Earned Premium: Definition and Why It Matters
Earned premium is the portion of an insurance premium that an insurer has recognized as revenue for the coverage already provided during a policy period. Premiums paid in advance start as unearned because the insurer still has an obligation to provide future coverage. As time passes and coverage is delivered, the unearned premium transitions into earned premium.
Key takeaways
- Earned premiums are recognized as revenue only for coverage already provided.
- Unearned premiums represent prepaid coverage for future periods and may be refundable if a policy ends early.
- Insurers commonly use the accounting (time-based) method or the exposure (risk-based) method to calculate earned premium.
- Understanding the distinction helps insurers report finances accurately and helps policyholders know their refund rights.
How earned premium works
When a policyholder pays a premium up front, the insurer records it as unearned premium—an obligation to provide future coverage. The premium becomes earned gradually as days of coverage elapse. Recording premiums as earned over time matches revenue with the period the insurer was at risk and avoids overstating income if claims occur early in the policy term.
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Example: For a one-year policy paid up front, if coverage has been in force for 90 days, the insurer recognizes the portion of the premium corresponding to those 90 days as earned.
Methods to calculate earned premium
- Accounting (time-based) method
- Most common approach.
- Allocates premium evenly across the policy term, often on a daily basis.
- Formula: Earned premium = (Total premium ÷ 365) × elapsed days.
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Example: $1,000 premium, 100 days elapsed → $1,000 ÷ 365 × 100 ≈ $273.97.
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Exposure (risk-based) method
- Focuses on how premiums are exposed to loss over time rather than booking date.
- Uses historical loss patterns and risk scenarios (high-risk vs. low-risk periods) to allocate premium to periods with greater expected exposure.
- More complex and used when risk exposure varies significantly during the policy term.
Earned vs. Unearned premium — practical examples
- If you prepay a six-month car policy and a total-loss claim occurs in month 2, the insurer keeps the premiums for the first two months as earned premium and returns the remaining four months’ prepaid amount as unearned premium.
- For a 12-month policy at $200 per month, cancelling after three months results in $600 kept as earned and $1,800 refunded as unearned.
Why it matters
Accurately distinguishing and calculating earned versus unearned premium ensures:
* Proper revenue recognition on insurers’ financial statements.
Correct handling of refunds when policies terminate early.
Clearer assessment of an insurer’s performance and solvency.
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Bottom line
Earned premium represents the portion of prepaid insurance that corresponds to coverage already provided and is recognized as revenue. Insurers usually calculate it using a straightforward time-based accounting method or, when appropriate, a risk-focused exposure method. Both approaches help align revenue recognition with actual risk and ensure transparent financial reporting.