Earned Premium

Definition

Earned premium is the portion of an insurance premium that represents coverage already provided by the insurer. It is the payment received by an insurance company for the period of time an insurance policy has been in force and active, thus reflecting the exposure the insurer has already accounted for. In other words, earned premium is the amount the insurer has earned by providing insurance protection up to a specific point in time.

Phonetic

The phonetic pronunciation of “Earned Premium” would be:ɜrnd ˈpriːmiəm

Key Takeaways

1. Earned Premium represents the portion of an insurance premium which has been “earned” by the insurance company through providing coverage for an agreed-upon period. As time passes and the insurer bears the risk for the insured party, the proportion of the premium considered “earned” increases.
2. Earned Premium is a key performance indicator (KPI) used by insurance companies to measure their financial performance. It provides insight into the revenues generated from providing insurance coverage, and it can be used to analyze growth, profitability, and risk exposure on the company’s book of business.
3. Calculation of Earned Premium can be done using two methods: the pro-rata method and the exposure method. The pro-rata method calculates earned premium by dividing the premium by the total policy term and then multiplying it by the number of days that have elapsed. The exposure method calculates earned premium based on the actual exposure of the insurance company to potential risks during the policy period and adjusts for any changes in the insured party’s risk profile.

Importance

The business/finance term “Earned Premium” holds significant importance as it represents the portion of an insurance premium that corresponds to the coverage provided by the insurer during a specific period. It serves as an essential metric to determine the financial stability and profitability of an insurance company. By measuring the earned premium, companies can accurately assess their risk exposure and make informed decisions regarding underwriting policies and pricing strategies. Additionally, this financial indicator helps regulators, investors, and creditors analyze the performance and solvency of insurance companies, thereby influencing investment and lending decisions. Overall, earned premium plays a vital role in managing an insurer’s position in the market and assessing their performance.

Explanation

Earned Premium plays a vital role in the insurance industry by reflecting the portion of the policy premium that has been utilized to provide coverage for a specific period. This metric is crucial for both insurers and policyholders, as it enables insurance companies to evaluate their financial performance, profitability, and claim-paying potential while ensuring that policyholders are accurately charged for the provided coverage. Calculating earned premium is essential for insurers to maintain a healthy financial position by ensuring that their revenue is adequately aligned with the policy risks they have undertaken. For policyholders, earned premium serves as an indicator of how much insurance coverage has been utilized; in the event of policy cancellation or adjustment, this information helps determine any potential refund they are entitled to. In addition, earned premiums can be used to gauge the effectiveness of premium pricing techniques and strategies among competing insurers. In the broader context of the finance and business world, earned premiums play an essential role in the assessment of the insurance sector’s stability, as they provide insights into the financial strength and solvency of insurance companies. This not only affects the decision-making process of stakeholders but also has an impact on the overall economy.

Examples

Earned premium refers to the portion of an insurance policy’s premium that has been “used up” or recognized as revenue over a specific policy period. It is a crucial financial metric used by insurance companies to measure the amount of coverage provided relative to premiums collected. Here are three real-world examples of earned premium in business and finance: 1. Auto Insurance: Consider a situation where a person buys a one-year auto insurance policy from an insurance company for a total premium of $1200. Six months into the policy, the insurer will have recognized half of the premium, or $600, as earned premium. This is because the insurance company has provided coverage for six months out of the twelve-month policy period .2. Health Insurance: Suppose an individual purchases a health insurance plan with a yearly premium of $2400. After three months into the plan, the insurance company would have recognized a quarter of the premium or $600 as earned premium. This is because the insurer has provided coverage for three months out of the twelve-month policy period. 3. Homeowner’s Insurance: A homeowner secures a home insurance policy for a one-year period with a total premium of $3600. Nine months into the policy, the insurer will have recognized 75% of the premium, or $2700, as earned premium. This represents the insurer’s revenue for providing nine months of coverage under the policy.In each of these examples, the earned premium represents the portion of the premium already used and recognized as revenue by the insurance provider for covering the respective policyholder during a specific period.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Insurance Revenue
• Underwriting Profit
• Risk Pricing
• Policy Period
• Unearned Premium

Sources for More Information

• Investopedia
• Corporate Finance Institute
• Insuranceopedia
• The Business Professor