Policy Provisions Preventing Indemnity

While policies in some classes of business promise to indemnify the insured, this has to be done subject to the express terms of the policy, if any. Some of these terms mean that something less than indemnity is payable. For example:

(a) Average: Most non-marine property insurances are expressly subject to average. This means that the insurer expects the insured property to be insured for its full value. If it is not, in the event of a loss the amount payable will be reduced in proportion to the under-insurance. For example, if the actual value of the affected property at the time of a loss was $4 million and it was only insured for $1 million, we may say that the property was at the time of the loss only 25% insured. Therefore, by the application of average, only 25% of the loss is payable.

In view of this penalty for under-insurance, it is very important for insurance intermediaries to do their best to ensure that their clients will arrange full value insurance.

Note: In marine insurance, ‘average’ has a totally different meaning. Here it means partial loss, a loss other than total loss. Average in marine insurance is complex and beyond the needs of this present study.

(b) Policy excess/deductible: An excess or deductible is a policy provision whereby the insured is not covered for losses up to the specified amount, which is always deducted from each claim.

Suppose a motor policy is comprehensive, with a $4,000 excess for damage to the insured vehicle. If an accident occurs and the repair bill for the car amounts to $14,000, the insurer is only liable for $10,000. On the other hand, with a minor accident and repairs costing $3,000, the insurer would have no liability at all.

(c) Policy franchise: Seldom seen today (except for time franchise – see example below), it is similar to an excess in that it eliminates small claims. On the other hand, it is different from an excess in that if the loss exceeds or reaches the franchise – depending on the wording used - the loss is payable in full. Like an excess, a franchise can be expressed as a percentage, an amount of loss, or a time period. Suppose a ship which is insured for $5,000,000 subject to a 5% franchise sustains insured damage. If repairs cost only $100,000 (2%), nothing is payable by the insurer. But if repairs cost $1,000,000 (20%), the loss is payable in full.

Example of time franchise: A particular hospitalisation policy contains a 2- day franchise provision; in other words, there is a waiting period of two days. If the insured person stays in hospital for one day, no expenses are reimbursable. But if he has to stay for 5 days, the policy pays the medical expenses incurred during the whole of that 5-day period.

(d) Policy limits: As the sum insured is the insurer's maximum liability, any loss exceeding that limit will not be fully indemnified. Other types of limits may also exist within the policy terms; examples include: (i) Single Article Limit: It is a limit commonly found in a household contents policy. Where such a policy covers property described in broad terms like ‘contents’ for a stated amount, there is no way the insurer can tell whether the insured contents will not, at the time of loss, be found to include an article which is so valuable that its value already accounts for, say, 90% of the sum insured for the whole of the contents. This is a situation the insurer will not want to see, partly because of the theft risk it represents. In fact, the insured could have declared the value of this item of contents to the insurer, requiring that it be separately subject to a sum insured representing its value. The benefit of this approach is that the insurer will be liable for an insured loss of this item of property up to its own sum insured. On the other hand, in the event that an insured has not made such an article the subject of a separate sum insured, the insurer will have to restrict the amount payable for a loss of this item to a limit specified in the policy, called the ‘single article limit’.

(ii) Section Limit: A policy may contain two or more sections, which take effect in relation to different subject matter of insurance (as in the case of a travel insurance policy, which normally covers property damage, legal liability and others), different insured perils, etc. Each of these sections is usually made subject to its own limit of liability, which operates similarly to a sum insured.