Earned Premiums

Earned Premiums are the portion of an insurance premium that an insurance company has actually “earned” by providing protection for a specific period. Think of it like a magazine subscription. When you pay for a full year upfront, the publisher hasn't earned all your money on day one. They only earn it month by month, as they successfully deliver each issue. Similarly, when a customer pays for a one-year insurance policy, the insurer doesn't recognize the entire payment as revenue immediately. Instead, it recognizes the revenue proportionally over the life of the policy. This earned portion is the true revenue for an insurer, reflecting the income generated from the insurance coverage that has already been provided. It’s a crucial metric for understanding an insurer's real-time financial performance, distinct from the total amount of premiums collected.

For an investor, especially one diving into the world of insurance stocks, understanding earned premiums is non-negotiable. It’s the difference between looking at a company’s sales brochure and reading its actual financial report. An insurer might sell a huge number of policies in a quarter, leading to a massive spike in Written Premiums (the total premiums on policies sold). While this shows great sales momentum, it doesn't represent the company's actual revenue for that period. Earned premiums are what appear on the Income Statement as revenue. This figure is the bedrock for calculating the most important performance metrics in insurance:

• Profitability: It’s the denominator in the Loss Ratio ((Incurred Losses + Loss Adjustment Expenses) / Earned Premiums), a key measure of how well the company is pricing its risk.
• Efficiency: It's also the basis for the famous Combined Ratio, which tells you if the core insurance business is making a profit before even considering investment income.

In short, earned premiums give you a stable, accurate picture of an insurer's core business earnings, smoothing out the lumpiness of sales figures.

The journey from a customer's payment to the insurer's revenue stream is a fascinating piece of accounting that creates one of the most powerful concepts in investing: the float.

The process unfolds in a clear, logical sequence, governed by accounting principles that ensure revenue is matched to the period in which it is actually earned.

1. Step 1: The Sale. A customer buys a policy and pays the premium. This entire amount is recorded as a Written Premium. The cash goes into the insurer's bank account.
2. Step 2: The Liability. The insurer can't count this cash as revenue yet. Instead, the portion of the premium that covers the future period is recorded on the Balance Sheet as a liability called the Unearned Premium Reserve (sometimes called Unearned Premium Liability). It’s a liability because the insurer owes the customer future coverage. This collection of unearned premiums is the source of Insurance Float.
3. Step 3: The Earning. As time passes, the magic happens. Every day, week, or month, a slice of the unearned premium liability is moved from the balance sheet to the income statement, where it is finally recognized as an “Earned Premium.”

Let's say you buy a one-year car insurance policy on January 1st for $1,200.

• On January 1st:
  • Written Premium: $1,200
  • Unearned Premium (on the Balance Sheet): $1,200
  • Earned Premium (on the Income Statement): $0
• At the end of January (after 1/12th of the policy has passed):
  • The insurer has “earned” $100 ($1,200 / 12 months). This $100 is now revenue.
  • The Unearned Premium liability on the balance sheet is reduced to $1,100 ($1,200 - $100).

This process continues month after month. By the end of the year, the full $1,200 will have been converted from an unearned liability into earned revenue, and the cycle begins again with new and renewed policies.

Value investors, particularly disciples of Warren Buffett, are obsessed with the economics of insurance. Understanding earned premiums is central to their analysis.

A value investor doesn’t just look at revenue growth; they demand profitable growth. By focusing on earned premiums, an investor can calculate the key ratios to determine if an insurer is a disciplined underwriter or just chasing sales at any cost. A company that consistently keeps its claims and expenses below its earned premiums is a potential long-term winner. If the combined ratio is consistently below 100%, it means the insurer is making a profit from its underwriting operations alone—a sign of a truly superior business.

The delay between receiving cash (written premiums) and recognizing it (earned premiums) is what generates the legendary insurance float. This float—the massive pool of unearned premiums the insurer holds—is essentially an interest-free loan from policyholders. The insurer can invest this float for its own benefit. A steady and growing stream of earned premiums is often a sign of a stable or growing float. Therefore, by analyzing the quality and growth of earned premiums, an investor gets a direct insight into the health and sustainability of the powerful engine that drives an insurance company's long-term value creation.