What is minimum earned premium? How does it differ from a pro-rated refund? Depending upon the insurance policy, there are often a variety of associated fees that a policyholder must pay in order to purchase, retain, or cancel a policy. This may include an annual or monthly premium, administrative fees, deductibles, and coinsurance. A premium can be paid in full at the start of a policy year, or it can be paid out at regular intervals throughout the year. Either way, the insurer expects that you will not cancel the policy and will pay the entire amount before the year is over.
What happens if you want to cancel? The insurance company has several options when considering how to refund their customers. The type of refund and the amount will be outlined in your policy, so it should come as no surprise to you. The following are possible cancellation and refund options:
Short-rate cancellation: If you decide to cancel the policy before the expiration date, then a short-rate cancellation fee may be issued. This is a higher penalty compared to a pro rata cancellation, but it depends upon the type of insurance policy. For example, the insurance company could charge you an additional ten percent more than the pro rata fee. The rate is higher as a way to discourage cancellation before the expiration date.
Pro rata cancellation: In some instances, there is no penalty for cancelling a policy before the expiration date. The insurer simply divides the total premium amount by the amount of time left on the policy when the cancellation occurs. Essentially, every day of the policy year costs the same, so you are returned the premium amount equal to the days you will no longer have coverage.
Flat cancellation: If you do not want to renew your policy, then you can cancel it on the renewal date without any penalties. This is because the policy has not started and you have not yet paid a premium to the insurance company. Therefore, no refund is necessary.
Minimum earned premium: Whether you pay your premium annually or monthly, the insurance company considers an “earned” premium to be the amount they have received up to that point in the policy year. If you want to cancel your policy, an insurer may require you to pay a certain amount of earned premium no matter how quickly you decide to terminate the contract. This is called a minimum earned premium.
Let’s look at an example of how minimum earned premium works. Sally takes out a personal auto insurance policy with The Pretend Insurance Co. The annual premium is $900. She pays that amount up front at the start of her policy year, which begins March 1.
In July, Sally decides that she no longer wants to have a policy with The Pretend Internet Insurance Co. and wants to switch to a different policy at Make-Believe Insurance Co. Her friends have a policy with the company and she likes the fact that she can work with an independent insurance agent in her area. She speaks with The Pretend Internet Insurance Co. and tells them she wants to cancel. They remind her that the policy has a minimum earned premium of $500.
Sally takes a day to review her situation. She has already paid the full premium amount of $900. That equals $75 per month. So, for the months of March through July, the insurance company’s earned premium is $375. If she had qualified for a pro-rated cancellation, she would have received $525 because that is the amount that would have been needed to cover the remaining months of the policy. However, her insurance company stipulated a minimum earned premium of $500 on a $900 policy. So, she will only receive a $400 refund. Essentially, this amounts to a $125 cancellation penalty fee because she will only receive $400 instead of $525. She decides she still wants to cancel, and calls her insurance company the next day.
Speak to an Agent
Minimum earned premium can sometimes be a confusing concept. However, it is essentially a way for an insurance company to discourage the cancellation of policies before the expiration date. When considering any type of insurance coverage, speak to an independent insurance agent. They can help you navigate the insurance market and help you to select a policy that you won’t want to cancel. They will also walk you through any sort of fees, including cancellation penalties.
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