Cancellation Clause

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Virtually all business insurance policies contain a cancellation clause. This clause describes the circumstances under which your insurer may cancel your policy.

Where is It?

The cancellation clause is typically found in the policy Conditions. Many policies contain a separate Conditions section for each type of coverage. For instance, a policy that covers both general liability and commercial property may contain both Liability Conditions and Property Conditions.

In this case, the cancellation provisions may be located in a separate form entitled Common Policy Conditions.

Standard Clause

Many commercial policies contain a standard cancellation clause drafted by ISO. This clause states that the policy may be cancelled by either the first named insured or the insurer. The first named insured is the person or entity listed first in the declarations, if the policy includes more than one named insured.

If you are the first named insured you may cancel your policy at any time by mailing or delivering written notice to your insurer. Notice must be provided "in advance." That is, if you want the policy cancelled on a specified date, you must notify your insurer prior to that date. 

When the Insurer Cancels

The standard cancellation clause states that the insurer may cancel your policy for nonpayment of premium or for any other reason. In either case, the insurer must mail or deliver written notice to you (the first named insured) within a specified time period.

If the policy is cancelled because you have not paid the premium, the insurer must mail notification to you at least 10 days before the cancellation becomes effective. If the insurer cancels for any other reason, it must mail notice to you at least 30 days in advance.

State Laws

Most states have laws that specify when and how an insurer may cancel an insurance policy (including an insurance binder).

The law may contain provisions that differ from the standard cancellation clause.

Virtually all states permit an insurer to cancel a policy mid-term for nonpayment of premium if the insurer fulfills the notice requirement. Yet, many states have special rules that apply when policies are cancelled for reasons other than nonpayment of premium. For instance, insurers may be required to provide 45, 60 or 90 days' notice. This is more the 30 days afforded by the standard cancellation clause.

Some states prohibit insurers from canceling policies except for specific reasons. The restriction may apply to all policies or only to those that have been in force beyond a specified time period (such as 60 days). Here are some reasons why an insurer might be permitted to cancel a policy:

  • the insured has failed to pay the premium;
  • the insured has committed insurance fraud;
  • the insured has been convicted of a violation of a federal or state law, and the violation has made the business riskier;
  • the insured has willfully violated safety standards;
  • the insured has failed to implement loss control measures that were a condition of  coverage; or
  • reinsurance obtained on the insured's business or property has been lost

Broader ProtectionsTake Precedence

When state law provides broader protection for policyholders than the cancellation clause in the policy, the law will override the policy. The reverse is also true. For example, suppose a policy provides 90 days' notice of cancellation for any reason other than nonpayment of premium. The law provides only 60 days' notice. In this case, the provisions in the policy will supersede the law.

Many states have drafted their own "amendatory" endorsement that outlines the circumstances under which a policy may be cancelled. This endorsement is typically mandatory, meaning it must be attached to your policy. 

Cancellation provisions vary widely from state to state. To find out what provisions apply in your state, contact your insurance agent, state insurance department or attorney.

Return Premium

Finally, your insurer will return unearned premium to you if your policy is cancelled mid-term. Depending on who initiated the cancellation (you or your insurer), your return premium may be computed on a pro rata or short-rate basis. If the insurer initiated the cancellation, your return premium will be pro rata. If you requested the cancellation, your return premium is likely to be short rate.

For instance, suppose that your insurer cancels your policy after it has been in effect for one month. Your return premium should be 11/12 (92%) of the full-year premium. However, if you initiated the cancellation, your return premium will be short rate, which is less than pro rata. The insurer retains a portion of the premium to cover administrative expenses.

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