Unearned premium - Unearned premiums are distinguishable advance premiums, which are premiums charged before the valuation date but which also provide insurance for periods starting after the valuation date. The Code does not further describe unearned premiums, but the 1959 Law regulations provide a description of unearned premiums as any sums which cover the cost of bearing the insurance risk for the duration for which the premiums are paid in advance. This term includes all unearned premiums for the purposes of determining whether an insurance company is a life insurance company are also taken into account in the Section 816 Qualification Fraction denominator (E. Robbins, R. Bush 2014, p. 151).
- The unearned premium reserve represents the premiums paid to the company for not provided insurance. If the plan is cancelled before the term of coverage has expired, the policyholder can receive a refund based on the unearned premium balance. The unearned premium fund is a short-term loan (because most plan coverage periods are one year or less), with no unique characteristics of risk. As the insurance period expires, funds issued from the unearned premium provision are used and transferred to the loss reserve to offset costs, expenditures, and taxes (G. Dionne 1992, p. 143).
How to remedy overstatement of the result of contributions for the year
To address the obvious overstatement of the year-written premium income, insurance companies used the notion of unearened premiums, as far as potential payment is concerned, the part of every premium earned in the year that applies to the next year. The unearned premiums will be a benefit allowance and included in expenditure in the year of receipt; in the next year the same sum will be treated as income and the unearned premiums of the next year will be deducted. For stock-in-trade, this method is much like that and is meant to serve much of the same purpose-allocating income to the right year (P. Harris, D. Cogan 2017, p. 139).
Minimum of unearned premium reserve
The total smallest unearned premium reserve which applies beyond the valuation date to the premium period is based on the net value model premium if contract reserves are necessary and on the gross model premium if contract reserves are not required. The unearned premium reserve shall be at least comparable to the present value of the claims for the duration beyond the valuation date indicated by the unearned premium to the degree not otherwise given. Where the value of the contract is at least equal to the net unearned premium reserve. The test is done as a whole, not on a contract-by-contract basis individually (E. Robbins, R. Bush 2014, p. 319).
Example of unearned premium
The explanation of the unearned premium on the basis of the earned premium (S. Clerk, T. Wickens 2014, p. 328-329):
- The premium earned is the part of the actual premium relating to the reporting period coverage. For example, if a new annual plan with a 120-unit premium goes into effect on April 1, and GFS is being planned for a calendar year, the calendar year premium received is 90.
- The unearned premium is the amount of the real premium received relating to the duration of the previous reporting period. In the example just given, an unearned premium of 30, intended to provide exposure for the first three months of the next reporting period, will be available at the end of the reporting period.
- Clerck S., Wickens T. (2014)., Government Finance Statistics Manual: Manual, International Monetary Fund, Washington, D.C., p. 328-329
- Dauber N., Shim J., Siegel J. (2012)., The Complete CPA Reference, John Wiley & Sons, p. 200
- Dionne G. (1992)., Contributions To Insurance Economics, Springer Science & Business Media, New York, p. 143
- Flood J. (2015)., Wiley GAAP 2015: Interpretation And Application Of Generally Accepted Accounting Principles, John Wiley & Sons, p. 1227
- Harris P., Cogan D. (2017)., Studies In The History Of Tax Law, Tom 8, Hart Publishing, US and Canada, p. 139
- Pohl S., Iranya J. (2018)., The ABC Of Reinsurance, VVW Gmbh, p. 113
- Robbins E., Bush R. (2014)., Tax Basis Assets And Liabilities Of U.S. Life Insurers, ACTEX publications, Winsted, p. 151, p. 319
Author: Wiktor Woźny