An unearned premium for an insurance policy is the payment you have made in advance, minus the amount of time that your policy has covered. An unearned premium reserve affects the refund you may qualify for if you decide to cancel your coverage. The unearned premium calculation is an inverse relationship where your earned premium goes up each month of your policy while your unearned premium shrinks.
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UPDATED: Oct 30, 2020
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When you take out an insurance policy in the United States or elsewhere you may elect to or be required to pay premiums for the whole of a coverage period or extended part of the coverage period of your policy.
Insurance companies do not consider this money to be “earned” in terms of being able to be placed in their assets, until such a point as the period for which the payment has been made is expired. So unearned premium is essentially the payment you have made in advance, less the amount of time that has been already covered premium.
For example; you take out a one year auto insurance policy and the total premium payable to the insurer is $1,200 for the year, you are offered a small discount for paying the full sum in advance and you agree to do so.
On the day before the policy starts the unearned premium is $1,200 as none of the sum has yet been used to pay for any coverage, and the earned premium is conversely $0.
After 3 months of your policy, the unearned premium is now $900 and the earned premium is $300.
After 6 months, the unearned premium has fallen to $600 and the earned premium risen to $600.
And after 9 months clearly the unearned premium will be $300 and the earned premium $900.
And so on…
Why is the unearned premium important to me?
Some, though not all, policies enable the policy holder to cancel the policy during the term of coverage. The policy holder would then normally expect to be refunded some portion of the unearned premium; of course the precise amount will depend on the individual insurance contract.
This is known as a pro-rated refund of premium and it’s based on a calculation of the unearned premium of any particular policy.
How do I know how much I would be refunded?
There’s no way of telling without examining your insurance contract as each insurer and policy may have different conditions on the return of premiums. If you’ve read your insurance contract and don’t understand how a refund may apply – you should talk to your insurance agent or insurance broker to find out. They will understand the terms of your insurance contract and be able to determine the precise figure for you.
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Additional Unearned Premium Definitions
- IRMI.com – That portion of the policy premium that has not yet been “earned” by the company because the policy still has some time to run before expiration. A property or casualty insurer must carry all unearned premiums as a liability in its financial statement since, if the policy should be canceled, the insurer would have to pay back a certain part of the original premium.
- Investopedia – The premium corresponding to the time period remaining on an insurance policy. Unearned premiums are proportionate to the unexpired portion of the risk, for which coverage has been sought by the insured party.