Why is that important?
It’s important to an insurance company because the money that has been earned, is theirs and will not be refunded to a customer in the event that they should cancel or alter their insurance premiums.
It’s important to a customer because the earned premium is money that they have already paid that they cannot ask for a refund on or change the terms of their policy around which the earned premium has been paid.
How do you calculate the earned premium?
It is a fairly simple matter to calculate the earned premium on a policy and a customer can work out their earned premium easily and conveniently using a calculator or even a pen and paper.
Imagine you have an insurance policy which runs for one year and to keep it simple, this policy begins on the 1st of January 2013 and expires on December 31st 2013. It’s not a leap year so there are exactly 365 days over which your policy has to run.
Your policy costs $12,000 at the start of the year which you pay for in one installment on December 31st 2012, so the insurer already has your money but on that day none of it can be classified as “earned premium” because the period of coverage doesn’t start until the next day.
Then let’s say on April 30th you decide you want to cancel your policy for one that better suits your needs and you want to know your earned premium and how much you might get back.
January has 31 days, February has 28 (at least in this example), March has 31 and it’s the 30th of April so that’s another 30 days. In total that’s 120 days of coverage that you’ve paid for.
So your earned premium is 120/365 x $12,000 which is $3,945.21 to the nearest cent. And that means you could expect a rebate of $12,000 minus $3,945.21 (and any fees deducted as part of your policy agreement for early cancellation) of around $8,054.79.