Property and Casualty Insurance Practice Exam

What occurs when the insured cancels an insurance policy before its expiration date?

1. The insurer refunds all premiums paid

2. The insurer retains the paid premiums and an allowance for expenses

3. The insured is required to pay a cancellation fee

4. The policy is extended without additional cost

The correct answer is: The insurer retains the paid premiums and an allowance for expenses

When the insured cancels an insurance policy before its expiration date, the insurer typically retains the premiums already paid, along with an allowance for expenses. This practice is based on the principle that the insurer must cover administrative costs and other expenses incurred throughout the policy period, even if the policy is canceled early. Insurance companies allocate a portion of the premiums to cover operational costs, and cancellation can lead to a situation where the insurer has not fully recouped those costs. Therefore, when a policy is canceled, insurers usually calculate a prorated refund based on the remaining coverage period, deducting any incurred costs or fees. This method allows the insurer to maintain financial stability while also ensuring that the insured is treated fairly according to the terms of their policy. The other options do not accurately reflect standard insurance practices regarding cancellation. For instance, refunding all premiums paid would not account for the expenses incurred by the insurer. Requiring a cancellation fee is not a universal practice, as it depends on specific policy terms and state regulations. Extending the policy without additional cost is generally not applicable since canceling a policy technically ends coverage rather than extending it.