Earned Premium (Insurance) Definition
Earned premium refers to a portion of the amount paid to the insurer as a premium that the insurer has earned at a given point in time. Restated, an earned premium is the amount of money or part of insurance premium that was paid to insurer as part of insurance policy. As the period of coverage passes, a portion of the policy has been earned by the insurer, as it has provided coverage during that time period.
There are two methods which are uses to determine earned premium; accounting method and exposure method.
- Accounting Method – The accounting method divides the premium amount by 365, and multiplies it by the number of days passed. For instance, an insurance company which receives a $1,000 premium on an insurance policy that has been in effect for 100 days, an earned premium would be $273.97 ($1,000 / 365) * 100.
- Exposure Method – The exposure method does not consider the premium date. Instead. This method analyzes how the premiums were subject to loss over a specific period. The method is complex and involves measuring the unearned part of premium exposed to loss during the period being calculated. The exposure method analyses many risk factors (using historical data) that may happen over a given period of time.
References for Earned Premium
Academic Research on Earned Premium
● Capacity constraints and cycles in property-casualty insurance markets, Gron, A. (1994). The RAND Journal of Economics, 110-127. This paper explores the expectancy of underwriting cycles, where financial capital is a major factor in output determinant. This paper focuses on two theories: Arbitrage theory and the ‘capacity constraint’ theory, and their relationship to the underwriting cycles. This article provides a test of the two theories by examining the empirical relationship between capacity and underwriting margins.
● Functional Relations between General Economic Indicators, Premium Income and Claims Costs in Different Insurance Sectors, Becker, F. (1979). The GENEVA PAPERS on Risk and Insurance, 12.
● Efficiency in the Greek insurance industry, Barros, C. P., Nektarios, M., & Assaf, A. (2010). European Journal of Operational Research, 205(2), 431-436. This paper employs the two-stage procedure of Simar and Wilson (2007) to analyse the effects of deregulation on the efficiency of the Greek insurance industry. The efficiency is estimated by means of data envelopment analysis (DEA). The companies are ranked according to their CRS efficiency score for the period 1994–2003.
● The declining US equity premium, Jagannathan, R., McGrattan, E. R., & Scherbina, A. (2001). (No. w8172). National Bureau of Economic Research. This study demonstrates that the U.S. equity premium has declined significantly during the last three decades. The study calculates the equity premium using a variation of a formula in the classic Gordon stock valuation model.
● Profit regulation in property-liability insurance, Hill, R. D. (1979). The Bell Journal of Economics, 172-191. This paper presents the question of how, and whether it is right for property-liability insurers to set rates based on investment incomes . This article uses the capital asset pricing model to determine the competitive insurance premium and profit rate.
● Investment returns and yields to holders of insurance, Smith, M. L. (1989). Journal of Business, 81-98. This article demonstrates how investment returns can affect yields to holders of insurance policies in a competitive market and empirically tests whether such effects are present. Data for U.S. stock property-liability insurers during 1950-82 were analysed.
● The efficiency of UK general insurance companies, Diacon, S. R. (2001). CRIS Discussion paper Series. Centre for Risk & Insurance Studies. The University of Nottingham. This paper explores the efficiency of UK specialist and composite insurers transacting general insurance business.
● Debt policy and the rate of return premium to leverage, Kane, A., Marcus, A. J., & McDonald, R. L. (1985). Journal of Financial and Quantitative Analysis, 20(4), 479-499. This paper presents a mandatory requirement of equilibrium in the market for real assets when trading with a levered firm. This paper wishes to show that a meaningful measure of the advantage to debt is the extra rate of return, net of a market premium for bankruptcy risk, earned by a levered firm relative to an otherwise-identical unlevered firm.
● On the Equivalence of the Loss Ratio and Pure Premium Methods of Determining Property and Casualty Rating Relativities, Brown, R. L. (1993). This paper discusses the two stages in property and casualty ratemaking process. Findings from past literatures states that loss cost (loss ratio and pure premium) are equivalent in the first stage. This paper reviews the proof of this equivalence.
● Property-liability insurer reserve errors: A theoretical and empirical analysis, Grace, E. V. (1990). Journal of Risk and Insurance, 28-46. This article formulates hypotheses concerning property-liability insurer use of reserving errors from 1966 through 1979. A general theory is developed in which an insurer maximizes discounted cash flow subject to estimation errors and income smoothing constraints.
● Evidence of capacity constraints in insurance markets, Gron, A. (1994). The Journal of Law and Economics, 37(2), 349-377. This article provides empirical support for the primary predictions of capacity constraint theories of property-casualty insurance cycles.