Advance Premium

What Is an Advance Premium?

An advance premium is an initial premium paid to bind an insurance policy for a given period of time. The most commonly known use of the term "advance premium" is with respect to fluctuating insurance payments, such as om payroll-based insurance policies, where the actual amount due is not known until after the fact.

An advance premium can also refer to pre-paid premiums, in which the policyholder makes a premium payment before it is due. Sometimes, he receives a small discount for paying in advance.

Understanding an Advance Premium

Some insurance premiums are actually due in advance of coverage being extended, and the non-payment of the premium will result in the cancellation of the policy. Insurance companies calculate the premium down to the day and apportion your premium due on that basis. You have probably noticed that you pay a little more premium at the start of your policy, and sometimes do not have payments towards the end of the policy term. By calculating and collecting money in advance, the insurance company is saying it will not extend you any coverage prior to your actual payment of the premium.

When you purchase home insurance, you are protecting yourself from future claims that will cause you financial loss. However, the risk of loss is uncertain and insurance, to a certain extent, is a gamble. If you were to pay insurance in arrears, such as you do with your home mortgage payments, the insurance company would have extended coverage and potentially suffered a loss without you paying any premium. If this practice were allowed, insurance companies would go out of business because consumers would only pay premiums after they have suffered a loss and put in a claim.

Advance Premium Funds

When it comes to book-keeping, insurance companies have to account for advance premiums in a special way.

Because the advance premiums paid to an insurer are not yet earned (that is, insurance coverage has not yet been written yet to correspond with those premiums), those funds must be kept in a separate account from the company's operating funds, and cannot be counted as earned income until the insurance coverage has been written.

So, advance premiums have to be noted as a separate liability item on an insurance company's balance sheet. They are listed in what is commonly referred to as the advance premium fund or account.

Advance Premiums and Automobile Insurance

In the case of automobile insurance, insurers must collect an advance premium in order to provide a form of backup to be used in case of a claim. Premiums are usually billed on a monthly basis, and each monthly payment is for coverage during the next month.

At one time, auto insurance policyholders could only pay for auto insurance for six months or one year in advance. This required drivers to exercise forethought and budgeting in order to ensure they had enough cash to foot that annual or semi-annual bill. As more states started requiring their drivers to have auto insurance, however, insurers began offering insurance policies with monthly payments.

Another benefit of advance monthly premium payments is that policyholders will know the due date of their car insurance rather than waiting for the annual bill from their insurer. In such cases, a policyholder can set up automated payments through a debit or credit card. Most insurance companies also have web portals; a policyholder can use them to check and pay monthly payments.