Pro Rata Clause
The pro rata clause in an insurance policy stipulates ways in which coverage is distributed. Because of pro rata clauses, there are instances in the insurance world where one policyholder can have one property insured by three insurance companies or three properties insured by one insurance company. How pro rata clauses work allows insurance companies to have a precise way of distributing the policies’ coverage. As pro rata stands for in portion, the pro rata clause stipulates that the policy will pay for losses in share to the amount of insurance coverage that the policy has in force. This manner of portioning the coverage concerning the total amount of insurance in force from all other policies helps companies not step on each other’s feet. Pro rata clauses draw the line between what loss is covered regarding other active policies involved. Unlike pro rata cancellations, pro rata clauses can be applied to assets and different types of life insurance policies.
How pro rata clauses work separates them into two distinct clauses—the pro rata liability clause which distributes the coverage of insurers, and the pro rata distribution clause distributes the coverage of the policy. Let’s see how.
The Pro Rata Liability Clause
The pro rata liability clause is a section in the insurance policy that limits the company’s liability to coverage for a loss if other insurance companies also cover the asset. There is no reason for a homeowner not to insure one property with several insurance companies. This can provide more security and better coverage in case of an incident. However, each insurance company will cover a portion of the total amount.
The amount of coverage for each company depends on several factors: the total premium, the total loss, the pro rata rate.
Example:
John has a house valued at $100,000, and he takes two property insurances in total for $100,000. Insurance company A makes a policy covering 60% of the property while insurance company B’s policy covers 40% remaining of the property. In case of total damage, the pro rata liability clause splits the loss the same way the policy was split, 60% for company A and 40% to company B. Like this, John will receive $60,000 from company A and $40,000 from company B.
This clause is to avoid instances when a policyholder gets maximum coverage from three insurance companies. That situation would provide an unjust profit for the insured and substantial loss for the insurance companies.
The Pro Rata Distribution Clause
The pro rata distribution clause is the opposite of the clause explained above—the number of companies changes with the number of assets. The meaning here is that there is one insurance company that has one policy with an insured that covers more than one property. This kind of policy is to have one payment that ensures more properties and this clause can provide a just distribution of the coverage. An insurance policy like this considers the value of each property separately, and the pro rata distribution clause splits the coverage in proportion to the value of each property.
Example:
John has two houses and he buys one insurance policy for $200,000. Property A is assessed at $140,000 and property B is assessed at $100,000. The $200,000 policy can not cover both properties in case of a total loss. If John suffers a total loss on property A then the coverage would be the total property evaluation’s portion of the policy. As the total value of the properties is at $240,000, but the total coverage can only be of $200,000, the pro rata distribution clause determines that property A is 60% of the total value of both properties, and that’s why it will get 60% of the total coverage. In this case, that would be $120,000. If both properties needed total loss coverage, property A would get 60% - $120,000, while property B would get the remaining $80,000.
The case above is presented for a too-small policy to cover both properties to show how important adequate coverage is. If the coverage would be for $240,000, then both properties could be covered wholly.
Another pro rata clause is enforced when multiple parties are responsible for damage, for example, in car accidents. The pro rata clause is used here to determine a fair and equitable liability among the responsible parties.
Popular Insurance Terms
Premium income divided by the surplus account. ...
Low-cost life insurance sold by savings banks in the states of Connecticut, Massachusetts, and New York. SBLI is a popular source of life insurance in these states for two reasons: it is ...
Management philosophy developed by W. Edwards Deming, the thesis of which is the continuous improvement in quality through research in customer satisfaction and the empowerment of ...
Variation of ordinary life insurance under which current mortality experience and investment earnings are credited to the insurance policy either through the cash value account and/or the ...
Clause included in or attached to a fidelity bond designed to pay the losses that would have been paid under another specific bond had that specific bond's period of discovery not expired. ...
Amount of reinsurance accepted by a second reinsurer which is in excess of the original insurer's retention limit and the first reinsurer's first surplus treaty's limit. ...
Part of a marine cargo policy that exempts the policyholder from vouching for the seaworthiness of the vessel. For example, while a purchaser of hull marine insurance warrants that a ship ...
Amount designated as a future liability for life or health insurance to meet the difference between future benefits and future premiums, net level premium is determined so that this basic ...
Coverage that indemnifies a third party lender if a customer refuses to repay a loan made on a faulty product and the dealer who arranged the loan refuses to correct the fault. This ...
Have a question or comment?
We're here to help.