Property and Casualty Insurance Practice Exam

What does the term "contribution by limits" refer to in insurance?

1. Retaining the maximum limit of liability without distribution

2. A method where all policies pay equally regardless of limits

3. Allocating loss payment based on each policy's limit of liability

4. A calculated approach to shared claims under a single policy

The correct answer is: Allocating loss payment based on each policy's limit of liability

The term "contribution by limits" refers to a method used in insurance to allocate loss payments based on each policy's limit of liability. This approach is applied in situations where multiple insurance policies cover the same risk and come into play for a particular claim. When a loss occurs, each insurer contributes to the payment based on the proportion of its coverage limit relative to the total of all applicable limits. For instance, if two policies are involved and one has a limit of $100,000 while the other has a limit of $200,000, and a loss of $300,000 occurs, the insurer with the higher limit would contribute more towards the claim based on its share. This method ensures that the insured receives compensation fairly based on the coverage available from each policy, promoting equitable distribution rather than equal sharing, which helps avoid potential conflicts when claims exceed policy limits. This concept is particularly significant in contexts where multiple coverages overlap or are involved, allowing for more streamlined and straightforward resolution of claims. In contrast, the other concepts mentioned do not align with the true meaning of "contribution by limits." For example, retaining the maximum limit of liability without limits does not involve any policy interaction; similarly, policies paying equally disregards their set limits,