Direct Earned Premium Definition

Minimum Earned Premium Definition

Some policies have a minimum earned premium stated. This number is the amount the insurance company sets for an earned premium, even if you have not yet reached a specific amount after signing a policy.

If your medical malpractice premium is $12,000 per year, and the policy indicates a minimum earned premium of $3,000, the insurer will be able to retain $3,000, even if you cancel after a month or two.

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Example 1

Let’s take an example of an insurance company that has written an insurance policy of $1,000.0 on June 30. The policy provides cover for the next year, and the insurance company has a fiscal year-end of December 31.

The gross written premium for the policy is $1,000.0. However, the insurance company has provided only 50.0% of the insurance cover during the year to December 31. Therefore the gross earned premium will be $500.0.

What Are Typical Minimum Earned Premium Rates for Medical Malpractice Insurance?

The minimum earned premium can vary widely, which is why it is always important to review any policy before accepting. In some cases, the amount can be modest, and in others, it can be significant. Rates may vary from 0 to 100 percent because malpractice policies tend to be for large amounts of money.

How Earned Premium Works

Most authorized insurers in the United States must follow Statutory Accounting Principles (SAP). These are closely related to Generally Accepted Accounting Principles (GAAP) and use the same fundamental framework.

These accounting principles generally require that insurance companies recognize revenues from premiums when they earn them, not necessarily when you pay them. That can happen at different times, depending on whether the policy in question is a short-duration contract or a long-duration contract.

Short-duration contracts provide coverage for a fixed period, usually no more than three to five years. These include most property and liability insurance contracts, such as homeowners insurance and liability auto insurance.

Insurers earn premiums from short-duration contracts by providing coverage for the financial risks outlined in your policy throughout its term. As each day in the term passes, the insurer records a little more of your premium as revenue. For example, if a policy has a 100-day term, the insurer would earn 1% of the total premium each day until coverage expires.

Long-duration contracts have a much longer (sometimes indefinite) coverage period that can last for decades. Most life insurance policies fall into this category, including permanent policies and term policies. For long-duration contracts, insurers earn their premiums on the dates they’re due.

If either you or your insurance provider cancels the policy partway through the term, you might not be able to recover any amounts the company has recorded as earned premium. Be aware that insurers may calculate their final earned premium slightly differently depending on the reason for cancellation.

How To Calculate Earned Premium

Here’s an example of an earned premium calculation. Say you have an insurance policy with a $2,000 premium. The first half is due on Jan. 1, the first day of coverage, and the second is due on July 1. You make the first payment on time.

If your policy is a short-duration contract, the insurer would record earned premium as the term passes. By March 31, after three of the 12 months (25%) of your policy term, the insurer would record 25% of the annual premium as revenue. That’s $500 in earned premium, even though you’d already paid $1,000, because the insurer won’t have earned the other $500 until June 30 (halfway through the policy term).

If your policy is a long-duration contract, the insurer would record premiums as revenue on the payment due dates. When you paid 50% of the annual premium on Jan. 1, they would have recorded your $1,000 as earned premium. They would not earn any additional premiums from you until your next due date in July.

The Accounting Method:

Unlike the exposure method, the accounting method is a lot easier to calculate and is the most commonly used method for earned premiums. The method is used to show earned premiums for the majority of insurers’ income statements.

To calculate, insurers will divide the total amount of premium by 365 and then multiple the rest by the days that have passed. For example, an insurer receiving a premium of $2000 on a policy that has been running for 200 days would have an earned premier of $547.95.

Formula: Premium Amount/365 X Days policy has been in effect.

How to Calculate Earned Premium?

The earned premium can be calculated in two ways – the accounting method and the exposure method.

The Accounting Method

This is the most commonly used method for calculating the earned premium. This method is used to indicate earned premium on most of the insurers’ corporate income statements.

The Exposure Method

The exposure method will not consider the date on which a premium is reserved. As an alternative, it considers how premiums are exposed to losses over a set period of time. It is a complex method and comprises inspecting the portion of the unearned premium exposed to loss during the period of calculation.

The exposure method will include the inspection of various risk scenarios via historical data that might occur over a time frame, between high-risk and low-risk scenarios, and applies the resulting exposure to the earned premiums.

Understanding Earned Premiums

An earned insurance premium is commonly used in the insurance industry. Because policyholders pay premiums in advance, insurers don’t immediately consider premiums paid for an insurance contract as earnings. While the policyholder meets their financial obligation and receives the benefits, an insurer’s obligation begins when it receives the premium.

When the premium is paid, it is considered an unearned premium—not a profit. That’s because, as mentioned above, the insurance company still has an obligation to fulfill. The insurer can change the status of the premium from unearned to earned only when the entire premium is considered profit.

The earned premium for a full year policy, paid up front and in effect for 90 days, would be for those 90 days.

Say the insurance company records the premium as an earning, and the time period hasn’t elapsed. But the insured party files a claim during that time period. The insurance company will have to reconcile its books to unwind the transaction listing the premium as an earning. So it makes more sense to hold off on recording it as an earning in the event that a claim is filed.

Key Takeaways An earned premium is the premium used for the time period in which the insurance policy was in effect.Insurance companies can record earned premiums as revenue after the premium's coverage period expires.Earned premiums can be calculated by using the accounting method and the exposure method.

Where to find Gross Earned Premium?

Insurance companies disclose the gross earned premium in their quarterly and annual income statements. It is disclosed at the top of the income statement, as it is a revenue item recognized from insurance premiums.

Below is a sample extract from an insurance company’s income statement:

Extract from DLG Insurance Company’s Income Statem

Extract from DLG Insurance Company’s Income Statement for the year ended December 31, 2020

It is worth noting that DLG’s gross earned premium was £3,189.3m in 2020, which is a 0.4% decrease in the gross earned premium in 2019. This reduction in gross earned premium could reflect either a fall in the volume of a new business or competitive pressures reducing the pricing of new business.

Earned vs. Unearned Premiums

While earned premiums refers to any premiums paid in advance that are earned and belong to the insurer, unearned premiums are different. These are premiums collected in advance by insurance companies who are required to give them back to policyholders if coverage is terminated before the period covered by the premium is over.

Say, for example, you take out an automobile insurance policy and prepay for a six-month term. If you get into a car crash and total your vehicle in the second month of the policy, the insurance company keeps the premiums paid for the first two months. These are the company's earned premiums. But the remaining four months' worth of premiums are returned to the insured party. Because they are unused, they are called unearned premiums. Similarly, if a policyholder pays $200 per month for a 12-month insurance policy and decides to terminate coverage after three months, the insurance company keeps $600 as earned premiums and refunds $1,800 to the policyholder as unearned premiums.

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