Pro Rata Cancellation

The term pro rata cancellation comes from the Latin term pro rata, which means in proportion or according to a certain rate. The term pro rata cancellation is used in the insurance business to repay policies revoked in the middle of their term in a way that respects a certain rate. The pro rata cancellation definition is the revocation of a policy by an insurance company or the policyholder that returns the unearned premium to the policyholder (the portion of the premium for the remaining time period that the policy will not be in force). A more straightforward pro rata cancellation definition would be the cancellation of a policy mid-term by either party. Unlike short rate cancellations, pro rata cancellations don’t have any cancellation costs or fees, and the insured will get a refund on the value that will no longer be used by the policy. Something to keep in mind is that the terms pro-rate or prorate are used interchangeably with pro rata.

Why are Pro Rata Cancellations used in Insurance?

The first important factor to remember is that pro rata cancellations may depend on insurers. Some accept pro rata cancellations regardless of the direction cancellation decisions come from, whether from the insured or the insurer. In contrast, others only apply pro rata cancellations if the insurer cancels the policy. This is mentioned in the contract so make sure to check the section about the cancellation.

Regarding pro rata cancellations, the insurance companies use them as legal grounds to repay the amount of money that is no longer used to insure the property. It’s simple: If a policyholder prepays a 12 month car insurance premium of $10,000 but only uses 6 months of it, the insurance company must give back the unused remaining 6 months ($5,000) to the policyholder.

There is one condition on this refunding. The insured should not damage the insured asset. Like that, no damage had to be covered by the insurance, and the insurance company suffered no loss.

How are Pro Rata Cancellations used?

The insurer mostly uses pro rata cancellations, but the insured might also use them, depending on the insured. How these types of cancellations can be used depends on who uses them. One thing that they have in common is the cancellation provision clause that requires either party, as other pro rata clauses,  to send a cancellation notice 30 days in advance.

The insurance company can cancel a policy through a pro rata cancellation if they find discrepancies between what the insured declared about their asset and the asset itself. 

For example: If the insured states that a car they are insuring has a much more powerful engine than it does in reality, the policy is canceled through the pro rata method. The reason for this is the premium difference. Using extremes here for a better understanding, a Ferrari will not have the same premium as a Honda. Similarly, the engine’s power can affect the car’s premium cost.

Another example would be when the policyholder uses a personal car for commercial purposes. The insurance company gives different insurances for commercial assets.

The policyholder can decide to end a policy at any point in its term for any reason as long as the insured asset was not damaged and the insurer paid no coverage. The decision to cancel the policy must be sent to the insurance company sometime before the policy is canceled. This information can also be found in the contract signed by both parties.