Illinois Casualty Insurance State Practice Exam

What is the typical outcome when an insured cancels a policy on a short rate basis?

1. The unearned premium is returned in full

2. The unearned premium is calculated to be equal to the pro rate return

3. The unearned premium is calculated on a short rate basis

4. The return of premium exceeds the total premium paid

The correct answer is: The unearned premium is calculated on a short rate basis

When an insured cancels a policy on a short rate basis, the unearned premium is indeed calculated on a short rate basis. This means that the refund amount the insured receives is typically less than the pro-rata amount, which would calculate the refund solely based on the time the policy was in force compared to the total policy term. Short rate cancellations generally apply a penalty to the unearned premium calculation as a way to account for the administrative costs incurred by the insurer and the fact that they have already begun providing coverage. Therefore, the amount returned to the insured is adjusted downward, reflecting this penalty. In contrast, the full return of unearned premium would reflect a pro-rata calculation, which is not the case for short rate cancellations. Similarly, stating that the unearned premium is calculated as a pro-rata return does not align with the specifics of short rate calculations. As for the return of premium exceeding the total premium paid, this does not happen under standard policy cancellations, as it would imply a refund greater than what was originally paid. Hence, calculating the unearned premium on a short rate basis accurately represents the process followed under such circumstances.