DEFINITION OF ‘EARNED PREMIUM’
The amount of total premiums collected by an insurance company over a period that have been earned based on the ratio of the time passed on the policies to their effective life. This pro-rated amount of “paid in advance” premiums have been earned and now belong to the insurer.
INVESTOPEDIA EXPLAINS ‘EARNED PREMIUM’
The premium that a policyholder pays for an insurance contract is not immediately recognized as earnings by the insurer. While the policyholder has met his or her obligation by paying for the policy and thus the benefits that he or she could receive, an insurer has only just begun its obligation when it receives the premium. When the premium is first received it is considered an unearned premium, and is not recognized as profit. As time passes, however, the insurer incrementally changes the status of the premium from “unearned” to “earned”. Until the policy end date is reached the insurer is responsible for any claims made, and only when that date is reached will the entirety of the premium be considered profit.
There are two different methods for calculating earned premiums: the accounting method and the exposure method.
The accounting method is more commonly used, and is how earned premium is shown on the majority of insurers’ corporate income statements. The calculation used in this method involves dividing the total premium by 365, and multiplying this by the number of days that have elapsed. For example, an insurer who receives a $1000 premium on a policy that has been in effect for 100 days would have an earned premium of $273.97 ($1,000 / 365 * 100).
The exposure method does not take into account the date that a premium was booked, and instead looks at how premiums were exposed to losses over a given period of time. It is the more complicated method, and involves examining the portion of unearned premium exposed to loss during the period being calculated. The exposure method involves the examination of different risk scenarios (using historical data) that may occur over a period of time – from high risk to low risk scenarios – and applies the resulting exposure to premiums earned.