Unearned Premium

You're going on a three-year exploration of the deepest uncharted territory in the Amazon rain forest. You won't be around to send in monthly checks, so the insurance company insists you pre-pay the policy: $50,000 a year for the three years, or $150,000 total up front. That $150,000 counts as your premium for the insurance.

You write the check and head into the jungle. The insurance company now has your $150,000. However, that money doesn't count as income for the company yet. You could still emerge from the jungle early and cancel the policy. If you did, the company would have to return a proportional share of the money.

Therefore, the amount is actually listed on the balance sheet as a liability. As time passes, the insurer can move funds over from the liability category to the income category. So, after a year, $50,000 will have been realized, with $100,000 remaining as a liability. After two years, $100,000 has been recognized and $50,000 remains as a liability.

The unearned premium represents the amount remaining on the liability side of the ledger.