What characterizes a short-rate cancellation?

A short-rate cancellation occurs when a policyholder cancels their insurance policy before the end of the coverage period, and as a result, the insurer does not refund the full premium. Instead, they deduct a cancellation penalty from the premium to be refunded, which means the amount returned is less than what would be refunded if the cancellation were done under a pro-rata method.

This method is designed so that the insurer can recover some of the costs associated with providing coverage during the policy term, as well as address administrative costs related to policy cancellations. The penalty typically increases the longer the policy has been active, hence the term "short-rate," because the refund is less than what would be expected based on the actual time the policy was in effect.

Other options include cancellation types that do not involve penalties or refunds of the full premium, which does not align with the definition of short-rate cancellation. For instance, a cancellation without penalty would mean the full premium is refunded, which is not characteristic of short-rate cancellation. Similarly, extending the policy period is not relevant to cancellation practices, as this would instead imply keeping the coverage active rather than terminating it.