State Farm Insurance License Practice Exam

What happens under a pro rata basis when an insurance company cancels a policy?

1. The insured pays a penalty

2. The unearned premium is returned

3. The policy remains active with higher premiums

4. The insured must repay the coverage amount

The correct answer is: The unearned premium is returned

When an insurance company cancels a policy on a pro rata basis, it means that the insured is entitled to a return of the unearned premium. This occurs because the insurance policy is being canceled before the term is completed, so the portion of the premium that corresponds to the remaining time is refunded to the policyholder. In a pro rata cancellation, the insurance company calculates the unearned premium based on the time left in the policy period. For example, if a policy was in effect for six months of a 12-month term and is canceled, the policyholder would receive a refund of half of the premium paid, reflecting the unearned portion. This approach is designed to provide fairness to the insured, ensuring they are only charged for the coverage they actually used. Other options refer to conditions that do not apply under a pro rata basis; there is no penalty incurred, nor are there higher premiums or repayment requirements that would typically be associated with different cancellation methods.