Alabama Property and Casualty Practice Exam

If a company cancels an auto policy mid-term, how will the refund be processed?

1. Pro rata basis

2. Short rate basis

3. Retroactive basis

4. Coinsurance basis

The correct answer is: Pro rata basis

When a company cancels an auto policy mid-term, the refund is typically processed on a pro rata basis. This means that the insured will receive a refund based on the exact time the policy was in effect. The insurer calculates the premium for the entire policy period and then determines the amount owed for the portion of the term that has not been used. In essence, the insured is reimbursed for the portion of the premium corresponding to the remaining coverage period, ensuring that they only pay for the time they were actually insured. This method is common because it is straightforward and fair, allowing both the insurer and the policyholder to settle accounts accurately without imposing additional penalties or fees. Other bases for refunds, such as short rate, might involve additional charges or penalties for early cancellation, which could complicate the refund process. Therefore, using a pro rata method is preferred for straightforward policy cancellations.