Normally, vehicle insurance premiums are calculated for a fixed period, which is usually six months or a year. But not all policies run for the full term and they may be cancelled either by the policyholder or insurer or adjustments made to them that require recalculation of premiums. In case of cancellations, companies typically calculate the premium due for the period the policyholder remained on cover to determine the premiums earned by the insurer so far. Alternatively, premiums are adjusted due to changes made in the middle of a policy term. In case of adjustments, the premium required is calculated for the remainder of the policy term to proportionally reflect the cost of additional coverage or refunds due to reduced coverage or risk.
Prorating in car insurance is a procedure employed by insurers to calculate the premium amount for the time a policy is active when it’s terminated before its original expiration date. Prorating is also utilized when modifications are made to the policy, adjusting the premium according to the timing and nature of the changes, ensuring you’re only billed for coverage starting from its effective date. This method ensures that you’re charged fairly for the coverage you require and the duration it’s needed, while also enabling insurance companies to bill for premiums earned during that time.
This amount is usually arrived at by dividing the full premium by the terms of the policy and multiply by the period the policy was or will be active. This process often allows the discounts offered to be prorated as well. For example, if the full car insurance premium for a six months policy was $800 and policy is cancelled after three months, it means that the company would normally charge half the premium (as 3/6 = ½), $400. This is a simplified version of pro rata car insurance premium calculations. In reality, every insurer may use a different formula to calculate the premium earned.
Depending on the company and situation, there may be cancellation and other fees added to the final amount required. For example, if the cancellation was due to missed payment, there may be a missed payment fee as well as cancellation fee. However, most auto insurance companies in the US either don’t charge cancellation fees or the amount is negligible.
If the policyholder has already paid more than the amount due for time on coverage or paid the full premium at the start, they would get a refund in due course from their insurers. If not, they would have to pay the difference between how much they paid so far and how much they owe at the time of ending the policy.
Since prorating an auto insurance premium determines exactly how much a policyholder owes for coverage provided up until the policy is terminated, this money is already earned by the insurer and therefore due. So, policyholders would have to pay this amount, even if the policy was cancelled by the insurer after the stipulated notice period.
Importance of Prorating Car Insurance Premiums
Prorating the time on risk serves as a fair and transparent method to ensure that policyholders are billed only for the insurance coverage they have actually used. This practice eliminates the imposition of premiums for any unused portion of a policy. It becomes particularly relevant in scenarios where an auto insurance policy is canceled before its term or when modifications are made after the policy’s inception but prior to its renewal. Knowing what will happen in such situations may make it easier for motorists to decide and even strategize accordingly as discussed below.
Making changes to policies: Prorated car insurance premiums are also calculated when you make changes to your policy. For example, if you add a new driver to your policy and need to pay additional premium for it, you only pay additional premium for the remainder of the policy term. So, the insurer calculates how much more they need to charge due to the changes in view of how long is left on your policy. You may also get a refund if the changes you made to your policy means your auto insurance premium goes down.
Paying the premium in full: Knowing that the car insurance premium you paid will be prorated and any unused portion will be refunded to you takes away the worries as to what may happen to your money if your policy is cancelled for whatever reason. In short, you don’t worry about your money and pay the premium in full to get the maximum discount for paying-in-full now. If the policy is ever cancelled the premium paid (and often the discounts qualified) prorated and returned promptly.
Buying a standard policy for short term needs: Normally, standard vehicle insurance policies work out much cheaper in comparison to any short-term policies may be offered in the market. Besides, only a handful of companies may offer short term policies but all insurers offer standard policies. So, it may be a smart strategy just to buy a standard six months auto insurance policy even if you think that you may only need coverage for two or three months, knowing that once you cancel your insurer will prorate the policy premium to determine how much you need to pay for a shorter term of coverage.
Switching insurers: The fact that you only pay for time on risk and you may not even need to pay a cancellation fee with many automobile insurance companies makes it easier for motorists to switch when they find a better or cheaper coverage or more satisfactory insurer. Prorating vehicle insurance premiums makes sure that policyholders don’t lose money in the process of switching.
Also, knowing every day will count encourages policyholders to give notice to their current insurers as soon as they know they will be replacing their current policies with an alternative one, instead of not paying the premium and letting the policy get cancelled by their current insurers.