What Is a Cancellation Clause?

Definition & Examples of a Cancellation Clause

Two business partners discuss cancellation clauses
•••

jacoblund / Getty Images

A cancellation clause, which is included in virtually all contracts, explains who may cancel the contract, the conditions for cancellation, and the procedures they must follow. Businesses may encounter cancellation clauses most often within the context of business insurance—it specifies the conditions under which the insurer may terminate the policy. The cancellation clause is typically located in the policy conditions.

Learn more about cancellation clauses and provisions that are commonly included in these clauses.

What Is a Cancellation Clause?

A cancellation clause outlines who can cancel a contract, why they can cancel it, and how they can go about canceling it. These clauses are included in most contracts, but they're especially common in insurance policies. In insurance contexts, the cancellation clause outlines how a policyholder can lose (or cancel) coverage.

Not all cancellations are instantaneous. A policyholder could lose their current coverage by violating the provisions of the cancellation clause, or the insurer may decide to let the policy expire without renewing coverage. These details will be included in the cancellation clause.

How Does a Cancellation Clause Work?

Many businesses obtain liability insurance, property insurance, and other coverages by purchasing a commercial package policy. In this type of policy, the clause may state that the policy may be canceled by either the first named insured (if the policy includes more than one named insured) or the insurer.

The standard cancellation clause permits the first named insured to cancel the policy at any time by mailing or delivering advance written notice to the insurer. The insurer in a standard cancellation clause can cancel your policy for reasons including nonpayment of the premium.

If an insurer using a standard cancellation clause terminates your policy because you have not paid the premium, your insurer must mail or deliver written notification to you at least 10 days before the cancellation becomes effective. If the insurer cancels your policy for any other reason, it must mail or deliver notice to you at least 30 days in advance.

These examples of standard policies—requiring 10 days of notice before canceling a policy for unpaid premiums and 30 days of notice for cancelation for other reasons—are among the scenarios outlined in the common policy conditions compiled by the Insurance Services Office.

The standard cancellation clause obligates your insurer to refund any unearned premium to you if your policy is canceled. The amount you receive depends on who initiated the cancellation. If your insurer canceled the policy, your return premium should be pro-rata. For instance, suppose your policy was canceled by your insurer after six months (50% of the policy term). If your annual premium was $5,000, your return premium should be $2,500.

Your return premium may be short-rate (less than pro-rata) if you initiated the cancellation. The insurer retains a portion of the premium to cover the cost of issuing and maintaining the policy while it was in effect.

State Laws

The standard cancellation clause allows the insurer to cancel your policy for any reason as long as it notifies you 30 days in advance (10 days if it cancels for nonpayment). However, this broad wording is often overridden by state law. Many states have laws that dictate when and how an insurer may cancel an insurance policy (including an insurance binder). These laws often contain provisions that differ from those in the standard cancellation clause.

For example, Florida's statute bars insurers from canceling a policy that has been in effect for 90 days in most cases. The only exceptions are when:

  • The insured has failed to pay the premium.
  • The insured has made a material misstatement.
  • There has been a substantial change in the risk covered by the policy.
  • The insured failed to comply with underwriting requirements established by the insurer within 90 days of the start of coverage.
  • The insurer is canceling an entire class of insureds that includes the policyholder.

State-Specific Endorsements

State cancellation requirements are incorporated into "amendatory" endorsements that are included in insurance policies. For example, a California changes endorsement is attached to commercial insurance policies in California. It amends the policy wording, which may be established by a national company headquartered in a different state so that the policy complies with California law regarding cancellation and non-renewal. State-specific endorsements afford broader protection for the policyholder than the cancellation provisions in the policy.

State-specific endorsements are mandatory—insurers must include them in policies.

Mortgage Clause

A standard mortgage clause in a commercial property policy will require an insurer to notify a lender if it cancels a policy that covers mortgaged property. The common policy standards for notifying the lender are like those for notifying the insured; the insurer must provide notice 10 days ahead of time if it cancels for non-payment of premium and 30 days in advance if it cancels for any other reason. State law may dictate a longer notification period regarding lenders.

Key Takeaways

  • A cancellation clause is a section of a contract that stipulates the conditions under which a contract can be canceled and who can cancel it.
  • Cancellation clauses are an important aspect of insurance policies because it outlines how an insured individual can lose their coverage.
  • State law often mandates certain protections for customers, such as a certain length of advance notice that insurance companies must provide before canceling a policy.

Article Sources

  1. Florida Legislature. "The Florida Statutes 2019: Insurance Rates and Contracts." Accessed Sept. 21, 2020.