In the insurance industry, an earned premium is a profit for an insurance company, based on the amount of time that has elapsed under a contract for a policy. While people pay premiums for their insurance up front, the company must “earn” the money by exposing itself to risk on behalf of the insured. In the accounting used by insurance companies, the earned portion can be counted as part of the profit for a given accounting period, while the unearned premium is not.
To determine an earned premium, a person can look at the length of the policy to determine how much time has elapsed. For example, if someone paid a premium for two years of home insurance and a year has gone by, the insurance company has earned half the premium, because the contract is half over. Likewise, if someone paid a premium for a year's worth of car insurance and three months have gone by, the insurance company has earned one quarter of the premium.
This assumes that the insurance company did not have to pay out on the policy. If the insurance company did pay, it may have taken a loss, since the cost of the premium is rarely high enough to cover any serious claims. This is why insurance companies calculate potential losses carefully, because they want to balance out their risks. The goal is to reduce payouts as much as possible to keep profits high, which can be accomplished by underwriting low risk policies and by scrutinizing claims very closely to see if it is possible to deny a claim on the basis of a technicality.
When insurance companies provide statements of account to policyholders, the company should disclose the amount of the earned premium. It is a good idea for policyholders to check to confirm that their records match the insurance company's. For example, if someone buys car insurance in January and receives a statement in June that says the insurance company has earned three quarters of its premium, this is clearly a problem.
The unearned premium is the part of the premium that the insurance company has not yet earned because it has not provided coverage for the full term of the policy. Insurance companies are not allowed to count this as profit and must demonstrate that they have sufficient funds in reserve to cover this amount. Should someone cancel a policy before the end of the term, part of the unearned premium must be returned, although the insurance company may claim a processing fee for handling the cancellation.
