PF&M at a Glance
A question of cancellation
The cancellation of insurance policies is a common occurrence. Every day agencies receive requests from insureds to cancel coverage and insureds receive notices from insurance companies that their coverage is about to be canceled. Because coverage ceases after a cancellation, any loss that occurs following an improperly handled cancellation can be a serious errors and omissions loss for the agent. Even if there is no loss, there may still be an argument between the carrier, the agent and the insured over the return premium due.
If there is a battle over the cancellation, all parties will look to the same section of the policy to justify their argument. On most ISO commercial lines policies, the IL 00 17-Common Policy Conditions is a required form, and the first condition on that form is called Cancellation. (This condition is modified in a number of states, but this discussion does not address any of the state-specific changes.)
The first part of the condition states that the named insured has the right to request that the policy be canceled. Because there is often more than one named insured on a commercial lines policy, this right is limited to the first named insured. Here is one area of possible contention. If an agent doesn’t list the named insureds in proper order or if the agent accepts direction to cancel from anyone other than the first named insured, the cancellation could be considered invalid.
The next parts of the condition explain when and how the insurance company can cancel a policy. The insurance company must provide written notification to the first named insured. If the cancellation is due to nonpayment of premium, 10 days’ notice is required; if it is for any other reason, 30 days’ notice is required. The notice must include the date upon which the cancellation is effective, which then becomes the policy expiration date.
The condition requires that the cancellation be either delivered or mailed to the last known mailing address of the first named insured. If the insurance policy was issued with an incorrect mailing address or if the first named insured has moved and the mailing address was not updated, a cancellation could be mailed and the cancellation may be in effect, yet the named insured may not be aware of it.
The insurance company is required only to prove that it mailed the notice. It is not required to prove that the notice was received. This is also significant because items do get lost in the mail. Many companies send notification to their agents that a notice has been mailed. An agent must decide how to respond to such notices.
The condition also explains that the company will mail the first named insured any premium refund but that the cancellation applies with or without a premium offer. This is important because the refund may come days, weeks or even months after a cancellation, yet the cancellation is still in effect as of the date indicated.
If the insurance company requests the cancellation, the return premium is calculated on a pro rata basis.
Simply stated, if the insurance policy was issued for 365 days and canceled after 30 days, the first named insured can expect a return premium of 335/365 times the annual premium.
If the first named insured requests the cancellation, the insurance company has the right to return “less than pro rata.” The condition does not indicate what is meant by less than pro rata, and this can lead to an incredible amount of confusion. If the policy is issued by an ISO company using ISO cancellation rules, the less than pro rata return premium is developed by multiplying the pro rata return premium by a factor of .90.
Not all companies use the ISO method of computing other than pro rata return premiums. Many companies use short rate tables instead. Short rate tables were used by ISO prior to 1985 but are still used by many carriers—particularly excess and surplus carriers and the National Council on Compensation Insurance (NCCI). The differences can be substantial but vary based on the date of cancellation.
The Conditions section of a policy does not include cancellation tables, and if the condition is open ended as to its method, only by reviewing state filings for a particular company, if any, can an agent know how return premium will be developed. When in doubt, it is always best to calculate the return premium using both of the methods (The Rough Notes Company provides calculator wheels for pro rata and short rate cancellations) and provide the lower premium as an estimate but remind the customer that there may be minimum premium and annualized flat charges that are not returnable. *