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 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.
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 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.
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.