Short Rate Cancellation

What Does Short Rate Cancellation Mean?

A short rate cancellation is when the policyholder cancels an insurance policy before the policy expiration date. Short rate cancellations do not entitle policyholders to a refund proportionate to the coverage period left in the policy term.

When a policy is a short rate cancellation, there are administrative costs and penalties charged by the insurance company. These costs are deducted from any unearned premiums and serve as a disincentive to cancelling policies early.

All types of insurance cancellations can be administratively time-consuming for insurance companies, with the short rate being the most common. However, when the insurance company cancels a policy, it is not referred to as a short rate cancellation. This type of cancellation is called a prorated (or pro rata) cancellation.

Prorated cancellations are calculated based on the amount of time left on the policy. This usually happens because of some material change in circumstances or when the insurer doesn't feel comfortable staying on the policy, so no additional fees are charged to the insured party.

Short rate cancellations are calculated using a table that shows the penalty amount over the term. For example, some companies have a 25% minimum, which increased to 100% near the policy's end. The main reason for the tables is that when an insurance company uses an annual term of coverage to calculate premiums, its cost is lower.

In essence, you are charged more if you requested a shorter term when you purchased the policy, which is taken into account for short rate cancellations. At the same time, each insurance company has unique rules and fees regarding cancellation calculations. Some companies do not charge short rate cancellation fees and use only prorated amounts for all cancellations.

Insuranceopedia Explains Short Rate Cancellation

Short rate cancellations are a standard method of calculating the insurance amount when you cancel a policy before the end of the term. Generally, the average cost of insurance and administration is higher for policies that are priced over a short time vs the cost over a full year. This is where the term “short rate” is derived.

When a policy is quoted for 365 days but is cancelled earlier, there is a penalty to make up for the early cancellation. This calculation is used to cover the upfront administration costs that are normally spread over the term of 365 days. Thus, in this case, the policyholder ends up paying more for the coverage they enjoyed up to that point than if they had kept the policy with the cost distributed over the full term.

In contrast, when the insurance company is the one who cancels the policy, a pro rata calculation is used. In these prorated cancellations, the policyholders are entitled to a refund proportional to the amount of coverage left in the term and no penalty is charged. In this case, the policyholder is not penalized further for the insurance company's decision to cancel.

For example, if you paid $1000 for a 12-month policy and cancel after three months, you will get back $750 or nine months' worth of premiums. On the other hand, if you cancel this policy after three months, and the company uses a short rate, you would not receive the full $750 of the remaining premium. While exact short-rating fees depend on the policy and table used, you will usually pay more in penalties the earlier in your policy you decide to cancel.