What is a prepaid insurance asset?
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Insurance is an inescapable expense in today’s world. Car insurance, home insurance, life insurance and health insurance are all necessities for most Americans today. In some cases, it may make sense for an individual or business to pay the premiums for insurance coverage in advance, or they may be required to do so. This allows the payer to enjoy a period of coverage without having to fork over additional money once the premium has been paid. This type of arrangement may be beneficial for businesses or self-employed insureds who have irregular cash flows. Here we will look at exactly what prepaid insurance is and how it is used.
What is prepaid insurance?
Prepaid insurance simply refers to any type of insurance coverage that the insured pays up front before the term of coverage actually begins. In most cases, a year’s worth of premium is paid up front as an annual expense, but the period of coverage being paid for can be of any length. Prepaid insurance is simply insurance that is paid for in advance.
How does prepaid insurance work?
Prepaid insurance coverage is considered to be a prepaid expense by accountants. That means that it has been paid before the coverage or service has been used. Prepaid insurance is counted as an asset just like any other type of prepaid expense.
Types of prepaid insurance
Some types of insurance, such as auto and health insurance, almost always operate on a prepaid basis, where the insured pays the premium up front for the coming term of coverage. For these types of insurance, premiums can usually be paid on a monthly, semiannual or annual basis, where the insured pays the premium in advance of the upcoming period of coverage.
Many medical professionals also carry malpractice insurance that must be paid in advance. In most cases, the doctor or other medical professional pays for a year of coverage up front with a single payment. Many corporations also carry liability insurance to cover them if they inadvertently bring harm to people or property. This type of coverage is also usually paid up front.
Balance sheet entries
Insurance companies list prepaid insurance policies as assets on their balance sheet until they are completely used up and the term of coverage has expired. Once the coverage term begins, the entry is moved from the asset side of the balance sheet to the expenditure side. If the period of coverage is longer than one year, then the asset must be listed as a long-term asset at the end of the year. This is not very common, but it does occur in some cases.
Benefits of prepaid insurance
Once the initial payment has been made, the insured can enjoy the protection provided by the insurance policy until the end of the term. If the insured has a claim during the period of coverage that was paid for, then he or she can expect the claim to be paid. (This is, of course, assuming that the claim falls within the prescribed limits of coverage outlined in the insurance policy.)
Prepaid insurance example
When an auto insurer receives a payment for six months of auto insurance coverage, it is initially recorded as an asset. Then the asset is converted to an expense one month at a time until the coverage expires. The insured will then make another payment for the next six months and the process starts again. The premium that is paid will usually be the same.
So if the insured makes a payment of $600 for six months of auto insurance in January for coverage that begins on February 1st, the insurance company will record the entire $600 as an asset on its balance sheet. This number will drop by $100 every month for the next six months until the asset has expired. At that time, the insured will make another premium payment that is again credited as an asset and will continue to drop by $100 each month on the insurance company’s books.
Prepaid insurance frequently asked questions
Do I get a discount for prepaying for more than a month in advance?
In many cases, yes, you will pay slightly less for a longer period of coverage than you will for monthly coverage. Many companies offer discounts for paying your auto insurance in larger amounts, such as semiannually or annually. You may also reduce billing fees by paying this way. But other types of insurance are also often discounted when they are paid for up front. It all depends upon the term of the prepaid coverage and the insurer.
Is prepaid insurance a current asset?
In most cases, prepaid insurance is listed as an asset on the insurance company’s balance sheet. The amount that is recorded will then drop by a certain amount each month until the asset has expired. Then another payment must be made in order to keep the coverage in force. This process will repeat itself over and over for as long as the insured maintains coverage with the insurer.
Is prepaid insurance a debit or credit?
Prepaid insurance is a credit to the insurance company at the time that it is made. In the previous example, the premium that is received for six months of car insurance coverage is initially recorded as a credit. Then there is a monthly debit for each month in the term until the credit is zero.
- Prepaid insurance is common with some types of insurers, such as for auto and health.
- The amount that is paid up front is always entered as a credit in the insurance company’s books.
- This credit is reduced by a certain amount each month until it expires.
- Credits that remain for more than a year are counted as long-term assets.
Prepaid insurance is commonly used by car and health insurance companies as well as malpractice and liability insurers. The amount paid before the term begins is considered an asset by the insurance company, and this asset declines in value every month until the term has expired. Consult your agent for more information on prepaid insurance and how it can affect you.