Pro-rata and Short-rate are two different ways of determining the refund amount that an insured party will receive if their insurance policy is cancelled before the expiry date. An insurance policy will state in the Terms and Conditions section which approach applies and in which situation.
What is pro-rata cancellation?
With the pro-rata cancellation method, you compute the refund amount based on the remaining length of the policy. This means the insured only ends up paying for the number of days the insurance contract is actually in effect. The pro-rata method applies when the insurance company initiates the cancellation and, in some cases, when the insured does.
What is short-rate cancellation?
The short-rate cancellation method is similar to pro-rata but it also includes a penalty as a disincentive for early cancellation. In other words, the insured receives less of a refund with this calculation. From the insurance company’s perspective, a short-rate cancellation penalty covers their administration costs. It also better balances the money they collect with their chances of paying for a loss.
Different insurance policies use different methods for determining a short-rate penalty amount:
- Some insurance policies charge a set percentage of the unearned premium amount as a penalty. With this approach, the total refund would be the unearned premium amount less, for example, 10%. This results in a larger penalty amount if the policy is cancelled when the policy is new than if the policy is cancelled shortly before the policy expiry date.
- Other insurance policies charge a penalty according to a short rate table. This table, which you’ll find in your policy document, states the penalty amount that will be charged and when it applies. For example, they may charge a different percentage or factor depending on the number of days that the insurance policy has been in force.
Whichever way you compute it, generally the longer the insurance policy remains in effect, the smaller the short-rate cancellation penalty.
Although an insurance policy can be cancelled at any time, policy buyers should appreciate the consequences of doing so. As with any legally binding agreement, buyers should carefully review their insurance documents making sure that they fully understand the cancellation terms before making the commitment.
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