Multiple Insurance Coverage: Pro Rata Liability, Contribution of Equal Shares, and Primary and Excess Insurance

Some losses may be covered by more than 1 insurance policy. However, insurance policies are written to prevent people from profiting from insurance—the principle of indemnity—because otherwise potential profits from insurance can create a moral hazard by motivating people to file claims for profit rather than to cover losses, which would increase premiums substantially.

Insurance companies have developed various solutions to prevent the insured from profiting from multiple insurance policies: pro rata liability, contribution of equal shares, and primary and excess insurance. Additionally, exculpatory clauses may relieve the insurer of liability for losses if their contract specifically states that property that is separately and specifically covered by other insurance will not be covered.

Pro Rata Liability

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If a loss occurs that is covered by more than 1 insurance policy that was purchased by the insured, then each policy pays a portion of the loss that is proportional to the amount of that policy over the total amount of all policies for the loss—each policy pays its pro rata share.

Example—Pro Rata Liability

You want to insure a building for $1,000,000, but, for underwriting reasons, the maximum amount that you can purchase from 3 insurance companies is $600,000; $300,000, and $100,000, so you purchase the 3 policies with the maximum limits. If you suffer a $200,000 loss, then the 1st company will pay 60% of the loss, the 2nd, 30%, and the 3rd, 10%.

Contribution by Equal Shares

Some policies handle multiple coverage through payments of equal shares rather than pro rata payments. Each company pays an equal amount until the loss is covered, or the policy limit of any policy is reached. If 1 or more of the policy limits are reached, then the equal share principle applies to the remaining insurers. As each policy limit is reached, the remaining insurers make equal payments with the remaining amount of uncovered loss until the loss is covered or all policies are maxed out.

Example—Contribution by Equal Shares

Consider the same facts as in the 1st example. If you have a $150,000 loss, then each company pays $50,000 for a total of $150,000. If your loss was $400,000, then each company pays $100,000, and the 2 with higher coverage pay an additional $50,000 for a total of $400,000. If your loss was $800,000, then the low-limit company pays its policy limit of $100,000, the next company pays its policy limit of $300,000, and the remaining insurance company pays the remaining $400,000 to cover the loss.

Primary and Excess Insurance

Sometimes the amount that each company pays is determined by which insurance is considered primary and which is excess. This method of determining insurance payouts is commonly used where insurance by different people's policies cover the same loss or with insurance that was not purchased directly by the insured, such as health insurance received as a benefit of employment.

For instance, if you drive someone's car, and have an accident, then the car owner's insurance is considered primary, and your auto insurance is considered excess. If the owner's insurance was capped at $300,000, and the liability for the accident was $40,000, then the owner's insurance would pay the entire bill. However, if the liability was $350,000, then the owner's insurance would pay the policy limit of $300,000 and your insurance would pay the remaining $50,000.

Group health insurance has a coordination-of-benefits clause that stipulates which insurance is primary and which is excess. The National Association of Insurance Commissioners (NAIC) has written the coordination-of-benefits provision that has been adapted by nearly every state. While this provision has many complexities, 2 simple rules determine insurance coverage in many cases.

First, insurance received as part of employment is primary while coverage provided by being a dependent is excess. Thus, if both partners in a marriage have insurance and they have dependent benefits coverage, then if a spouse injures himself, his insurance is considered primary and his wife's insurance is excess.

If this same couple had children, then the birthday rule applies when a child is injured. The birthday rule stipulates that whichever parent has the earlier birthday is the insurance that is considered primary. Thus, if the father's birthday is in January and the mother's is in February, then the father's insurance is considered primary. This rule seems arbitrary, but it was adapted for that specific reason—to prevent gender discrimination.

Ocean marine contracts generally stipulate that if there is multiple insurance coverage, then the policy with the earliest effective date will be the primary insurance. Other policies obtained later are treated as excess coverage.