FIN 4320: Chapter 10 - Analysis of Insurance Contracts - Other-Insurance Provisions

Other-Insurance Provisions

• Definition and Purpose:
  • These provisions are typically found in Property & Casualty (P&C) and Health insurance contracts.
  • Their primary purpose is to prevent an insured from profiting from a loss by collecting from multiple policies, thereby upholding the Principle of Indemnity.
• Approaches to Handling Multiple Policies:
  • Pro Rata Liability
  • Contribution by Equal Shares
  • Primary and Excess Insurance
  • Coordination-of-Benefits (Health)

Pro Rata Liability

• Mechanism: Each insurance contract pays its percentage of the total insurance covering the property or loss.
• Example:
  • Scenario: Building A is valued at $800,000$ and is covered by three policies for a total of $800,000$ in limits.
    • Policy X: $400,000$
    • Policy Y: $300,000$
    • Policy Z: $100,000$
  • Loss Amount: A covered loss of $50,000$ occurs.
  • Calculation:
    • Policy X: Limit $400,000$ / Total Insurance $800,000$ = $50.0\%$ percentage of total insurance.
      • Amount Paid: 0.50 \times 50,000 = $25,000
    • Policy Y: Limit $300,000$ / Total Insurance $800,000$ = $37.5\%$ percentage of total insurance.
      • Amount Paid: 0.375 \times 50,000 = $18,750
    • Policy Z: Limit $100,000$ / Total Insurance $800,000$ = $12.5\%$ percentage of total insurance.
      • Amount Paid: 0.125 \times 50,000 = $6,250
    • Total Paid: 25,000 + 18,750 + 6,250 = $50,000

Contribution by Equal Shares

• Mechanism: Each contract contributes an equal amount to the loss until its limit is exhausted or the loss is fully paid. If one policy's limit is reached, the remaining burden is shared equally among the remaining policies.
• Example:
  • Scenario: Building A is valued at $800,000$ and is covered by three policies:
    • Policy X: $400,000$
    • Policy Y: $300,000$
    • Policy Z: $100,000$
  • Loss Amount: A covered loss of $600,000$ occurs.
  • Calculation Steps:
    1. Initial Equal Share: Divide the loss ($600,000$) by the number of policies (3) = $200,000$ per policy.
    2. Adjust for Limits:
       • Policy Z's limit is $100,000$, which is less than $200,000$. So, Policy Z pays its limit of $100,000$.
       • The remaining loss is $600,000 - 100,000 = 500,000$.
    3. Remaining Policies (X and Y): Divide the remaining loss ($500,000$) by the remaining number of policies (2) = $250,000$ per policy.
    4. Final Payments:
       • Policy X: Pays $250,000$ (within its $400,000$ limit).
       • Policy Y: Pays $250,000$ (within its $300,000$ limit).
       • Policy Z: Pays $100,000$ (its limit was exhausted first).
    5. Total Paid: 250,000 + 250,000 + 100,000 = $600,000

Primary and Excess Insurance

• Mechanism: One policy (the primary policy) pays first, up to its limit. The other policy (the excess policy) only pays after the primary policy's limits are exhausted.
• Common Example: When borrowing a car, the borrowed car's insurance policy (e.g., the owner's Personal Auto Policy - PAP) typically pays first (primary), and the driver's own PAP would pay second (excess) if the loss exceeds the primary coverage.
• Legal Case Study (Kentucky Supreme Court, Dec 23, 2024 - Rabb):
  • Incident: A 5-year-old child was fatally hit by a truck driven by an employee of Alltrade (a contractor) at Whispering Brook apartment complex in 2016.
  • Contractual Indemnification: The apartment service agreement stipulated that Whispering Brook would indemnify Alltrade and hold it harmless for liability.
  • Insurance Policies Involved:
    • Whispering Brook's Commercial General Liability (CGL) Policy (from First Specialty): Included a non-owned auto endorsement providing $1$ million in coverage, but stated its coverage was excess over any other insurance.
    • Alltrade's Commercial Liability Policy (from Motorists Mutual): Also provided that for any covered 'auto' Alltrade did not own, its insurance was excess over any other collectible insurance. This policy also had $1$ million in business auto coverage.
  • Legal Challenge: The family filed a wrongful death lawsuit. Motorists Mutual asked the court to determine which policy should pay first.
  • Court Ruling: The circuit court judge found that the excess clauses in both policies were "mutually repugnant." This means the conflicting excess clauses canceled each other out. As a result, both insurers were ordered to contribute equal amounts to the loss, rather than one being strictly primary and the other excess.

Coordination-of-Benefits (COB) Provision (Health)

• Application: Primarily found in health insurance contracts.
• Core Principle: Similar to primary and excess, it establishes which health policy pays first when an individual is covered by more than one health plan.
• Rules: Various rules have been developed by organizations like the National Association of Insurance Commissioners (NAIC) to determine the order of payment.
• Common Rules:
  • Primary vs. Dependent Coverage: Generally, coverage where an individual is the primary insured pays first, followed by coverage where they are a dependent.
  • "Birthday Rule": For children covered by two parents' health plans, the plan of the parent whose birthday occurs earlier in the calendar year is typically considered primary. The year of birth is irrelevant, only the month and day.