Short-Rate vs Pro Rata Cancellation: What’s the Difference?

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Nobody likes feeling as if they’re stuck in an inflexible, binding contract—especially when it comes to insurance policies. But you know as well as we do that contracts are what keep insurance companies in business. If a client could up and leave any time they wanted to without consequence, they’d constantly be bouncing around from insurance company to insurance company, scouring for the best rates.

On the other hand, insurance companies don’t want to be stuck in a contract with a client who has become uninsurable, for whatever reason. So when it comes to contracts, it’s important for insurance companies to understand what happens when they or their clients need to cancel a contract early.

Cancellation policies are a necessity in insurance companies’ terms and conditions, so it’s vital to be well versed in the standard options. Of these, there are two: short-rate and pro rata insurance cancellations. So what do these types of cancellations mean for insurance companies and their clients?

two people sitting at a table going over paperwork

Pro Rata Cancellations

Pro rata cancellations (it’s Latin, not a typo) are relatively straightforward. When an insurance policy is cancelled before the expiry date, the insured party receives a refund based on the remaining portion of the contract.

You can think of pro rata as a “you get what you pay for” type of cancellation. (Notice the association between pro rata and the term prorated?) The client only needs to pay for the insurance coverage you’ve given them, so you’ll end up refunding them for whatever proportion of time remains unused in the contract.

For example: if a client pays $16,000 for a year’s worth of coverage, but the insurance company needs to cancel the contract after three months because their client turns out to be a recreational arsonist, the company would need to refund said arsonist 75% of the original cost. In this case, the pro rata refund is $12,000.

Short-Rate Cancellations

Short-rate cancellations are similar to pro rata, but they’re often more beneficial to the insurer. During a short-rate cancellation, the client can receive part of their initial premium, but with a catch. The refund will be similar to the pro rata cancellation rate, but you’ll also have the leeway to deduct additional administrative or cancellation penalty fees.

In this example, let’s say that your client finds a certain insurance company that can offer them 15% off (or more) on car insurance in roughly a quarter of an hour (I won’t name any names). If your client hopes to jump on that bandwagon, they’d need to cancel their current year-long contract with you six months early.

In a purely pro rata cancellation, insurance companies would refund roughly 50% of their original investment. However, with a short-rate cancellation, the company would be able to charge them additional fees for breach of contract. In this case, they would be released from the contract, but this insurance company would be able to mitigate some of their potential losses from losing business (and discourage mid-contract bandwagon-hopping).

It all comes down to who’s canceling the contract.

If an insurer needs to cancel a policy early, then it stands to reason that the client would need their money back. It’s a simple quid pro quo (more Latin today!). Whether a client is moving out of the country, or they decide to set fire to the Quizno’s on 7th Street again, whenever (and why-ever) a contract ends early, both parties want a fair deal.

However, when clients need to cancel a contract before the expiry date, companies have already spent time and resources managing their policy. So short-rate cancellation administrative fees cover the costs these companies spent to open, close, and maintain the policy.

While some insurance companies don’t use short-rate cancellations, having that safety net can be an important financial buffer, depending on how many resources you’ve put into each contract.

So what’s the difference?

While contracts can feel harsh, they’re a crucial part of doing business. And no matter who needs to back out of a contract, there must be a mutual understanding of the financial consequences. So while pro rata cancellations help clients stay flexible in their coverage, short-rate cancellations are there to lower your chances of sinking resources into squirrely clients.

If you need help managing cancellations, consider the Eclipse Insurance Agency Management System. With guidelines for short-rate cancellations and policy management tools, you can keep track of your insurance companies’ policies with just a few clicks. Get a free quote today and give yourself a safety net for the unexpected.

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