There is a myriad of reasons an Insured may elect to cancel their insurance coverage. From the selling of business vehicles, business closure, and more. It is essential to understand how policy cancellations and return premiums work. Regardless of the reason, there is a methodical process upon which the cancellation is documented and unearned premiums are returned to the Insured. This entire process is closely governed by State insurance law.
Below we break down the process in simple terms so you can feel confident navigating your insurance decisions.
Common Reasons for Ending Coverage
Insurance needs change over time. A few common reasons policyholders cancel coverage include:
- Selling an asset as car or building
- A child reaching adulthood and securing their own coverage
- Closing or restructuring a business
No matter the reason, the return premium process follows a structed, State-regulated system.
Understanding Policy Cancellation Agreements, Exclusions, and Terms and Conditions
To begin, every insurance policy has its own insuring agreements, exclusions, terms and conditions, wherein the specific cancellation process and methodology will be confirmed. These outlines:
- How cancellation must be documented
- How premium is calculated upon cancellation
- Any penalties that may apply
The most common provision details that all unearned premiums are to be returned to the Insured, minus an early termination penalty of 10%. This applies if the policy was cancelled by the insured. If the policy is cancelled due to non-payment of premium this penalty, known as a short-rate, then the penalty does not apply.
Policy Cancellation Return Premiums Through Earned vs. Unearned Premium Calculations
Let’s break down a simple scenario.
Policy premium: $1,200 annually
Cancellation timing: 6 months
- Earned Premium: $600
- Unearned premium: $600
With a 10% early termination penalty, the Insurer would process a return premium of $540 ($600 X 90%), and within the State mandated timeline which ranges from 30 days to an open, unspecified timeline.
State Mandates and Their Impact on Automobile Policy Cancellation Return Premiums
This simple example unfortunately can become complicated when applied to automobile insurance where State mandated filings require minimum cancellation periods, with a Form E filings. In most States, a Form E filing requires the insurance company to maintain coverage in force for a full 30 days post the requested cancellation date, and during this period, premium continues to “earn”.
Using the earlier example with this mandate:
- Coverage continues for 7 months instead of 6
- Earned premium increase to $700 ($100/month)
- Unearned premium decreases to $500 ($1,200 – $700)
- Refund becomes $450 ($500 * 90% (early termination fee applied))
Obviously, the additional earned premium and corresponding reduced return premium typically infuriates an Insured who is surprised to learn that the State mandated filing has penalized them in this manner.
Why Penalties Matter When Understanding Policy Cancellation Return Premiums
When understanding policy cancellations and return premiums, it also helps to know why an insurance company charges an early cancellation penalty in the first place. The reason for them doing so is to simply try and recoup their administrative expenses of underwriting and issuing the policy in the first place. Insurance companies price their administrative expenses into every policy, including reinsurance, which in many cases is fully earned upon inception, and amortize it over the life of the policy. If the policy is terminated early, they have been granted the opportunity to try and recover some of these expenses by virtue of the penalty. In that they actually incur additional administrative expense to cancel the policy, in most cases they still lose money even with capturing the 10% penalty.
Public Protection: A Key Factor in Understanding Policy Cancellation Return Premiums
As for State filings that require insurance companies to maintain coverage for an extended period beyond the requested cancellation date, the intent is to protect the public. In certain industries, States have determined that it’s in the public’s best interest to make certain that your insurance remains in effect for a reasonable period after you request a cancellation. We can debate the virtues of this State directed logic; however, the reality remains the same: the insurance companies must follow what the State dictates.
We Are Here to Help
Insurance cancellation can be confusing, but you don’t have to navigate it alone. Our team is here to simplify the process, answer your questions, and guide you toward the best decision for your situation.
Get clear, customized insights into your coverage and cancellation options. Request your review today and feel confident in your next steps – contact us. Your Sovereign Team looks forward to continuing the right to earn your trust, your business, and the privilege of being your insurance advisor.