When a policy ends before its expiration date, the insurer refunds the unearned premium. How much it refunds depends on the cancellation method:
- Pro rata: the refund is exactly proportional to the time left. Cancel halfway through an annual policy and get half the premium back.
- Short rate: the insurer keeps more than the pro-rata share, using a short-rate table or a formula (some carriers use 90% of the pro-rata refund). The difference compensates the insurer for its up-front costs.
- Flat: cancelled as of the effective date, as if the policy never took effect. The full premium is returned.
Which method applies depends on the policy form and state law. As a rule, cancellations the insurer starts are pro rata, and cancellations the insured requests may be short rate. Many standard commercial forms now use pro rata for both, but some carriers, programs and E&S policies still use short rate.
How it shows up in an agency
A client sells their business four months into a $12,000 annual policy and asks to cancel. Pro rata, the refund would be $8,000. Under a short-rate calculation keeping 10% of the pro-rata refund, it would be $7,200. If the policy also had a 25% minimum earned premium, the carrier would keep at least $3,000 whatever the method.
The CSR checks the cancellation provision before telling the client what to expect. Promising a pro-rata refund on a short-rate policy creates an awkward conversation later.
Common confusion
- Financed premiums. If the premium was financed, the refund goes to the finance company first, and the client may still owe the difference.
- Rewriting with a new carrier. Moving a client mid-term can trigger short-rate penalties. Compare the savings against the penalty first.
- Earned premium is what the insurer keeps; the refund is the unearned part.