Unearned premium reserve
Unearned Premiums Reserves (UPR or UEPR) are reserved premiums because the relevant insurance coverage period has not yet expired. This part of the income from contributions is recognized in the books during the accounting period. Part of this income is held at the end of the accounting period for risks that are not yet expired. This is the sum of unearned premiums from policies that are not valid on the day of estimation using the pro-rata temporis method, due to local regulations. A common situation is that in other countries, Unearned premiums reserves assume a value equal to the sum of all unearned premiums, which are reduced by deferred acquisition costs (B. Pavlović 2012, p. 4-5).
Unearned premiums reserves contain additional elements other than the premium itself (such as expenditure charges and risks). Not taking into account the transaction costs, unearned premiums reserves required pure premium reserve (T. Struppeck 2001, p. 50). R. L. Vaughan says that: "The Unearned Premium reserve is the largest liability on the balance sheet of most writers of Warranty Insurance" (R. L.Vaughan 2014, p. 1).
Usually, unrealized reserves of premiums going into the reserves of losses and surplus over the life of the policy are considered. Unfortunately, sometimes, losses occur faster than expected and in these cases, the excess may flow into the reserves of losses (T. Struppeck 2001, p. 54).
All insurers who draw up direct and / or established contracts or policies (excluding financial guarantee, mortgage guarantee and surety contracts) for a period of 13 months or longer, which the insurer cannot cancel and for which the insurer cannot raise premiums during this period in order to establish an appropriate unrealized premium reserve for each of the last three years of the policy, the reserve of unearned gross premiums must be not less than the highest score of the three tests. The three tests are:
- The most appropriate estimate of the amounts to be recovered for contract holders at the submit date.
- Gross premium multiplied by the ratio (a) to (b) where:
- (a) are the anticipated future gross losses and expenses that will be incurred during the period when the contracts expired;
- (b) is the estimated total gross losses and contractual expenses
- The amount of expected future losses and costs that will be incurred during the period of non-performance of the contract (after adjustment), reduced by the present value of future secure gross premiums (T. Struppeck 2001, p. 61).
Unearned Premium is the part of the premium applicable to the unused term of the policy. The liability represented by the premium for unexpired risk associated with the insurer's books is called "Unearned premium reserve". This is the amount of all premiums corresponding to unused parts of policies or contracts that the insurer or reinsurer has on its books as at a given date (T. Struppeck 2001, p. 47).
- Unearned Premium Reserve for Property and Casualty Insurance: Unearned Premium Reserve for Property and Casualty Insurance is a reserve held by an insurer to cover the portion of the premium income that has not yet been earned. It is calculated by taking the total earned premium income and subtracting the earned premium income for the period in question. The Unearned Premium Reserve is a necessary reserve to ensure that the insurer has sufficient funds to pay out claims when they become due.
- Unearned Premium Reserve for Health Insurance: Unearned Premium Reserve for Health Insurance is a reserve held by an insurer to cover the portion of the premium income that has not yet been earned. It is calculated by taking the total earned premium income and subtracting the earned premium income for the period in question. The Unearned Premium Reserve is a necessary reserve to ensure that the insurer has sufficient funds to pay out claims when they become due. This reserve can also be used to cover any administrative costs associated with the health insurance policies.
- Unearned Premium Reserve for Life Insurance: Unearned Premium Reserve for Life Insurance is a reserve held by an insurer to cover the portion of the premium income that has not yet been earned. It is calculated by taking the total earned premium income and subtracting the earned premium income for the period in question. The Unearned Premium Reserve is a necessary reserve to ensure that the insurer has sufficient funds to pay out claims when they become due. This reserve can also be used to cover expenses associated with managing the life insurance policy such as commissions and expenses related to policy administration.
A Unearned Premium Reserves (UPR or UEPR) is a reserve of premiums that have been recognized in the books during the accounting period, but the relevant insurance coverage period has not yet expired. This reserve carries with it many advantages, including:
- UPR allows insurance companies to hold a reserve of premiums that can be used to cover future claims from policies that have not yet expired. This helps reduce risk and ensure that the company is not overexposed to losses.
- UPR also helps to ensure that companies are able to meet future obligations related to their policies. This helps to ensure that the company is able to pay out claims when they are due, and helps to maintain good customer relations.
- UPR also helps to prevent companies from over-allocating resources to their policies. It allows the company to have a better understanding of its overall financial position, and helps to ensure that resources are allocated in the most efficient manner.
- UPR also helps to ensure that companies are able to maintain a healthy cash flow, as the funds held in reserve can be used to pay out claims when they are due. This helps to keep the company in a stable financial position.
- Unearned Premium Reserves are limited in that they do not account for the changing nature of risk or the changing cost of providing insurance services. The reserves only account for the premiums that have been paid for policies that have not yet expired and do not account for any differences in the risk or cost associated with providing the services.
- UPRs also do not account for any changes in the market or in the pricing of the insurance services. This can result in the reserves being mispriced, as the cost of providing the services may have changed over time.
- The UPRs also do not account for any claims that may have been paid out. This means that the reserves will not be able to account for any changes in the cost of providing insurance services due to claims being paid out.
- UPRs are also limited in that they cannot account for any additional costs that may arise due to changes in the market or in the cost of providing the insurance services. This can result in the reserves being mispriced, as the cost of providing the services may have changed over time.
- Lastly, UPRs are limited in that they are only applicable to policies that have not yet expired. This means that the reserves will not be able to account for any changes in the cost of providing the insurance services due to policies that have already expired.
In addition to the pro-rata temporis approach, there are other methods for calculating Unearned Premium Reserves, such as:
- The "ultimate net loss ratio" method, which estimates the expected ultimate loss ratio based on past claims experience. The unearned premium reserve is then calculated as the difference between the expected ultimate loss ratio and the current loss ratio.
- The "gross premium reserve" method, which estimates the expected gross premium reserve at the end of the period by taking into account the current period's gross premiums and the expected future claims costs.
- The "net premium reserve" method, which estimates the expected net premium reserve at the end of the period by taking into account the current period's net premiums and the expected future claims costs.
These methods can be used to calculate Unearned Premium Reserves in different countries, depending on local regulations. In summary, Unearned Premium Reserves are an important part of the income from contributions that are recognized in the books during the accounting period and must be held at the end of the period in order to cover potential risks. Different methods can be used to calculate Unearned Premium Reserves, depending on the country's regulations.
| Unearned premium reserve — recommended articles |
| Unearned Premium — Unexpired risk reserve — Prepaid income — Insured value — Depletion expense — Grant date — Period of indemnity — Average clause — Doubtful account |
References
- Brander J., Manof S., (2003), ERM and DFA Using Active Knowledge Structures, The Casualty Actuarial Society Forum, Summer 2003 Edition
- Gould A. J, Linden O. M., (2000), Estimating Satellite Insurance Liabilities,
- Pavlović B., (2012), Unexpired Risk Reserve, Achieved Results and Prospects of Insurance Market Development in Modern World, Belgrade: Faculty of Economics, Publishing Centre
- Struppeck T., (2001), Premium Earning Patterns for Multi-Year Policies with Aggregate Deductibles, Journal of Actuarial Practice Vol. 9, Finance Department
- Vaughan R. L., (2014), The Unearned Premium Reserve for Warranty Insurance, Casualty Actuarial Society E-Forum, Fall 2014-Volume 1
Author: Katarzyna Satro
