Skip to main content

Other Important Provisions

Insurance policies often contain provisions that address how losses are shared when multiple policies cover the same risk. These provisions are designed to prevent the insured from profiting from a loss and to ensure that each insurer pays its fair share of the claim.

I. Pro Rata Liability:

  • A. Definition:
    • Description: A pro rata liability clause states that each insurer will pay a proportion of the loss based on the ratio of its policy limits to the total policy limits of all applicable insurance policies.
    • Purpose: To ensure that each insurer pays its fair share of a covered loss in proportion to the amount of coverage it provides.
  • B. Formula:
    • *Insurer's Share of Loss = (Insurer's Policy Limit / Total Policy Limits of All Insurers) * Loss Amount
  • C. Example:
    • Scenario: A building is covered by two insurance policies: Policy A with a limit of $200,000 and Policy B with a limit of $300,000. A fire causes $100,000 in damage.
    • Calculations:
      • Total Policy Limits = $200,000 + $300,000 = $500,000
      • Policy A Share = ($200,000 / $500,000) * $100,000 = $40,000
      • Policy B Share = ($300,000 / $500,000) * $100,000 = $60,000
    • Result: Policy A pays $40,000, and Policy B pays $60,000.

II. Contribution by Equal Shares:

  • A. Definition:

    • Description: A contribution by equal shares clause states that each insurer will pay an equal share of the loss, up to its policy limits, until the loss is fully covered.
    • Purpose: To ensure that each insurer contributes equally to the loss, regardless of its policy limits, until the loss is fully paid.

  • B. Process:

    1. Determine the number of applicable policies.
    2. Divide the loss amount by the number of policies to determine each insurer's initial share.
    3. If any insurer's share exceeds its policy limit, that insurer pays its policy limit, and the remaining loss is divided equally among the remaining insurers.
    4. Repeat step 3 until the loss is fully covered or all insurers have paid their policy limits.

  • C. Example:

    • Scenario: A loss of $150,000 is covered by three policies: Policy A ($100,000 limit), Policy B ($75,000 limit), and Policy C ($50,000 limit).
    • Calculations:
      1. Initial share per insurer: $150,000 / 3 = $50,000.
      2. Policy A pays $50,000 (within its limit).
      3. Policy B pays $50,000 (within its limit).
      4. Policy C pays $50,000 (up to its $50,000 limit).
    • Result:
      • The loss is fully covered: $50,000 + $50,000 + $50,000 = $150,000.

  • D. Example (with Insufficient Coverage):

    • Scenario: A loss of $300,000 is covered by three policies: Policy A ($100,000 limit), Policy B ($75,000 limit), and Policy C ($50,000 limit).
    • Calculations:
      1. Initial share per insurer: $300,000/3 = $100,000
      2. Policy A pays its limit of $100,000, leaving $200,000 outstanding.
      3. Remaining amount divided by 2 (Policies B & C): $200,000/2 = $100,000
      4. Policy B pays its limit of $75,000, leaving $125,000 outstanding.
      5. Policy C pays its limit of $50,000, leaving $75,000 uncovered.
    • Result:
      • Policy A pays $100,000
      • Policy B pays $75,000
      • Policy C pays $50,000
      • $75,000 of the loss remains uncovered.

III. Primary and Excess Insurance:

  • A. Definition:
    • Description: A primary and excess insurance provision specifies which policy pays first (the primary policy) and which policy pays only after the primary policy's limits have been exhausted (the excess policy).
    • Purpose: To determine the order in which multiple insurance policies covering the same risk will respond to a loss.
  • B. Application:
    • Common in liability insurance: Often used when there are multiple layers of coverage, such as a primary liability policy and an umbrella liability policy.
    • Other scenarios: Can also apply in other situations where multiple policies cover the same risk, such as auto insurance or property insurance.
  • C. Process:
    1. The primary policy pays first, up to its policy limits.
    2. Once the primary policy limits are exhausted, the excess policy pays the remaining loss, up to its policy limits.
  • D. Example:
    • Scenario: A business has a primary general liability policy with a limit of $1,000,000 and an umbrella liability policy with a limit of $5,000,000. The business is sued for $3,000,000.
    • Calculations:
      1. The primary policy pays its limit of $1,000,000.
      2. The excess (umbrella) policy pays the remaining $2,000,000 ($3,000,000 - $1,000,000).
    • Result:
      • The primary policy pays $1,000,000
      • The excess policy pays $2,000,000.

These provisions are essential for coordinating coverage and preventing the insured from profiting from a loss when multiple insurance policies apply. Understanding these provisions is crucial for insurance professionals and policyholders alike.

No Comments
Back to top