How much will cancelling that policy cost?

It depends who’s cancelling - the insurer or the insured.

The NSW Supreme Court has held that the premium payable on a cancelled insurance policy need not be limited to a pro rata amount for the period of cover. Insurers are entitled to charge a higher amount when the insured cancels the policy. They can do this without specifying in the contract the formula for calculation of the amount payable.

Background

A D&O policy allowed a policy holder to cancel a policy, "in which case the insurer shall retain the customary short rate proportion of the premium". The policy holder cancelled the policy after 107 days, without making any premium payments. The insurer then issued a statutory demand for AUD$38,441, its calculation of "the customary short rate proportion of the premium".

The policyholder contested the demand, on the grounds that there was a genuine dispute about the amount of the alleged debt. According to the policyholder, the customary short rate proportion of the premium should be calculated by reference to the length of time that the policy had been in existence - meaning, in this case, about 1/3 of the annual premium (which would be AUD$23,328).

Two different premiums

The policy holder lost. The Court held that the policy allowed the insurer to set a "customary short rate proportion of the premium" that was more than the proportional amount of the time for which the policy had been live.

Two factors were crucial to the Court’s decision.

The first was the cancellation clause in the policy, which read:

"The policy holder may cancel this policy by providing written notice to the insurer in which case the insurer shall retain the customary short rate proportion of the premium. The insurer may cancel this policy in the manner permitted by law and shall be entitled to retain the pro rata proportion of the premium … ."

The Court said that this clearly distinguished between:

• the premium that would be payable if the policy holder cancelled the policy (the customary short rate proportion of the premium); and
• the premium that would be payable if the insurer cancelled the policy (a time-based pro rata proportion of the premium).

According to the Court, this showed that the customary short rate proportion of the premium was not limited to a time-based pro rata proportion of the premium.

The policy holder argued that this would allow the insurer to charge any premium it wanted, without any warning to a policy holder. The Court rejected this, because the insurer had a Short Rate Premium Calculation Table which it used to calculate the customary short rate proportion of a premium. That information was available to policy holders.

The lesson

This decision contains practical lessons for both insurers and insureds.

Insurers will retain the right to set the cancellation premium provided that:

• that right is set out in the policy; and
• the insured can find out how the cancellation premium is calculated.

The lesson for insureds is somewhat simpler: check the premium payable before cancelling a policy and preferably before taking out the policy - this is just one of the issues that should be considered when reviewing the terms of the more complex commercial insurance covers.