The Unearned Premium Reserve is there because when an insurance company writes insurance, it receives a premium upfront. So if we take a year here and the premium is written let's say in the middle of the year, the 30th of June and the insurance company receives a $100 in premium there. It means that the year end which is the 31st of December, how much of that premium will have been earned? Well, in actual fact, the premium year or the insurance period is going to run right the way through to the 30th of June the following year. So this means you've got a problem because at the year end, you've only earned 50% of the premium.

You have unearned, or to be earned, a 50% amount at the year end. And that's all the unearned premium reserve is trying to reflect, the bit of the premiums you received that you haven't earned yet. Now that 50% we haven't earned, of course will be earned in the following financial year. We've got a little example here and we have an insurance company and we're assuming that the insurance company is writing a hundred of premiums every single month and they're writing them and they're receiving them at the very beginning of the month. So in January they're receive a $100 in premiums and because it's the beginning of January they're going to earn the full amount of those premiums in that year. So the earned amount will be a $100 and there'll be no unearned premium. But the February premium that was written at the beginning of February and received, we have a $100, because we've got 11 months remaining of that financial year we'll have 11 twelfths, which earned. But we'll have a little nub at the year end, which won't be earned and that's 8.3. And as you go through the year and you get towards the end of the year, you'll have a higher proportion will be unearned, a smaller proportion that is earned. And at the bottom, we've just summed that up. You can see at the year end, if we had 1200 of premiums received, 650 will have been earned and 550 will be unearned. And that's a proportion at the bottom, those percentages. So just shows you by example how an insurance company will earn some of the premiums and some of the premiums will go into the unearned premium will remain in the unearned premium reserve. How does this affect our financial modeling? Well, let's take a look at an example and we're going to assume that these two percentages are pretty accurate. In other words, if we write a premium in a year, 54.2% of it will be earned and 45.8% of it will be unearned. So here we've got a little forecast for five years and we've got written premiums starting with a hundred in the historical year and then growing by 4%. And we're assuming that the split between earned and unearned in the year follows those percentages that we saw earlier, 54.2% and 45.8%. So of that 104 in year 1, 54.2% of it will be earned, which equals 56.3 and 45.8% will be unearned, which equals 47.7.

Now from a modeling perspective what we'll do if we started last year with 45.8% of the unearned premium reserve we'll begin with that in the first forecast year and then we'll take the unearned premium and add it to the unearned premium reserve. But of course, last year's unearned premium will become this year's earned premium in addition to the amount that we earned from the premiums written in this year. So if we take the earned premiums in year one so I just take the earned premiums it's going to be the 56.3 plus the piece of the unearned premium reserve, the 45.8 which was unearned last year, okay? And that will be the total earned premiums. And if we just add that together, we get 102.1. Now there's slight rounding here cause the numbers are used calculated in Excel. But another way you can actually reach that and this is how it's often presented on the income statement of the insurance company is to take the written premiums and then just take the delta or the change in the unearned premium reserve. And if the unearned premium reserve has increased it means some of the written premiums haven't been earned. So we are seeing the increase of 1.8 shown as a reduction to give us the earned premiums of 102.2 which should be the same as this number here but there's some rounding cause the numbers were calculated using Excel. So that just shows you how we would put it into a model. From an accounting perspective, all written premiums will go into the unearned premium reserve and then they'll come out as they get earned. But from a modeling perspective this is the easiest way of doing it.