Short rate cancellation

From CEOpedia | Management online

Short-rate cancellation appears when an insurance policy is cancelled at the request of the insured prior to the expiration date. The insurance company may claim a penalty for such action, as long as it is stated in the policy agreement. Usually, such penalty is calculated by returning only 90% of the pro-rata cancellation amount. It may be also included as a part of the policy. A simple example shows the standard calculation method. Suppose you have a house policy with $500 annual premium and after 150 days into the policy it is cancelled short-rate. Return premium would be calculated as: 365 days - 150 days in force = 215 days remaining, what gives: 215/365 X $500 = $294.52 X 0.90 = $265.07[1] Short-rate cancellation is used by company to offset some of the cost associated with setting up the policy. There are few cancellation methods that are in common use:

  • Pro rata - method without penalty for short cancellation
  • Short-rate
  • Short period Rate (90% pro rata) - the penalty is 10% of the unearned premium

Pro-rata cancellation

Pro-rata calculation method is used when an insurance policy is cancelled and the return premium is calculated "pro rata temporis" (from Latin - accordance with the time) by dividing the number of days remaining in the policy term by the total days of the policy period[2].

Short rate table

Short rate table is a table used for calculation of the return premium for a policy resolved prior to the expiration date by the insured. It is represented as a table conatining all days form the insurance period with the corresponding percentage of the premium that has to be paid by insured. Ratio of th percentage to period is decreasing until one year where it equal one. For the loger periods of the policy than one year, the artes are starting to be more bargain [3]. Below is an example of the abridged version of the short-rate table. A full table would contain a rate for every day of the whole year.

Table 1 Short-Rate Fire Insurance Table for One Year[4].
Days in Force Percentage of Basic Rate Days in Force Percentage of Basic Rate
5 8% 75 31%
10 10% 80 32%
15 13% 85 34%
20 15% 90 (3 months) 35%
25 17% 120 (4 months) 44%
30 (1 month) 19% 150 (5 months) 52%
35 20% 180 (6 months) 60%
40 21% 210 (7 months) 67%
45 23% 240 (8 months) 74%
50 24% 270 (9 months) 80%
55 26% 300 (10 months) 87%
60 (2 months) 27% 330 (11 months) 94%
65 (2 months) 28% 360 (12 months) 100%
70 30

Cancellation by the insurer

In the scenario when the cancellation is requested by the insurance company, the-short rate cancellation procedure does not apply. Then, there is an opposite situation and it is the insurer who will have to pay off the accrued amount to the insured subject. The total premium is prorated (divided equally) over the entire insurance period[5].

Examples of Short rate cancellation

  • Short-rate cancellation is common in auto insurance policies. When a policyholder decides to cancel the policy before the expiration date, the insurance company will return only 90% of the pro-rata cancellation amount.
  • Homeowner's insurance policies may also be subject to short-rate cancellation. In this case, the insurance company would return only 90% of the annual premium paid.
  • Health insurance is also subject to short-rate cancellation. In this case, the insurance company may return only 90% of the pro-rata premium amount, depending on the terms and conditions of the policy.
  • Life insurance policies may also be subject to short-rate cancellation. In this case, the insurance company would return only 90% of the premiums paid.

Advantages of Short rate cancellation

  • Short rate cancellation allows the policyholder to cancel the policy before the expiration date, allowing them to avoid any further premium payments.
  • It is also beneficial for the insurance company as they can recover some of the funds that would have been paid out if the policyholder had maintained the policy until the expiration date.
  • Short rate cancellation can be beneficial for the policyholder if they no longer need the coverage, as they can receive some of their premiums back instead of forfeiting them completely.
  • Short rate cancellation can also be beneficial for the insured if they find a better deal elsewhere, as they can receive some of their premiums back while still taking advantage of the new policy.
  • In some cases, a short rate cancellation can also be beneficial to the insurance company as they are able to recoup some of the costs of providing the policy.

Limitations of Short rate cancellation

  • Short rate cancellation may not be applicable if the policy is being cancelled due to non-payment, fraud or other non-voluntary factors.
  • Short rate cancellation applies only to voluntary cancellations, and does not apply to policies that are canceled by the insurer due to non-payment or other reasons.
  • The amount of the pro-rata cancellation amount may not be sufficient to cover the costs associated with a short rate cancellation, such as administrative fees and other costs.
  • Depending on the specific policy, the insurer may not be willing to offer short rate cancellation to the insured.
  • The insurer may require additional documentation in order to process a short rate cancellation, such as proof of coverage for the remaining period of the policy.
  • Short rate cancellation may not be available for certain types of policies, such as term life insurance.
  • Some insurers may have different criteria for short rate cancellation and may not offer it in certain cases.

Other approaches related to Short rate cancellation

Introduction: In addition to short-rate cancellation, there are other approaches to cancelling an insurance policy.

  • Non-forfeiture: This is when the policyholder has the option to receive a reduced amount of money, usually in the form of a cash surrender value, in exchange for cancelling the policy.
  • Modified premium: In this approach, the insurer may allow the policyholder to reduce the premiums they must pay in order to keep the policy in effect.
  • Reinstatement: This option allows the policyholder to reinstate the policy after a lapse in coverage, but at a higher cost.

In summary, there are several approaches related to short-rate cancellation besides the traditional approach of returning only 90% of the pro-rata cancellation amount. These include non-forfeiture, modified premium, and reinstatement.

Footnotes

  1. ↑ Silver L. and others 2010, page 140
  2. ↑ Outreville J. F., 1998, page 234
  3. ↑ Kaliski B. S. 2014, page 117
  4. ↑ Kaliski B. S. 2014, page 117
  5. ↑ Sentlowitz M. 2014, page 293


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References

Author: Arkadiusz Liszka

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