What Happens If Damages Exceed Policy Limits?

Insurance policies protect individuals and businesses from financial burdens by specifying maximum amounts, known as policy limits, an insurer will pay for a covered loss. While insurance provides a safety net, damages from an incident can exceed these limits. When damages surpass coverage, the insured faces direct financial exposure, highlighting the importance of appropriate policy selection and diligent claim management.

Understanding Insurance Policy Limits

Policy limits define the maximum financial obligation an insurance company assumes for a covered claim. These limits are established when the policy is purchased and are stated within the insurance contract. For example, auto liability insurance limits are often expressed as $25,000/$50,000/$25,000. This signifies $25,000 for bodily injury per person, $50,000 for total bodily injury per accident, and $25,000 for property damage per accident. Homeowners insurance policies also include liability coverage, typically with limits from $100,000 to $500,000, to protect against claims for injuries or property damage.

Two main types of limits apply to liability insurance: per-occurrence limits and aggregate limits. A per-occurrence limit is the maximum amount the insurer will pay for all damages from a single incident. For example, if an auto policy has a $50,000 bodily injury per accident limit, the insurer will pay no more than that amount for all injuries sustained in one accident. Aggregate limits, less common in personal lines like auto and home, represent the total maximum amount an insurer will pay over the entire policy period for all covered losses. These limits are typically found in commercial policies and cap the insurer’s total payout, even if multiple separate incidents occur.

Selecting appropriate policy limits balances premium costs with potential financial exposure. While state minimums exist for certain coverages, such as auto liability, these often provide minimal protection and may not adequately cover significant damages. Opting for higher limits, or considering umbrella insurance policies, can provide an additional layer of protection beyond the limits of primary auto or home policies.

Insured’s Financial Exposure Beyond Policy Limits

When a judgment or settlement exceeds insurance policy limits, the insured becomes personally responsible for the amount surpassing coverage. The policyholder must pay the difference from their own assets. For example, if a policy has a $100,000 limit and a court awards $200,000 in damages, the insured is liable for the remaining $100,000.

Personal assets are at risk when damages exceed policy limits and a judgment is entered against the insured. These assets can include savings accounts, investment portfolios, real estate holdings, and personal property. Creditors may employ various collection methods to satisfy the outstanding judgment. These methods include wage garnishment, where a portion of earnings is withheld, or bank account levies, which involve seizing funds directly from accounts.

Judgment liens can be placed on real property, preventing asset sale or transfer until the debt is satisfied. Personal property can also be seized and sold to fulfill the judgment. This can lead to financial distress, potentially forcing individuals into bankruptcy. Protecting assets through careful financial planning and adequate insurance coverage is a prudent step to mitigate this exposure.

Navigating Excess Claims

When a claim is likely to exceed policy limits, the insured faces a complex situation requiring proactive engagement. Communication with the insurer is important, as they manage defense and settlement negotiations. Insureds should review all correspondence and respond promptly to requests for information. Maintaining detailed records of all interactions, including dates, names, and discussions, can be beneficial.

Understanding the settlement process is important when an excess claim is at hand. The insurer’s attorneys, assigned to defend the insured, handle negotiations with the claimant’s legal representation. If the claim’s value appears to surpass policy limits, a conflict of interest can arise. This is because the insurer’s financial exposure is capped while the insured’s personal liability is unlimited. In such scenarios, the insured may consider seeking independent legal counsel.

An independent attorney, separate from the insurer’s counsel, can advise the insured on personal financial exposure and advocate for their interests during settlement discussions. This counsel helps evaluate settlement offers, particularly those within policy limits, to ensure the insured’s personal assets are protected. While the insurer’s attorney represents the insured’s defense, their primary duty is to the insurer within the policy’s scope. Separate representation helps navigate potential conflicts and ensure comprehensive protection.

Insurer’s Duty to Settle and Bad Faith

Insurance companies have an implied obligation, known as the “duty to settle.” This requires them to accept a reasonable settlement offer within policy limits when a judgment against the insured is likely to exceed those limits. This duty arises because the insurer controls defense and settlement decisions. Failure to settle reasonably could expose the insured to significant financial hardship. If a reasonable settlement offer is presented and the insurer rejects it, leading to a larger judgment against the insured, the insurer may face severe consequences.

“Bad faith” refers to an insurer’s unreasonable or deceptive practices in handling claims, especially when prioritizing their own financial interests over the policyholder’s protection. Examples include denying a valid claim, delaying payment without proper cause, failing to conduct a thorough investigation, or offering a settlement significantly lower than what is owed. When an insurer breaches its duty to settle by unreasonably refusing an offer within policy limits, it can be considered an act of bad faith.

If an insurer is found to have acted in bad faith, the consequences can be substantial. The insurer may become liable for the entire judgment against the insured, even the amount exceeding policy limits. For example, if an insurer unreasonably rejects a $100,000 settlement offer on a $100,000 policy, and the subsequent judgment is $500,000, the insurer could be held responsible for the full $500,000, not just the original policy limit. Insurers found guilty of bad faith may also face punitive damages, designed to punish egregious behavior and deter similar conduct.