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When you buy any financial product, you must understand all the terms related to the product. The same holds for offline and online life insurance. Not understanding the language and terminology when investing in a life insurance policy can be confusing and frustrating. Moreover, you may buy the wrong policy if you do not understand the product you are purchasing.
A life insurance premium is undoubtedly the most crucial aspect of a life insurance policy.
Let us understand the concept of an ‘unearned’ premium in life insurance and how it differs from an ‘earned’ premium.
Defining Life Insurance Premium
Before moving to unearned and earned premiums in life insurance, it is essential to understand what a premium is. A premium is associated with every insurance policy you buy, including a life insurance policy.
In simple terms, it is the price of the policy you pay to the insurance provider. The premium for a life insurance policy differs depending on the terms of the policy. Earned and unearned premiums are particular portions of the life insurance policy premium.
What is Unearned Premium in Insurance
Unearned premium in life insurance is the premium amount for the remaining policy duration. It is the portion of the total premium of an insurance policy that the insurer takes from the customer beforehand but for which protection still needs to be provided as the policy is still active.
In this case, the policyholder has met his financial obligation at the start of the policy and is obliged to receive its benefits from the same date the insurance provider’s obligation has just started. Therefore, a portion of the premium is applicable for coverage for each day of the policy.
Although the insurance provider has received the premium, it is treated as unearned income and is written on the liabilities side of his balance sheet. If the insurance provider or the policyholder cancels the policy before the end of its term, the insurance provider has to return this sum to the customer. However, the terms of the unearned premium are governed by the provisions of the insurance policy contract.
Example of Unearned Premium
Suppose a customer pays ₹ 10,000 towards his life insurance policy premium to the insurer on December 28, 2022, for coverage from January 1, 2023, to December 31, 2023. Even though the insurer has received the amount, he cannot consider the premium as an asset till December 31, 2022.
The company reports this amount in its cash account and as a current liability in its unearned premium revenue account. As the insurer earns the premium, the amount will be moved from the liability account to the revenue account.
When is Unearned Premium Not Returned
There can be some situations when the insurance provider is not liable to return the unearned premium to the policyholder.
Providing false information to the insurer: One such situation is when the policyholder has given false information to the insurer when purchasing the life insurance policy. Under this situation, the insurer may not refund the unearned premium to the customer on cancelling his life insurance policy.
Not meeting the conditions in the contract: If the conditions detailed in the insurance contract are not met at the time of policy cancellation, the insurer may not refund the unearned premium.
Cancelling the policy without a valid reason: Another case is when the policyholder cancels the policy for no valid reason, like buying a similar policy from another insurer. Here too, the insurance company may refuse to refund the unearned premium. In such a case, it is best to wait for the entire coverage period of the last paid premium to get over before buying a new insurance policy.
Suppose the policyholder proves that the insurance company did not fulfil the terms and conditions of the insurance policy contract. In that case, the insurer will have to refund the unearned premium to the customer.
What is Unearned Premium Reserve Insurance
In the insurance company’s books of accounts, an unearned premium reserve account is where the advance insurance payments received are placed. These payments are considered a liability for the insurer since they may be returned to the customer.
Difference Between Earned and Unearned Premium
An unearned premium is different from an earned premium for a life insurance policy.
Earned premium is the other component of an insurance premium, along with an unearned premium. Earned premium is the amount of premium that the insurance provider has earned. It is the premium for that part of the policy which has expired and for which the insurer covered the policyholder’s risk.
As explained above, even when a policyholder pays the policy premium in advance, the insurer does not account for it as an asset. Instead, the amount is earned at an even rate throughout the policy’s life. Therefore, the portion of the premium applicable to the completed policy duration is the earned premium for the insurer and is accounted as income.
The earned and unearned premiums together form the premium for an insurance policy. While the earned premium accounts for the completed period, the unearned premium accounts for the advance period for which the insurer has to provide risk coverage to the policyholder.
Conclusion
The unearned portion of a life insurance premium is the advance premium an insurer receives for which coverage has yet not been provided to the customer. It is a liability in the insurer’s books of accounts as the insurer may have to return it to the customer on policy cancellation, subject to certain conditions.
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