When an insurer cancels a policy, how should unearned premiums be calculated?

When an insurer cancels a policy, unearned premiums are typically calculated on a pro-rata basis. This method ensures that the policyholder is refunded a portion of the premium equivalent to the unused coverage period.

The pro-rata calculation involves dividing the total premium by the number of days the policy was in effect, thereby determining the premium cost per day. From this daily amount, the insurer calculates how much of the premium corresponds to the time remaining in the policy term after cancellation. This method is fair and straightforward, ensuring that the policyholder receives a refund for the exact amount of time they did not have coverage.

For instance, if a policyholder cancels their policy halfway through the term, they would receive half of their premium back based on this pro-rata approach. This method contrasts with other potential methods, such as a flat rate basis, which would return a fixed amount irrespective of coverage duration, or a deferral basis, which generally pertains to postponing premium payments rather than refunds upon cancellation. The discounted rate basis, on the other hand, usually applies to premium calculations and payment structures rather than directly addressing unearned premium refunds upon cancellation.