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Calculating the equity date of a policy can be one of the most difficult things for an IT professional to comprehend when first entering the insurance profession. I have trained many developers and DBAs on this process and I am sure if you are in a leadership role of an IT team you have done the same. My hopes are with this article you will not have train anyone again as you will be able to simply refer them to this page. I will cover some of the fundamental concepts of insurance rating, processing, and billing. Let???s start by covering some of the foundation of Underwriting by explaining some of the important terms.

**Policy Term**

Policy term is the days a policy or a policy change is in effect. For example, a policy that is written for twelve months would have an annual policy term. A six month policy is known as having a semi-annual term. ??A policy change may have a term of only a couple of days.

**Annualized Premium**

Annualized Premium is vital for insurance systems and rating calculations. When designing any system make sure this amount is stored at each premium action. ??Simply put, it is the cost of the premium for the policy for a full year. This amount needs to be known for each coverage included with ??the policy.

**Per Diem**

Latin for ???for each day???, per diem in insurance means premium cost per day.

**Pro Rata Calculations and Equity**

Webster defines pro rata as ???*proportionately according to an exactly calculable factor (as share or liability)*???. In simpler terms, a pro rata calculation determines how much of the annualized premium should be charged based on the term of the action. For example, a six month policy???s premiums, in theory, should be half of annualized premium.

Let???s discuss equity. Let me explain this concept through a simple analogy. As a teenager my neighbor paid me to mow her grass. She paid me $10 per week but she was often out of town so she would pay me in advance. If she paid me $50, I knew that I had been paid for 5 weeks. I knew that if I didn???t get paid for the 6^{th}??week in advance and chose to still mow the grass, I might not get paid and thus would be mowing the grass for free. ??In a nutshell, that is equity. And as with almost all businesses, insurance companies do not like to provide coverage for risks for no premium.

To apply this analogy to insurance, if a 12 month policy premium is $1200, and the insured paid the company $600 towards premium, it just makes sense that the half of the policy is paid, correct? So if no other monies are received from the insured, we should cancel their policy at the end of the 6^{th}??month. So the insured has 6 months of equity.

The pro rata ratio for any premium action would equal??(no days in effect)/365.So if a policy was being cancelled was original effective on 1/1/2013 and it was being cancelled on 2/15/2013, the pro rata calculation would include the days in Jan (31) and the days in Feb (15) so??(45/365)=0.1233.

Calculating the equity date correctly is vital so that the cancellation is effective on the exact date. When a policy is on installment billing, the goal is to cancel the policy on the exact date where the company will not be owed money (bad debt) and we will not have to return money which in some states makes the cancellation invalid. This is a calculation which must be perfect.

**Written Premium**

Written Premium is the amount charged to the insured for the policy. How is that different than Annualized?

- As previously discussed, semi-annual policies with have half the premium of an annual.
- Policies are cancelled for things like non-payment, because of an insured???s request, and for underwriting reasons.
- Insureds will make changes to their policies (e.g., change of address).

The written premium for a policy is calculated based on all of the changes made during the policy term. This is an important concept to understand. Let???s examine an endorsement to an auto policy for the basis of discussion. (There will be a lot of assumptions made below for the sake of keeping this article as simple as possible. Please do not consider this example as being ??typical.)

**Policy Change Example**

Let???s say we have a policy with 1 vehicle that has a 12 month term with the coverage for BI and PD.

Policy POL100001 John Doe Effective 1/1/2013 through 1/1/2014 ????????????????Annualized??????????Written BI????????????????$??1200????????????????$??1200 PD????????????????$????600????????????????$????600 Total??????????$??1800????????????????$??1800

As you can see in this example, the annualized and the written premiums are the same on new annual-term policies.

Now if the insured add another vehicle with the same annualized premium half way through the policy, the current annualized and written premiums would end up looking like this:

Policy POL100001 John Doe Effective 1/1/2013 through 1/1/2014 ????????????????????????Annualized??????Written ??Car??1??BI??????????$??1200????????????$??1200 ??????????????PD??????????$????600????????????$????600 ??Car??2??BI??????????$??1200????????????$????600??????Added??Eff??7/2 ??????????????PD??????????$????600????????????$????300??????Pro-rata??ratio??0.5 ??????????????Total????$??3600????????????$??2700

As you can see above the 2^{nd}??vehicle was not in effect for the total term of the policy and therefore should not cost the same amount as the 1^{st}??vehicle that was included at inception. So if we really examine the policy, the first half of the year had a written of $ 900 while the second half of the year had a written of $ 1800. Added together the total written for the policy is $ 2700. This concept is important to understand as we go forward.

**??**

**Calculating the correct Equity Date**

To determine the equity date, you are determining when the cancellation should be effective based on how much has been paid on the policy. A lot of people make the mistake of using the written premium to determine the date, which will not always work. Looking at the above example, if the insured had paid $900, the equity date should be 7/1 since the first half of the policy???s written was $900. Some programmers will use an invalid formula by saying Total Paid / Total Written should give you the percentage of the policy that has been paid. ??That formula would result in 5/2 instead of the correct result of 7/1.

So how do we calculate the correct date?

The first step is to determine how much is due instead of how much has been paid:

Total Due = Total Written ??? Total Paid

The next step is to calculate the per diem of the current annualized premium:

Per Diem = Current Annualized / Days in Year

To determine the equity date, use the following formula:

Equity Date = Expiration Date ??? (Total Due / Per Diem)

So, in the above example, the equity date calculation would look like this:

Total??Due????????=??$2700???????$900??=??$1800 Per??Diem??????????=??$3600??/??365??=??9.863 Equity??Date????=??1/1/2014???????(1800??/??9.863) ??????????????????????????????1/1/2014???????(182.5)Final??Result??=??7/2/2013

**Notes**

- When you are calculating per diem you should do the formula on each coverage???s annualized premium. You should check your rate pages to determine if you round at the coverage level which is typically the case. If so, round the per diem for each coverage and total to determine the policy???s per diem as this will be done at the point of cancellation.
- On leap years, you need to check to see if February 29
^{th}??falls within the policy???s term. You may need to set your formula at 366. - Some 6 month policies will have 181 days and some will have 184. One issue is that most filed rates will apply a 0.50 factor on semiannual policies. You may find it easier to deal semiannual policies using the semi-annualized premium (0.50 of annualized) instead of annualized and use the difference in days between the original expiration date ??? original effective date as the days portion of the calculation.
- Keep in mind that the policy expires at 12:01am on the expiration date. In other words there is no coverage provided for the expiration date on the declarations page as it expired 1 minute after midnight. The last date is not inclusive.
- Because of policy changes, never attempt to calculate equity from the inception date of the policy. Using this formula should provide you with the expected results.
- To test equity date calculations, calculate the equity date and then cancel the policy for a pro rata cancellation type on that date to ensure that any premium due is less than the per diem. If the amount due is greater than the per diem you have a problem with your formula.
- Throughout this article I have only been discussing premiums. Most fees are fully earned, meaning that the will remain the same regardless of the cancellation. Unless the fee is not fully earned, you should not include any fees in any formula. The formula shown above does account for fully earned fees.
- Special handling may be necessary to handle installment or late fees associated with installment billing when using this calculation to determine billing cycles or notices of non-payment. Typically installment and late fees are not earned until the associated installment has been paid so you will need to work with your BA or underwriting department to see how these fees may affect your formulas.

**Conclusion**

This is a very complex subject especially for professionals that have not had a lot of exposure to the insurance industry. Please post any suggestions you may have for changes to this article or any questions you may have on this subject. Any and all recommendations are appreciated. I would be happy to rephrase any portion or discuss this further in the comments.

*Hope this helps.*

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Deborah Grey CICVery informative article.

guy>So if a policy was being cancelled was original effective on 1/1/2013 and it was being cancelled on 2/15/2013, the pro rata calculation would include the days in Jan (31) and the days in Feb (15) so (45/365)=0.1233.

Except (31) + (15) = 46, not 45?

Scott Cross(author)Thanks for pointing that out. If cancelled effective on 2/15, the policy expires at 12:01 AM on 2/15 allowing for no coverage for the that day. So you would count 31 days for Jan and 14 for Feb. A better way to state it is that the number of days is (Cancellation Date – Effective Date) which would result in the 45 as stated.

Thank you for the comment.

Scott

guy>Total Due = $2700 ??? $900 = $1800

>Per Diem = $3600 / 365 = 9.863

>Equity Date = 1/1/2014 ??? (1800 / 9.863)

>1/1/2014 ??? (182.5)

>Final Result = 7/2/2013

This calculation is only correct if the person had paid $900 or more. I.e. you’re counting backwards from the expiration date, using the per diem that in effect from 7/2/2013–1/1/2014

If the person had paid e.g. $800 so far, you have to use a **$4.93** per diem for dates before 7/2/2013; the policy would be paid up to about 20 days earlier, or about 6/12/2013

Scott Cross(author)Correct. If the calculation of equity passed the effective date(s) of policy changes then the per diem would have to be modified in the calculation. While that is a valid point, in a real world case if the amount paid provides less the the per diem total remaining in the policy you would be in an upside down position and would go straight to cancellation. The calculation of the equity date is used to determine the effective date of the cancellation notice. In cases you describe there would not be enough equity to matter. You would simply allow the minimum amount of days for billing and go right to notice.

I appreciate your point and I think it adds valuable discussion to the article and wish to thank you for that. I have not experienced a situation in my 28 years experience where this scenario would result in an invalid cancellation.

Thank you,

Scott