Pro-rata and Short-rate are two different ways of determining the refund amount that an insured party will receive if their insurance policy is cancelled before the expiry date. A policy will state in the Terms and Conditions section which approach applies and in which situation.
With pro-rata cancellation, the refund amount is calculated based on the remaining length of the policy. This means the insured only ends up paying for the number of days the insurance contract is actually in effect. Pro-rata cancellation applies when the insurer initiates the cancellation and, in some cases, to an insured initiated cancellation.
Short-rate cancellation calculation is similar to pro-rata but it includes a penalty as a disincentive for early cancellation. In other words, the insured receives less of a refund with this calculation. From the insurer’s perspective, a short-rate cancellation covers their administration costs. It also better balances the money they collect with their chances of paying for a loss.
Policies have different methods for determining the penalty amount. Some policies charge a percentage of the unearned premium amount. This means the total refund would be the unearned premium amount less, for example, 10%. The result is that the penalty amount will be higher if the policy is cancelled when the policy is new than if the policy is cancelled shortly before the policy expiry date.
Other policies provide a short rate table that lists out the penalty amount that will be charged and when it applies. For example, they may charge a different percentage or factor depending on the number of days that the policy has been in force. Whichever way it is calculated, typically the longer the policy is in effect, the smaller the short-rate cancellation penalty.
Although an insurance policy can be cancelled at any time, it is important to appreciate the implications for doing so. Like any legally binding agreement, the documents should be reviewed thoroughly, and the cancellation provisions fully understood before entering the commitment.