banks charge for payment processing, and there are always ongoing operational costs.
Square One’s minimum retained premium is $50, for example.
If you buy a policy and cancel it immediately (for some reason), you’ll receive a full refund minus the minimum retained premium. Once you’ve paid more than that minimum in total premiums, you’ll get a refund of all unearned premiums.
Looking for another insurance definition? Look it up in The Insurance Glossary, home to dozens of easy-to-follow definitions for the most common insurance terms. Or, get an online quote in under 5 minutes and find out how affordable personalized home insurance can be.
About the expert: Daniel Mirkovic
A co-founder of Square One with 25 years of experience in the insurance industry, Daniel was previously vice president of the insurance and travel divisions at the British Columbia Automobile Association. Daniel has a bachelor of commerce and a Master of Business Administration (MBA) from the Sauder School of Business at the University of British Columbia. He holds a Canadian Accredited Insurance Broker (CAIB) designation and a general insurance license level 3 in BC, Alberta, Saskatchewan, Manitoba and Ontario.
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