What is 'Earned Premium'
Earned premium is a pro-rated amount of paid-in-advance premiums that has been "earned" and now belongs to the insurer. The amount of the earned premium equates to the sum of the total premiums collected by an insurance company over a period of time. In other words, the earned premium is the portion of an insurance premium that paid for a portion of time in which the insurance policy was in effect, but has now passed and expired...but since the insurance company covered the risk during that time, the insurance company can now consider the associated premium payments it took from the insured as "earned."
BREAKING DOWN 'Earned Premium'
The premium that a policyholder pays for an insurance contract is not immediately recognized as earnings by the insurer. While the policyholder has met his or her obligation by paying for the policy and, thus, the benefits that he or she could receive, an insurer has only just begun its obligation when it receives the premium. When the premium is first received, it is considered an unearned premium, not profit. As time passes, however, the insurer incrementally changes the status of the premium from “unearned” to “earned.” Until the policy end date is reached, the insurer is responsible for any claims made, and only when that date is reached will the entirety of the premium be considered profit.
Calculating earned premium
There are two different methods for calculating earned premiums: the accounting method and the exposure method.
The accounting method is more commonly used, and is how earned premium is shown on the majority of insurers' corporate income statements. The calculation used in this method involves dividing the total premium by 365, and multiplying this by the number of days that have elapsed. For example, an insurer who receives a $1,000 premium on a policy that has been in effect for 100 days would have an earned premium of $273.97 ($1,000 / 365 * 100).
The exposure method does not take into account the date that a premium was booked, and instead looks at how premiums were exposed to losses over a given period of time. It is the more complicated method, and involves examining the portion of unearned premium exposed to loss during the period being calculated. The exposure method involves the examination of different risk scenarios (using historical data) that may occur over a period of time – from high risk to low risk scenarios – and applies the resulting exposure to premiums earned.