When it comes time for many small-business owners to buy business insurance, decoding the jargon can be the most frustrating and difficult part of the process: you have to sift through pages of contracts to figure out not only what kind of coverage your client contracts require you to carry, but also which coverage various policies offer.
This post explains one of the more common terms our customers ask us about: the minimum earned premium. (For an explanation of other terms we get asked about a lot, take a look at our posts on additional insured status, coinsurance, and vicarious liability.)
How Minimum Earned Premiums Affect Your Business
In insurance, the “premium” is the amount you pay the insurance company for coverage. The “earned premium” is the amount of that premium a company has “earned” at any given point in your policy. So for example, if you have a $500 premium on a one-year policy, at the six-month mark, the insurance company’s earned premium is $250.
The “minimum earned premium” is the smallest amount of money an insurance company is willing to accept for writing a business insurance policy. The minimum earned premium becomes an issue mainly when a business owner decides to cancel a policy before its expiration date. Let’s say that, at the six-month point of that $500 policy I mentioned above, you (the policyholder) decide to cancel coverage.
If the insurance company has no minimum earned premium in place, it would refund you the remaining premium – what it hadn’t yet earned – which, in this case, is $250. But if the company had a minimum earned premium of, say, $300, the most it would refund you is $200, regardless of how early into the policy’s term you canceled it.
Why Do Insurance Companies Use Minimum Earned Premiums?
For insurance companies, minimum earned premiums are a way to manage risk and prevent customers from buying an insurance policy with the intention of canceling it after a single event or project. With a minimum earned premium in place, insurance providers have a much more reliable revenue stream and can therefore offer coverage when their customers need it.
And really, minimum earned premiums are not unique to the insurance industry. Many service providers require a down payment on long-term services or projects or charge a cancellation fee for appointments canceled within a set window. Insurance companies just use a different name.
Here are a few key things to know about how minimum earned premiums might affect you:
- Not all insurance policies come with a minimum earned premium. Some are pro-rated so that refunds after cancelation are calculated by dividing the total cost of the policy by the amount of time remaining when it is canceled.
- Regardless of minimum earned premium practices, the taxes and fees you pay on your insurance policy are never refundable.
- It’s possible to have a minimum earned premium of 100 percent – the entire yearly cost of your policy. This is more common in Errors & Omissions policies, which tend to have expensive claims and thus require larger payouts from insurance providers.