What Is Prepaid Insurance?
Prepaid insurance is coverage you pay for in full before you receive its benefits. For example, if you take out a mortgage to buy a new home, the lender may require you to pay a one-year homeowners premium at closing. When the policy goes into effect, you’ll then get the benefits of the coverage over a 12-month period. Insurance companies often offer incentives to customers who prepay their premiums, but this type of plan requires making a large lump-sum payment.
How Prepaid Insurance Works
In accounting, prepaid insurance is a type of prepaid expense. Other types of prepaid expenses can include:
License renewalsMaintenance contractsProtection plansSubscriptionsWarranties
You must pay prepaid expenses upfront before you receive any type of benefit. For example, you might buy a one-year magazine subscription and receive one magazine per month for 12 months.
Prepaid Expense Accounting
Prepaid insurance is a future expense, which you must pay upfront and receive its benefits over time. Prepaid insurance is an expenditure. However, once you make the premium payment, the policy’s coverage becomes an asset, which diminishes over time during the coverage period. If you keep a ledger, enter the prepaid insurance payment as both a debit and credit. Let’s say you purchase a one-year home insurance policy for $1,200. Here’s how you will account for the expenditure and assets.
Pros Explained
Lower premiums: Many insures give you the option to make monthly payments for auto and home insurance policies. However, some providers offer a lower rate for paying premiums in full. If you can afford to make a lump-sum payment for a six- or 12-month policy, you could qualify for discounts and/or pay fewer fees, depending on the carrier. Some providers also offer a discount for paying your premium in two payments rather than monthly installments No monthly payments: Another advantage to making one lump-sum payment is that you will not have to worry about making regular monthly payments. You can plan your monthly budget without the additional expense once you’ve prepaid.
Cons Explained
Lump-sum payment: Prepaying an entire premium requires making a large lump-sum payment, which may be difficult for some people, depending on their cash flow. For example, some homeowners may have difficulty paying a $1,500 annual home insurance premium in a single payment. However, many providers offer monthly installment payment plans for car and homeowners insurance. Cancellation hassles: Paying monthly premium installments can make the cancellation process easier. For instance, if you decide to switch to a new carrier, you can time the change according to your billing cycle.
Prepaying your insurance premium might complicate the cancellation process. For example, if you pay your $1,500 annual home insurance premium in one payment, then sell your house six months into the policy’s term, the insurer will have to refund the unused premium. Although providers do issue prorated refunds, you may have to wait days or weeks to receive the money. When canceling an insurance policy, you may incur a cancellation fee.
Alternatives to Prepaid Insurance
While prepayment and monthly billing are standard ways to pay an insurance premium, some auto insurance companies offer pay-per-mile policies. Since your mileage varies from month to month, pay-per-mile programs do not offer a prepay option, only monthly billing. Pay-per-mile car insurance policies are designed to benefit customers who maintain low annual mileage, such as people who work from home, are stay-at-home parents, or are retirees.
