Most insurance policies contain a clause giving either party the right to cancel – provided they give sufficient notice. The consumer will generally receive a pro rata refund of premiums paid, less a cancellation charge. This charge will often be greater if the policy is cancelled during its first year than if it is cancelled later, because insurers want to cover the cost of setting up the policy.
In the complaints referred to us involving cancellation of annual policies, consumers generally accept that the firm may wish to make some charge to cover the costs incurred in cancelling a policy. But they often query the firm’s approach if it fails to offer them any refund at all – or if it offers substantially less than a pro rata calculation of their premiums.
In assessing such disputes we are guided by the Unfair Terms in Consumer Contract Regulations 1999 (UTCCR) and by the statements on unfair contract terms made by the Financial Services Authority (FSA) in its publication ‘Challenging unfair terms in consumer contracts’ (available on the FSA website – www.fsa.gov.uk).
The UTCCR state that ‘a contract term that has not been individually negotiated shall be regarded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations under the contract, to the detriment of the consumer’.
Schedule 2 of the UTCCR sets out an indicative and non-exhaustive list of terms which may be regarded as unfair, including Term (d):
‘Permitting the seller or supplier to retain sums paid by the consumer where the latter decides not to conclude or perform the contract, without providing for the consumer to receive compensation of an equivalent amount from the seller or supplier where the latter is the party cancelling the contract.’
In some policies the cancellation clause states that if the firm decides to cancel a policy at any point during the period of insurance, it will refund some of the premiums already paid – on a pro rata basis. However, if the policyholder cancels, then the firm retains all the premiums already paid, or refunds a smaller proportion than if it had itself cancelled the policy.
The FSA statement specifically refers to terms that charge policyholders a disproportionately large sum if they do not fulfil their obligations under a contract, or if they cancel it. We share the view that giving consumers the right to cancel – and then penalising them financially for exercising that right – is likely to be unenforceable in law, as well as unfair and unreasonable.
In cases referred to us, if a customer has cancelled a policy and received a significantly smaller refund of premiums than could be expected as a pro rata settlement, we will ask the firm to explain how its approach complies with the requirements under the regulations.
It is not usually unreasonable for the firm to recover any additional administrative costs it incurs. Nor is it usually unreasonable for its charge to reflect the costs it necessarily incurred in setting up the policy – and that will not now be spread over the assumed lifetime of the insurance.
Similarly, the provision that premiums for an annual contract are not refundable if a claim has been paid does not appear to be unfair.
We recognise that there may also be seasonal or other features of the policy which could justify different approaches to refunds. And we recognise the more fundamental point that under some policies, both the risk and the insurer’s potential liability may be higher at the outset of the policy than at the end – so the premium calculation will reflect this.
But in any event, it is important for the firm to have fair reasons for its approach to premium refunds – and for it to explain its approach clearly to the customer.
In some circumstances, regulatory rules require ‘cooling-off’ periods for contracts. We would expect firms to make particular provision for these periods, as it is important that cancellation rights are not restricted by unfair charging practices. For example, the Insurance Conduct of Business rules require insurers to allow a cooling-off period of 30 days for pure protection contracts. If a customer decides to cancel the contract during this period, insurers are not entitled to charge anything.
Complaints about refunds under payment protection policies – and under other policies that are not renewable – require us to consider some additional factors. We hope to comment further on this in a future edition of ombudsman news.
Mr A took out the firm’s standard motor policy in February 2005 and paid the annual premium in full. Five months later, he decided to sell his car as he no longer needed it. However, when he returned his policy to the firm, it refused his request for a refund of some of the premium.
The firm said that if it cancelled a policy, then it would normally make a pro rata refund of the amount the customer had paid. However, when a customer cancelled the policy it did not refund any premiums if the cancellation was made four or more months after the start of the policy. When the firm rejected Mr A’s complaint about this, he came to us – saying he thought the firm was ‘grossly unfair’.
We asked the firm for a copy of the policy conditions. These included the following:
... If you return your certificate... to us we will refund the part of your premium which applies to the period of insurance you have left. If we cancel this insurance because you have not paid the full premium, we will work out the refund using the rates shown below. We will not give you a refund if anyone has claimed in the current insurance period.
If you have not made any claims in the current period of insurance, and you are not going to make a claim, we will work out a charge for the time you have been covered using our short-period rates shown below. We will refund any amount we owe you.
Period of time you have had the cover
Any refund made to you for any reason above will only be provided if your annual premium per vehicle exceeds £150.
We asked the firm to explain why it had made these particular conditions. It said its main concerns had been to discourage customers from cancelling their policies and to recover the costs it incurred if they did so.
We then asked the firm how its costs could be so large as to justify its making no refund at all to customers cancelling more than four months after taking out a policy. The firm was unable to do this.
We concluded that the policy condition was unfair and contrary to the UTCCR. So we told the firm it should make a pro rata refund, after deducting a reasonable administration fee.
Mr Y insured his house with the firm in June 2005. When he married in December that year, he sold the house and cancelled his policy. In accordance with the cancellation condition in the policy document, the firm made a pro rata refund of his premiums, less a sum of £50 to cover its administration costs.
Mr Y thought it unfair of the firm to levy an administration fee, since he considered that administrative costs should already have been built in to the amount he had paid for his insurance.
We agreed with Mr Y that the firm had allowed for administration costs when it calculated the price of its policy. However, since the policy had only - in the event - lasted for six months, the firm would not have recouped all of these costs; it had only received half the annual premium. And we were satisfied that it had also incurred additional and unexpected costs in cancelling the policy. We therefore rejected the complaint.
ombudsman news gives general information on the position at the date of publication. It is not a definitive statement of the law, our approach or our procedure.
The illustrative case studies are based broadly on real-life cases, but are not precedents. Individual cases are decided on their own facts.