Actuarial Notes

Policy Provisions

Study guides: Exam DISC-IA, Exam GI-302

Policy Provisions are the statements in an insurance policy that together decide what it covers and how much it pays. Endorsements add to or change any of them. No single provision answers whether a loss is covered, so they are read together, as a coverage analysis does.

\text{Pay} = \mathbb{1}_{\text{IA}} \times \big(1 - \mathbb{1}_{\text{Ex}}\big) \times \mathbb{1}_{\text{Co}} \times g(X)

g(X) = \min\big(\max(R \times X - D,\ 0),\ C\big)

  • Symbols: \mathbb{1}_{\text{IA}} is 1 when the loss falls within an insuring agreement, \mathbb{1}_{\text{Ex}} is 1 when an exclusion applies and no exception to it restores coverage, and \mathbb{1}_{\text{Co}} is 1 when the conditions have been met. g(X) is the amount the valuation and limit provisions produce from the loss X, where R is the coinsurance ratio, D the deductible and C the limit, as on Property Insurance. The general payment function is on Policy Information.
  • Declarations: The declarations page holds the facts particular to this policy: the named insured, the policy period, the property or activities insured, the limits, deductibles and premium, and the forms and endorsements attached.
  • Definitions: Defined terms, usually printed in quotation marks or bold, mean only what the definition says, and they can narrow or widen a coverage. Courts read genuine ambiguity against the insurer that drafted the form.
  • Insuring agreements: An insuring agreement states what the insurer promises. The CGL Coverage A agreement promises to pay the sums the insured becomes legally obligated to pay as damages because of bodily injury or property damage to which the insurance applies, and to defend the insured. It applies only to injury caused by an occurrence, in the coverage territory and during the policy period. An open perils agreement promises to pay for any direct physical loss not excluded, and a named perils agreement only for the perils listed. Additional coverages and supplementary payments are smaller insuring agreements of their own.
  • Exclusions: Exclusions remove causes of loss, kinds of loss or kinds of property from the insuring agreement. An exception to an exclusion gives back part of what the exclusion took away.
  • Conditions: Conditions qualify the insurer's promise. The insured must pay the premium, report a loss promptly, protect property from further damage, cooperate and submit proof of loss, and the insurer is relieved of its obligation if the insured fails to comply in a way that matters. Other conditions set out the insurer's own duties, such as when it must pay.
  • Other provisions: Forms also say how the policy shares a loss with other insurance and how the parties settle a dispute over the amount of a loss; the homeowners form places both among its conditions.
  • Valuation provisions: For property insurance, the provisions that value a loss are the valuation basis, such as actual cash value, replacement cost or agreed value, the coinsurance clause (Insurance to Value), the deductible and the limit. Together they make up g(X).
  • Where provisions are found: Whether a provision sits on the declarations page, in a coverage form, a causes of loss or conditions form, or an endorsement depends on how the policy is assembled, self-contained or modular, preprinted or manuscript (Insurance Policy Structure). The legal features that shape how courts read the provisions are on Insurance Contract Characteristics.

Frozen Pipes in an Empty House An HO-3 insured spends a winter month away and turns off the heat without shutting off and draining the water. A pipe freezes and bursts, causing $14,000 of damage to the floors and walls and $6,000 to furniture. The deductible is $1,000. Is the loss covered? What would the insurer pay if the insured had kept the heat on and a pipe had burst anyway?

Answer The dwelling is insured on an open perils basis, so its insuring agreement applies. The HO-3 excludes freezing of the plumbing unless the insured used reasonable care to maintain heat or to shut off the water and drain the system. The furniture's named peril, freezing, carries the same qualification, so \mathbb{1}_{\text{Ex}} = 1 for both and the insurer pays nothing. With the heat maintained, the exclusion doesn't apply and the loss is covered.

\begin{align*}
\text{Pay} &= 1 \times (1 - 0) \times 1 \times (14{,}000 + 6{,}000 - 1{,}000) \\
&= 19{,}000
\end{align*}

Three Claims Against a Contractor's CGL A contractor's CGL policy has a $1,000,000 each occurrence limit. During the policy period a crane on a job site drops a beam, which damages a client's car parked nearby, costing $22,000; damages the contractor's own truck, costing $9,000; and injures one of the contractor's employees. Which claims does Coverage A pay?

Answer Damage to the client's car is property damage the contractor is legally obligated to pay, caused by an accident at the job site. It is within the insuring agreement, no exclusion applies, and the payment is within the limit.

\begin{align*}
\text{Pay} &= \min(22{,}000,\ 1{,}000{,}000) \\
&= 22{,}000
\end{align*}

The truck fails the insuring agreement, because a CGL pays damages owed to others, not the insured's own property damage, which belongs to auto physical damage coverage. The employee's injury is within the insuring agreement, but the employer's liability exclusion removes it, and the claim goes to workers compensation. Each claim is settled by a different provision.

How it appears on the exam

  • DISC-IA: Questions ask candidates to identify which category a given provision belongs to. Applied questions give a policy and a loss and ask whether an insuring agreement, an exclusion or a condition decides it, including the CGL Coverage A insuring agreement and the HO-3 Section I exclusions.
  • GI-302: Candidates explain how the policy provisions for valuing losses, together with insurable interest and insurance to value, determine the loss payment under property insurance.

Exam traps

  • Start with the insuring agreement: An exclusion can only remove what an insuring agreement granted. A loss outside every insuring agreement is not covered, and no exclusion needs to be found.
  • Exceptions restore coverage: An exception to an exclusion gives back coverage for the cases it names. Stopping at the exclusion denies losses the form deliberately covers, such as fire following an excluded earthquake.
  • Conditions are not exclusions: A condition doesn't remove a type of loss. It sets duties, and a breach can release the insurer from a loss that would otherwise be covered. Classifying the duty to report a loss promptly as an exclusion confuses the categories.
  • Definitions matter: A defined term means only what its definition says. Reading "occurrence" or "insured" in its everyday sense can put a claim inside or outside the coverage wrongly.