When you purchase insurance coverage paid with an annual premium, your protection is in force for the next 12 months. The insurance company is, however, accepting payment for coverage it has not yet earned. If you cancel your policy, you would receive this unused portion of your premium back. From a balance sheet perspective, unearned premium revenue is, at the time of payment, both a cash asset and a current liability. As the coverage period progresses, the unearned premium amount reduces until, at the end of the policy, all premiums are earned.
Step 1
Collect the information needed to perform the calculations. You will need the amount of the premium, the length of the policy and the periods of unearned premiums remaining. For an example, use a $1,200 premium over a 12-month term, with five months remaining on the policy.
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Step 2
Divide the premium by the total number of periods in the term. Using the example, the $1,200 premium is divided by 12, giving a monthly amount of $100.
Step 3
Multiply the monthly amount by the periods remaining in the policy. In this example, $100 is multiplied by the five months remaining, for an unearned premium amount of $500.
Tip
In double-entry accounting, both the cash account and the liability in the unearned premium account reduce by the same amount each period. Using the example, both accounts would reduce by $100 monthly.
Warning
If you are calculating unearned premiums in anticipation of cancelling insurance coverage, check your policy for any administrative fees or penalties added for early cancellation that may reduce your refund amount.
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