Accounting framework: annual accounting: Unearned Premium Provision (UPP)
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Under the annual basis of accounting premiums are regarded as earned over the period of a policy having regard to the incidence of risk. Few premiums will be for a period of risk which coincides with the insurer’s accounting period. There will generally be a proportion of premiums unearned at the end of the accounting period which needs to be carried forward as an unearned premium provision (UPP) representing the deferral of premiums to be earned in a subsequent accounting period. The effect of the UPP is to convert the credit for premiums in the trading or profit and loss account from a credit for premiums ’written’ to one for premiums ’earned’. Written premiums are the total premiums receivable for the whole period of cover provided by the policies that incept during the accounting period.
Paragraph 91 of the 2005 ABI SORP states that UPP should be calculated on a time apportionment basis unless there is a marked unevenness in the incidence of risk over the period of cover. This might cover seasonal risks such as hail or frost, or longer term risks such as mortgage indemnity guarantees or extended warranties when a basis which reflects the profile of the risk will be used. Insurers may apportion the earned and unearned portions of each contract on a strict daily basis (sometimes referred to as the 365ths method), although more approximate methods, such as the 24ths method may still be encountered. The 24ths method assumes that contracts incepting in a given month will be spread evenly through that month. For a company with a 31 December year-end all January premiums are 1/24th unearned at the year-end, February premiums 3/24ths unearned and so on.
An example of the calculation of an Unearned Premium Provision using the 24ths method and the 365ths method is set out in GIM2110.