What Is a Cancellation Clause?
Insurers Must Follow State Laws
Virtually all business insurance contracts contain a clause that explains who may cancel the policy and the procedures they must follow. It also specifies how many days' notice the insurer must provide when terminating the policy. The cancellation clause is typically located in the policy Conditions.
Who May Cancel the Policy
Many businesses obtain liability, property, and other coverages by purchasing a commercial package policy. In this type of policy, the cancellation clause appears in a separate form called the Common Policy Conditions. The clause states that the policy may be canceled by either 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 advance written notice to the insurer.
The standard cancellation clause permits your insurer to cancel your policy for any reason, including nonpayment of the premium. If it 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.
Any cancellation notice your insurer provides must state the effective date on which your coverage will end.
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 percent 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.
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). Fortunately, this broad wording is often overridden by 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 those in the standard cancellation clause.
For instance, Florida's statute bars insurers from canceling any policy that has been in effect for 90 days or more except for the following reasons:
- 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 date coverage began.
- The insurer is canceling an entire class of insureds that includes the policyholder.
Florida requires insurers to notify policyholders at least 20 days in advance if their policy is canceled for non-payment of premium and the policy has been in effect for 90 days or more. If the policy has been canceled for any other reason permitted by the law, the insurer must provide 45 days' notice.
State cancellation requirements are incorporated into "amendatory" endorsements that are included in insurance policies. An example is the California Changes endorsement, which is attached to commercial policies. It amends the policy wording to comply with California's law regarding cancellation and non-renewal. Like many state-specific endorsements, the California endorsement affords broader protection for the policyholder than the cancellation provisions in the policy.
State-specific endorsements are mandatory, meaning insurers must include them in customers' policies.
The ISO cancellation clause does not mention mortgagees (lenders). Even so, the insurer is obligated to notify a lender if it cancels a policy that covers mortgaged property. Why? The answer can be found in the standard mortgage clause located in the ISO in commercial property policy.
The mortgage clause requires the insurer to notify the lender in advance if it cancels the 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.
IRMI, "Notice of Cancellation Clauses," accessed February 4, 2020.
Colony Insurance, "Common Policy Conditions," accessed February 4, 2020.
The 2019 Florida Statutes, "Insurance Rates and Contracts: Notice of Cancellation, Nonrenewal, or Renewal Premium," accessed February 4, 2020.
Property Insurance Coverage Law, "Building and Personal Property Coverage Form," page 14, accessed February 5, 2020.