August 25, 2006
AUTO INSURANCE CANCELLATION FEE
By: Janet L. Kaminski, Associate Legislative Attorney
You asked if it is legal for an auto insurer to charge a cancellation fee if the policyholder cancels his auto policy before the renewal or expiration date. You also asked whether the insurer must disclose the fee and whether there is a maximum fee amount that may be charged.
There is no law or regulation prohibiting an insurer from charging a policyholder a cancellation fee for cancelling his policy before the policy renewal or expiration date. There is also no law or regulation requiring disclosure of such a fee or limiting the amount of the fee. However, the policy may include a general reference to cancellations being processed in accordance with company procedures, according to the Connecticut Insurance Department.
The department points out that there are several different methods available for processing cancellations and calculating any premium to be returned to the policyholder because of the cancellation. Methods include pro rata, 90% of pro rata, short rate, and a flat cancellation fee. If the pro rata method is used, the policyholder is not penalized for the mid-term cancellation because the premium charged is adjusted in proportion to the time the policy was in effect.
The other methods all result in some additional charge to the policyholder to cover expenses incurred by the insurer to process the off-cycle cancellation, with 90% of pro rata being the most common method used, according to the department. Ninety percent of pro rata returns 90% of the premium prepaid for the unused policy period. Short rate means a higher rate applies for the short term used under the policy than would have applied if the policy stayed in effect for the full term. (Short rate is not used by many companies, although many people now refer to 90% of pro rata as a short rate, according to the department.) Under the flat cancellation fee method, an insurer charges the policyholder a flat dollar amount while settling premiums pro rata.
Assume a policyholder cancels his 12-month policy after six months and he had prepaid the 12-month premium of $1,000.
If the insurer uses the pro rata method, it refunds $500 to the policyholder (no early cancellation penalty).
If the insurer uses the 90% of pro rata method, it refunds $450 to the policyholder (90% of $500), keeping $50 as an early cancellation fee.
If the insurer charges a flat cancellation fee, it would return $500 minus the flat fee to the policyholder.