Insurance Terms & Related Concepts

Correct

The answer is B: A smaller refund, since the insurer keeps a penalty

Short-rate cancellation applies when the insured initiates cancellation. The insurer retains a larger portion of the premium as a penalty for early cancellation, resulting in a smaller refund to the insured. Pro rata cancellation, which applies when the insurer initiates the cancellation, returns the exact proportional unearned premium with no penalty. Short-rate cancellation compensates the insurer for the administrative costs of issuing and then canceling a policy. In Texas, personal auto and residential property policies can no longer use short rate: since September 1, 2026, their unearned premium must be refunded pro rata whoever cancels, although a filed minimum retained premium is still allowed (28 TAC §5.7015).

Reviewed in our October 2026 Texas fact-check.

Correct

The answer is D: A binder

A binder is a temporary contract that provides immediate evidence of insurance coverage until the formal policy is issued. Binders are commonly used in property insurance when coverage needs to be effective immediately, such as at a real estate closing. A binder contains the essential terms of coverage and stays in force until the policy is issued or the binder is ended. Texas sets no general time limit on binders, but a lender that requires insurance for a residential mortgage or commercial real estate loan must accept a binder as evidence of it if it was issued by an agent appointed by the insurer and authorized to issue binders, the premium has been paid, and the original policy will replace it on or before the 30th day (Insurance Code §549.055).

Source: Insurance Code §549.055

Correct

The answer is D: A valued policy sets value up front; unvalued, at time of loss

The fundamental difference is when the property's value is determined. In a valued policy, the insurer and insured agree on the value at the beginning of the policy, and that amount is paid in a total loss regardless of actual value at time of loss. In an unvalued (open) policy, the face amount represents the maximum the insurer will pay, but the actual amount paid is based on the proven value of the property at the time of loss (typically ACV or replacement cost). Most standard property policies are unvalued policies. Texas law adds one exception: under Insurance Code §862.053, a fire policy on real property is a liquidated demand for its full amount when the property is a total loss by fire, as if it were valued. The rule does not apply to personal property.

Source: Insurance Code §862.053

Correct

The answer is A: Utmost good faith

The principle of utmost good faith requires both parties to an insurance contract to act honestly and disclose all material facts. By deliberately inflating the claim amount, the homeowner has committed fraud and violated the duty of utmost good faith. The insurer owes nothing for the invented $10,000, and the policy's fraud condition may put the rest of the claim at risk. In Texas, though, a policy provision that voids the policy over a false statement in a proof of loss is a defense only if the statement was fraudulent, material, and misled the insurer into waiving or losing a valid defense (Insurance Code §705.003). Insurance fraud is also a criminal offense. Both the insurer and the insured owe each other honesty: the insurer in describing coverage and the insured in presenting claims.

Source: Insurance Code §705.003

Correct

The answer is B: Pro rata cancellation: the insured receives exactly $900 (3/12 of the annual premium)

When the insurer initiates cancellation, the refund is calculated on a pro rata basis, whatever the reason. This reason is one Texas allows: after the first 60 days of a commercial property policy's initial term, and on any renewal, an insurer may cancel only for fraud in obtaining coverage, nonpayment, an increase in hazard within the insured's control that would raise the rate, loss of reinsurance, or the insurer's supervision, conservatorship or receivership (Insurance Code §551.052). The insured receives the exact proportional unearned premium with no penalty. With 3 months remaining on a $3,600 annual policy, the unearned premium is 3/12 x $3,600 = $900. Short-rate cancellation (with a penalty) only applies when the insured initiates the cancellation. This distinction between insurer-initiated and insured-initiated cancellation is a key exam concept.

Source: Insurance Code §551.052