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Insurance explained - what are cancellation fees?

Insurance companies can sometimes throw words and phrases around assuming everyone knows what they mean. Here we explain what cancellation fees are. Dictionary
What are cancellation fees?

When you get a quote for insurance, typically you're getting a quote for one year of cover. Your premium represents the income the insurance company expects to receive in return for covering the risk you've presented them, plus their costs for administering your policy. If you decide to cancel your policy early, you'll normally get a pro-rata refund (assuming no claims have been made) which means the insurance company is no longer getting the premium they expected to, but they've already had to cover the costs of setting up and administering your policy. The cancellation fee helps the insurer off-set some of those costs.

For example, if your annual premium was meant to be £600 and you cancelled after exactly six months, you'd expect a £300 refund. A typical cancellation fee on car insurance is around £50, so in this example you'd get £250 back but it does vary from insurer to insurer, so if you think there's a chance you'll need to cancel early, factor in the cancellation fee when you're getting your quotes. And don't forget, if you make a claim during the year (unless it's a settled as no fault claim), you'll most likely be on the hook to pay the whole year's premium, regardless of how little time the policy had been running for.

There are rules which stop you being over penalised for cancelling your policy early - you should never pay more than the original total cost of the annual premium. So, for example, if your annual premium was meant to be £300 and you cancelled after 11 months, your pro-rata refund would be £25 refund. If the cancellation fee is £50, the most they could charge you is £25 so you still only pay the £300 for the year that you would have done if you hadn't cancelled.

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