Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Cancellation

What it is:

In the finance world, a cancellation is a notice informing a broker that a trade was made incorrectly. In the insurance world, a cancellation occurs when a policyholder stops paying the premium on an insurance policy and/or the insurance policy is no longer effective.

How it works (Example):

Let's say Jane Smith calls her broker, John Doe, and tells him to buy 1,000 shares of Company XYZ. John puts the trade in, but gets a cancellation telling him that the floor accidentally bought 1,000 shares of Company X instead. John quickly puts in a new trade for Jane and then calls and tells her what happened. Because the price of Company XYZ rose about $0.25 before Jane could actually get her shares, John offers to make her whole on the trade.

In another example, let's say Peter Walker has a term life insurance policy that costs him $100 a month. He loses his job and can't afford to pay the premium anymore. In turn, the insurance company cancels the policy and Peter no longer has life insurance.

Why it Matters:

Computerized trading has vastly improved the accuracy of trading in developed markets, but occasionally somebody types the wrong ticker symbol or transposes a number, causing a cancellation. Cancellations can be a sneaky way of covering up wrongdoing in an account, so they involve a considerable amount of paperwork and verification.

In insurance, cancellations may relieve a consumer of monthly premium payments, but they can also expose the consumer to considerable risk. In Peter's case, a lack of life insurance might mean that if he dies now, his children may have to sell his assets just to pay for his funeral and estate taxes if they are no longer the beneficiaries of his life insurance policy.