If you’re thinking about canceling your errors & omissions insurance policy before the end of the one-year term, it pays to understand how much of a refund or "return premium" to expect. The return premium is the amount of the insurance premium that was not used or "earned."
Let's say you have a one-year policy with a $2,000 annual premium. If you kept the policy for exactly six months, you might expect to receive a prorata (daily calculation) return premium of $1,000. But depending on the insurance company and the type of policy, that may or may not be the case.
Short-Rate and Prorata Cancellations
There are basically two formulas used by insurance companies to calculate the amount of the return premium you receive: short-rate and prorata. Some, but not all, insurance policies include a “short-rate cancellation” provision. That means that the company effectively charges for early cancellation. Typically, the charge is reduced and ultimately eliminated as the policy expiration date approaches.
Other insurance carriers process cancellations on a prorata basis, with no charge for early cancellation. The amount of unearned premium that you get back is determined by dividing the number of days the policy was active by the total number of days in the policy term. So, if you paid for a 365-day E&O policy, but the carrier cancels it at 300 days, you’ll receive a refund for the full amount you paid for the remaining 65 days of coverage.
To help you understand the ramifications of a decision to cancel your E&O policy early, we’ve provided answers to some of the questions we frequently hear from our customers about pro-rata and short-rate cancellations:
Short-rate cancellation: Why don’t I get a full refund when I cancel?
The insurance carriers that use short-rate cancellation formulas argue that they incur some expense in establishing and maintaining your account. Rather than bill you for that cost up front, the carrier distributes it across the entire life of the policy. When you cancel before the policy is up for renewal, the insurance carrier keeps enough money to cover its administrative costs, but refunds you the money you paid in advance as premium. Because these administrative costs are distributed across fewer days of coverage, you end up paying more per day of coverage than you would if you had kept the policy in place for the entire term.
How much does the insurance company keep?
Because many business insurance carriers have their own short-rate schedules, the amount of return premium in short-rate cancellations varies. However, some carriers use a “Short-Rate (90% Pro Rata)” calculation method, in which the carrier keeps a charge of a flat 10 percent of the unearned premium, which is the amount of premium remaining in your policy when you cancel. In such cases, you’ll get back 90 percent of your unearned premium. In some cases, insurance carriers may also establish a "minimum earned" premium, which means they will charge a certain percentage of the total premium, even if you only keep the policy for a month or two. Minimum earned premiums charges are generally 25 percent or 30 percent of the total annual premium.
So, what does this mean for me? Does it make more sense to wait and cancel my E&O policy at renewal time?
That depends on if your carrier uses a short-rate calculation method and how far into the term you are. In a short-rate cancellation, insurance carriers base their administrative fees on the number of days the policy has been active, compared to the length of the policy term. If your policy has almost run its course, it may make sense to just keep it in force and not renew. On the other hand, if you’re three months into a one-year policy when you choose to cancel, the amount of money you won’t get back could be substantial. Before canceling, contact your insurance agent or broker for a cost-benefit analysis.
But what if my insurance company cancels my policy?
Short-rate cancellation only applies when you’re the one who chooses to cancel the policy. If your insurance company chooses to cancel your policy for any reason other than non-payment of premium, you’ll receive pro-rata refund, defined as the full amount of your unused premium.
When you buy your errors & omissions insurance policy, be sure you understand your carrier’s cancellation terms. It is also important to note that if you cancel your policy or allow your policy to lapse, you will have no coverage in effect and no protection against any future claims of professional negligence or against a future claim for an incident that occurred during your policy's term.
If you’re unsure about whether or not to cancel your policy, ask your agent or broker for advice. For more information or to speak with an agent, please contact www.techinsurance.com.
Writtten by Brenna Lemieux - check her out at Google+ or Twitter