Unearned premium refers to the premium of an insurance policy that has been paid but has yet to be earned by the insurer as the time period of coverage in which the premium is meant for is in the future.
Unearned premium is a feature built into the mechanism of almost all types of insurance policies and how they work.
For example, a typical medical insurance plan might have an annual premium policy that was paid by the insured on the first day of January. At the end of January, 1 month of that annual premium would have been earned by the insurance company while the premium for the remaining 11 months of the year is unearned.
So if the annual premium was $120, then at the end of January, $10 would be earned premium while $110 would be unearned premium.
This is because even though premiums for the whole year has been paid by the policy holder, the insurer has provided coverage for that first month only.
The remaining 11 months coverage has not occurred. And therefore, unearned from the perspective of the insurer.
Unearned premium reserve (UPR)
Unearned premiums are usually kept in an unearned premium reserve account so that in the event that refunds has to be made, then there is no instances of commingle and a clear record of where the funds are.
Regulations for insurers to maintain such requirements are meant to ensure that the interest of customers are protected. This can also be the case for the pool of reinsurance funds.
But insurers might not be required to main the exact amount of unearned premiums, and are to keep a unearned premium reserve requirement instead.
By right unearned premiums are money that don’t belong to insurers until they have been earned. These monies are meant to be kept safely until requirements are met before insurers can take them into account as sales revenue.
The irony is that many policy holders today are still not aware that there is such a thing as unearned premium and that they would receive the unspent amount of their premiums back when they terminate their policies.
Having this knowledge, a consumer might find it an easier decision to make should he or she be considering whether to terminate a policy.
On the other hand, insurers would find it to their benefit that consumers are not aware of such practices as people who assume that their premiums are paid and non-refundable would most probably retain their policies until it’s renewal date before allowing them to lapse.
There is also such a thing as unearned premium insurance.
For such plans, the insured would be able to have the unearned premiums on their policies returned to them.
For example, a whole year of property fire insurance might have been purchased by a factory owner. And in the fourth month of the policy, the building burned down resulting in full condemnation and total loss. The insurance company would payout according to the coverage and claims. But as there is no property to insure for the fire insurance policy from the fifth month onwards, premiums for the remaining 8 months of pro-rata unearned premium might be reimbursed to the policy holder. This is assuming that there is no administrative costs incurred by the insurer to account for.
The example above can also occur for disability insurance policies.
