What Is a Short Rate?
A short rate is a term used in insurance, referring to a kind of penalty imposed when the insured person decides to cancel an insurance policy before it reaches full term. It is a charge or fine charged by the insurance company to cover administrative expenses and other costs, incurred from the early termination of the insurance policy. When a short rate is applied, the insured person does not get a pro-rated or proportional refund of the money that they have paid. Instead, what they get is the pro-rated amount minus a certain penalty, usually a set percentage of the calculated pro rata value.
What this means is that instead of getting back the proportional amount according to the unpaid or canceled number of days remaining in the contract period, the insured person will get a set percentage of loss. Bear in mind that a standard percentage rate is the usual short rate deduction, but it can be more or less than this depending on what’s specified in the insurance policy. If the insurance company, not the policyholder, was the one that terminated the policy, no short rate penalty will be imposed. It is only upon the insured person’s voluntary cancellation that the reduced refund is employed.
To illustrate, suppose that the insurance premium is $5,000 US Dollars (USD) after the full term of one year, or 365 days. If the insured person decided to cancel the policy after just 200 days, this would mean that there is a canceled portion of the contract equivalent to 165 days. The daily prorated or pro-rata value would be $5,000 USD divided by 365 days, or $13.70 USD per day. Multiply this rate by 165 days and this would yield $2260.27 USD, which is the pro-rata value. Next, multiply this by 0.90 in order to deduct a 10% penalty. The final answer is $2034.24 USD, and this is the short rate amount. This is the amount of the premium refund after taking into account a 10& deduction.
Pro-rata refunds are also called non-penalty refunds because no penalty or surcharge is included. In short rate refunds, a penalty of usually 10% is implemented. Again, it is not always 10% that is deducted. It can be a higher percentage, so be sure to be familiar with the policy contract, including the fine print, to know all the details. A faster method to calculate the premium refund is to use a wheel calculator. This is a table showing the factor to be multiplied against the unearned premium corresponding to the date of termination of the policy plan.
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