May 11, 2010

Earned Premiums and What Happens If You Cancel Your Policy

The time may come when your car insurance policy needs to be cancelled. This could be for any number of reasons – a switch to another provider, a change in address, or an environmentally-friendly choice to make due without a vehicle. Regardless of the reason, almost everyone will need to leave a provider at some point during their term and many wonder what will happen to any auto insurance premiums paid in advance. Some companies offer month-by-month options, ensuring that policyholders only pay for the coverage they are currently using, but some require an entire year of payments upfront. This can be due to a client’s claim history or driving risk, but it may also be at the request of a customer that does not want to deal with auto insurance premiums being deducted from their account every month. No matter the cause, there are certain rules in place that insurance companies must follow when dealing with pre-paid premiums.

In essence, the company is only entitled to the amount of premium paid that covers the length of time the term has been in effect. These amounts are known as earned premiums, because the company has earned them by exposing themselves to risk during this period. Risk, in this case, is the chance that the policy will need to be paid out, in part or in full. A year-long policy that has been pre-paid in full that has just finished its second month of coverage would be considered to have only two months of earned premiums, as the company has only been exposed to loss during that time. According to statutory account practices in the US, a company must maintain a reserve of money for the unearned premiums paid to it by consumers, in the event they need to be repaid.

Logic would dictate that if a policy were cancelled early or voided, the reserve premiums would be paid back to the client. Although this should be the case, it will vary with each individual auto insurance policy. Some may have clauses that state an early cancellation of the coverage, or a termination due to fraud or other misuse of the policy will void the return of any unearned premiums. Since this can be a substantial amount, it is worth carefully checking policy details before paying out a year’s worth of auto insurance premiums.

The concept of earned premiums and reserve money helps to keep insurance companies honest and from speculating with money that they have not yet earned. This is good for consumers, but they must still be watchful and keep up-to-date on the details of their policy so they do not lose money they have already paid.