An insured pays an annual premium of $1,200 and the policy is canceled after three months. The insurer returns the premium for the remaining nine months. The returned amount is called:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Premium is earned as time passes and the insurer's obligation to provide coverage runs. After three months of a twelve-month policy, three months' worth of premium is earned, while the premium attributable to the remaining nine months — the period during which no coverage will be provided — is unearned and must be returned on cancellation. The unearned premium belongs to the insured because the insurer has not yet performed its part of the bargain for that time period. This accounting of earned versus unearned premium is the basis for refunds on cancellation and for the insurer's responsibility to hold unearned funds as a liability until the coverage period elapses.
Why the other options are wrong
- B) Earned premium is the portion already used up by the elapsed time the policy was in force; it is retained by the insurer as payment for coverage actually provided.
- C) Gross premium is the total premium charged before adjustments such as dividends or refunds; it is the full amount, not a portion returned for unused coverage. The gross premium includes all components, and only the unearned portion of it is returned when coverage is canceled before the term ends.
- D) Loading is the portion of premium added to cover expenses, profit, and contingencies; it is a component built into the premium, not a refund for unexpired coverage. Loading funds the insurer's operating costs and profit margin; it is built into the rate rather than returned for time not covered.
Memory hook
Earned = time already used. Unearned = money back for time not yet used.