Earned Premium refers to the amount of the total premium that has actually been ’earned’ by an insurance company, as it provides coverage over the period of the policy term. Simply put, it is the portion of the policy’s premium that corresponds to the expired portion of the policy.
Explanation
Prepaid Premium: When an insurance policy is purchased, the cost of the policy is often paid upfront. This total amount is known as the prepaid premium.
Allocation: Over the course of the policy term, a part of this prepaid premium is gradually allocated as earned by the insurer. This allocation arises because the insurer is actively assuming risk and providing coverage during this period.
Purpose: This term is crucial in the accounting of insurance companies as it determines the actual revenue generated from the policies. Earned premiums reflect the extent of exposure an insurer has had at any point within the coverage period.
It is a fundamental metric used in the financial statements of insurance companies and affects business decisions and policy pricing.
Importances in Insurance Accounting
Recognizing Revenue: Helps in determining when income is recognized on an accounting basis using guidelines such as those suggested by the Financial Accounting Standards Board (FASB) under generally accepted accounting principles (GAAP).
Financial Analysis: It serves as a key indicator in the assessment of an insurance company’s financial health and operational performance.
Risk Management: The measurement of earned premiums assists insurers in understanding trends, seasonality effects, loss projections, and requisite premium adjustments over time.
For deeper understanding and guidance on terms related to earned premium and insurance financial reporting, referencing regulatory resources like the National Association of Insurance Commissioners (NAIC) and guidelines established by FASB is recommended.
