Unearned Premium
Key points
Unearned premium is the portion of a paid insurance premium that covers future periods and has not yet been earned by the insurer.
It is recorded as a liability on the insurer’s balance sheet because it may need to be returned if coverage ends early.
As time passes and coverage is provided, unearned premium is moved from liability to revenue (earned premium).
Contract provisions and local regulations govern how unearned premiums are calculated and when they must be refunded.
What is an unearned premium?
An unearned premium represents advance payment for insurance coverage that has not yet been provided. Because the insurer still owes coverage for the remaining policy term, that portion of the premium is treated as a liability until the coverage period elapses.
Why it’s a liability
If a policy is canceled or coverage ends early, the insurer may have to return the unused portion of the premium. Until coverage is delivered, the insurer cannot recognize that amount as revenue, so it is recorded as unearned premium (a current liability).
How it’s calculated
Unearned premium is typically calculated on a pro rata basis:
* Unearned premium = Total premium × (Remaining policy time / Total policy time)
Specific contract terms or local regulations may require different formulas (e.g., short-rate vs. pro rata refunds) and can affect the refund amount when a policy is terminated.
Accounting treatment
At receipt: Premiums received in advance are recorded as cash (asset) and unearned premium (liability).
Over time: As coverage is provided, the insurer recognizes earned premium by transferring the pro-rated amount from the unearned premium liability to revenue on the income statement.
Example: An insurer receives $600 for coverage from Feb 1 to July 31. On Jan 31 the entire $600 is unearned (current liability). Each month a portion is moved to revenue as coverage is delivered.
Common examples and refund scenarios
Prepaid multi-year policy: If a five-year policy is fully prepaid at $2,000 per year (total $10,000) and one year has passed, the insurer has earned $2,000 and has $8,000 unearned remaining.
Total loss mid-term: A policyholder prepaying one year of auto insurance suffers a total loss after four months. The insurer keeps the earned portion (4/12 of the premium) and should refund the unearned two-thirds (8/12) unless contract terms or applicable law state otherwise.
* Cancellation and nonrefund situations: Refunds depend on policy provisions and law. An insurer may not owe a refund if the policyholder materially misrepresented facts, or if the policy specifies nonrefundable terms under certain conditions. Conversely, if the insurer breaches the contract, any unused premium should generally be returned.
Unearned premium vs. earned premium
Unearned premium: Money received for future coverage—recorded as a liability until coverage is provided.
Earned premium: The portion of premium that corresponds to coverage already provided—recognized as revenue.
Bottom line
Unearned premium reflects insurer obligations for future coverage and ensures premiums are recognized as revenue only as the risk is borne. Policy language and regulation determine the precise calculation and refund rules.