Accounting for Premium Liability: Recognition, Measurement, and Financial Reporting

Premium liabilities arise when a company has unearned obligations tied to premiums received or to promotional benefits promised in connection with sales or service contracts. The term has specific application in both the insurance industry (as a liability for unexpired risk) and in general commercial accounting for promotional activities such as loyalty programs or sales-based incentives.

In all contexts, a premium liability represents a future outflow of resources, and accounting rules require companies to recognize and measure such liabilities at the earliest point the obligation arises.

This article explains how to account for premium liabilities under both insurance accounting standards and commercial GAAP frameworks, supported by clear examples and recognition guidelines.

1. What Is a Premium Liability?

A premium liability refers to a company’s obligation to provide goods, services, or compensation in the future, triggered by the receipt of premiums or customer actions.

Two key contexts:

✦ In insurance, it refers to the liability for unexpired coverage where the insurer must still provide protection

✦ In commercial settings, it often refers to promotional premiums, like “buy-and-get” offers or customer loyalty benefits

2. Premium Liability in Insurance Accounting

Under IFRS 17 and ASC 944:

Premium liability reflects the unearned portion of premiums received for which the insurance company still owes coverage or services.

Recognition:

✦ Arises when the premium is received

✦ Related to the liability for remaining coverage (LRC)

Measurement:

• Initially equals the unearned portion of the premium

• Adjusted for expected claims and expenses related to future coverage

If expected future outflows exceed unearned premiums, a loss component is recognized immediately.

Example – Unearned Premium Liability:

An insurer collects $1,200 for a 12-month auto policy:

At month-end 1, 1 month has expired, and 11 months remain.

Unearned Premium = $1,200 × (11 ÷ 12) = $1,100

Journal Entry:

Debit: Cash – $1,200

Credit: Unearned Premium Liability – $1,200

Each month:

Debit: Unearned Premium Liability – $100

Credit: Premium Revenue – $100

If projected future claims and expenses exceed remaining premiums, an additional premium deficiency reserve is recorded.

3. Premium Liability in Commercial Transactions

In retail and consumer industries, premium liability arises when customers are offered future incentives, such as:

✦ Free products after a number of purchases

✦ Bonus items after a spending threshold

✦ Redeemable coupons for future use

These obligations must be recognized as liabilities when the sale that triggers the incentive occurs.

Applicable Standard:

Under ASC 450 (Contingencies) and IFRS 15 (Revenue from Contracts with Customers), companies must:

✦ Recognize a liability and related expense for the expected cost of redeeming premiums

✦ Match the expense to the period of sale, not redemption

Example – Sales Promotion with Premium Offer:

A company sells 10,000 units of detergent for $5 each, offering a free item for every 10 units purchased. Based on past behavior, it expects 60% of customers will redeem.

Cost of the premium item = $1.50

✦ Expected redemptions = 10,000 ÷ 10 × 60% = 600

✦ Premium liability = 600 × $1.50 = $900

Journal Entry:

Debit: Cash – $50,000

Credit: Sales Revenue – $50,000

Debit: Premium Expense – $900

Credit: Premium Liability – $900

When the customer redeems the item:

Debit: Premium Liability – $1.50

Credit: Inventory (or Cash) – $1.50

4. Disclosure and Reporting

Companies must disclose:

✦ Nature of premium obligations

✦ Basis for estimating redemption rates or expected future claims

✦ Changes in assumptions or redemption patterns

✦ Reconciliation of liability balances (opening, additions, redemptions, closing)

These disclosures support transparency around future obligations, particularly in sectors with recurring promotions or loyalty programs.

5. Key Differences: Insurance vs. Commercial Contexts

Aspect	Insurance Premium Liability	Sales/Promotion Premium Liability
Trigger	Premiums received for coverage	Sale of product with future incentive
Standard	IFRS 17 / ASC 944	IFRS 15 / ASC 450
Measurement	Unearned portion of premium	Expected redemption cost
Recognition	Over time as coverage is provided	Upfront when sale is made
Revenue Impact	Premium revenue is deferred	Sales revenue recognized immediately

6. Financial Analysis Considerations

✦ Underestimating premium liability can overstate profits

✦ Changes in customer redemption behavior can affect margins

✦ Analysts watch trends in unearned premium reserves (insurance) or redemption rates (retail)

✦ Adjusted EBITDA may exclude changes in promotional liabilities depending on materiality