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1 + 1 = 2... Or does it?

The Aggregate Limit vs Reinstatement Debate:

What I am about to discuss is something that surprises even those in the industry, so don’t be surprised if it’s difficult to grasp at first. Even some of the most respected brokers I come across in the market, sometimes with 30 years’ experience, still get this one wrong. What I am talking about is the difference between an Aggregate Limit and Reinstatements of the limit on a policy – or rather, the fact that there actually is a difference at all.

This issue presents itself on a multitude of policy types but for present purposes, we will just talk about Professional Indemnity because it’s the most obvious and the most readily available. The average Professional Indemnity policy might have limits which look like either one or the other of the below:

Now what Option 1 means is that for any one claim, the maximum the insurer will pay is $1 million. And then for all claims during the one policy year, you can claim as many different times as you would like until the $2 million total is reached. Now on first inspection, Option 2 may appear to do the same thing… You have a maximum of $1 million for any one claim as with the first option, and then if you exhaust that limit the insurer will reinstate it which gives you $2 million in total, right?

Well… not exactly. Consider the following scenario:

  • A company has a claim brought against it for a frivolous matter for which they had no fault and the insurer decides that although they don’t believe any fault exists, they don’t want to get involved in a drawn out and expensive legal process so they settle the claim for a nominal $5,000.

  • Another claim is then brought against this insured totalling $500,000. However, this time the claim is more serious and the policy holder realises that there was an issue with the way a certain member of staff was doing something and thus, they expect more claims.

  • They start to try to repair the issues where they can but there is one particularly large client where they feel they’re particularly exposed.

  • Their worst fears are realised and this large client now brings a claim for $1 million and they once again turn to their insurer for assistance…

Now there has been a total of $1.505 million claimed under the policy so without doubt under Option 1 the aggregate limit of $2 million is not yet exhausted and the claim should be paid. Well contrary to logic, the same is not true under Option 2. Why you ask? It’s actually quite simple:

  • The reinstatement clause in the policy reads something like “If the limit under the policy is eroded, either wholly or partly, then the insurer will reinstate the limit under the policy for any subsequent claims”

  • Upon making the first claim for $5,000, the insurer makes payment to the third party and then reinstates the limit as promised.

  • On the next claim, the insurer once again pays the claimed amount of $500,000 but remember, there are now no resinstatements left so the $1 million limit is now reduced to $500,000.

  • When the final claim arrives, the insured is paid up until the $500,000 limit but then is left with a $500,000 uninsured loss.

  • Under this policy, the maximum amount the policyholder was able to claim was $1,005,000 despite the limit seeming to be $2 million.

So the moral of the story here is not that Reinstatements are bad. Rather, when reviewing a policy you should simply be aware of the difference and make sure that there are adequate reinstatements for your purpose. There are a number of policies which operate on a reinstatement basis which are significantly better in all other respects that their Aggregate Limit peers. It’s just important to be aware of the difference and factor this in to any policy review and comparison.

I’ve said it once and I will say it again – insurance is a minefield and I wouldn’t recommend that anyone attempt to navigate it without proper guidance. Talk to us today if you’re in need of assistance or even a policy review.

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