What Is a Cancellation Clause?
Many commercial policies contain a standard cancellation clause drafted by ISO. This clause is typically found in the policy Conditions. Policies that include more than one type of coverage may contain multiple conditions sections. For example, a package policy that includes general liability and commercial property coverages will likely contain separate liability conditions and property conditions. When a policy provides two or more types of coverage, the cancellation clause often appears in a separate form called Common Policy Conditions (or something similar).
Who May Cancel the Policy
The standard cancellation clause states that the policy may be canceled by either of two parties: 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.
The first named insured may cancel the policy at any time by mailing or delivering written notice to the insurer. The notice must be provided "in advance." This means that if a business owner wants the policy to be canceled on a specified date, he or she must notify the insurer before that date.
The ISO cancellation clause permits the insurer to 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 canceled 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.
The standard cancellation clause allows the insurer to cancel your policy for any reason it chooses. Fortunately, this broad wording is often overridden by a state law. Most 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 the standard cancellation clause. The state provisions are typically spelled out in an endorsement attached to the policy.
Virtually all states permit an insurer to cancel a policy anytime for nonpayment of premium if the insurer fulfills the notice requirement. However, special rules apply when insurers cancel policies for reasons other than non-payment of premium. For instance, insurers may be required to provide 45, 60, or 90 days' notice instead of the 30 days' notice afforded by the standard cancellation clause.
Some states bar insurers from canceling policies except under certain circumstances. Here are some reasons an insurer might be permitted to cancel:
- The insured has failed to pay the premium.
- The insured has committed insurance fraud.
- The insured has been convicted of violating a federal or state law, and the violation has made the business riskier.
- The insured has willfully violated one or more safety standards.
- The insured has failed to implement loss control measures that were a condition of coverage.
- Reinsurance the insurer previously obtained on the insured's business or property is no longer available.
Some states prohibit insurers from canceling policies at any time except for the reasons specified. Others allow insurers to cancel policies for any reason during a certain time period, such as 60 days from the policy inception date. After that time has elapsed, insurers may cancel only for a reason listed in the endorsement.
Broader Protections Take Precedence
State laws often provide broader protection for policyholders than the cancellation clause in the policy. In this case, the law will supersede the policy. If the policy wording is broader than required by state law, then the policy wording will apply. 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 canceled. 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.
If your policy is canceled, your insurer must pay you the unearned premium. The amount of the payment can vary depending on who initiated the cancellation, you or your insurer. If the insurer initiated the cancellation, your return premium should be calculated on a pro-rata basis. If you requested the cancellation, your return premium may be short-rated.
For instance, suppose your policy has been in effect for one month when it is canceled by your insurer. 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 its administrative expenses.
Finally, suppose you own a commercial building that you purchased with a mortgage. You have insured your building under a commercial property policy. The ISO cancellation clause does not mention mortgagees (lenders). Even so, your insurer is obligated to notify your lender if it cancels your property insurance. Why? The answer can be found in the standard mortgage clause in your property policy.
The mortgage clause requires the insurer to notify your lender in advance if it cancels your policy. The insurer must provide 10 days' notice if it cancels for non-payment of premium and 30 days' notice if it cancels for any other reason. State law may dictate a longer notification period.