Anatomy of an Insurance Policy

Benjamin Franklin is quoted as having written that “nothing is certain, except death and taxes“.  Closely following death and taxes is insurance.  Whether for business or personal reasons, it is likely that you will have to deal with insurance and insurance policies at some stage.

Unfortunately, despite the prevalence of insurance policies and products, there is little guidance or education on insurance and how it operates.  This article explains some of the basics.

What is Insurance?

The first thing to remember is that an insurance policy covers an uncertain risk. In exchange for your money (premiums), an insurance company agrees to pay a sum of money, or to do something (e.g. conduct repairs), if the risk occurs.

If the risk occurs, you lodge a claim to let the insurance company know that you think it has an obligation to pay money, or do something else, under the insurance policy.

When you lodge a claim, the insurance policy dictates what, if anything, the insurer has to do in response to the risk having happened.

How does an insurance policy work?

Broadly speaking, a policy of insurance and the obligations under the policy can be split into two distinct parts:

1. the insuring (or coverage) clause, which identifies the risks covered by the insurer; and
2. any limitations that apply to the risks covered by the insurer (exclusion clauses).

It is important to understand that not all exclusions fall under the “exclusion clauses” section of an insurance policy.  Other clauses in a policy of insurance may limit the circumstances in which the policy responds (or does not respond) to a risk occurring. This is why it is important to carefully review the entirety of an insurance policy. Exclusions clauses may be worded such that there are exceptions to when an exclusion applies. That is, there may be circumstances when an exclusion clause does not apply.

When an insurance claim is made, there are distinct roles and obligations that need to be discharged by the insured and the insurer:

1. The insured has the responsibility of establishing that the insurance policy responds to the risk that has occurred. That is, something has happened (also known as an “insured event”) that entitles the insured to receive the benefit (for example, money) of the insurance policy.
2. If it is established that an insured event has occurred, then the insurer is at first instance required to provide the insured with the benefits of the insurance policy. However, this will not be the case if the insurer establishes that an exclusion clause applies to the claim.  If an exclusion applies, then the insurer may be entitled to deny the claim.  Depending on the type of policy, there may be laws that limit whether or how an insurer can rely on any exclusion clause.
3. If the exclusion relied on by the insurer is subject to exceptions, then the responsibility switches back to the insured to establish that the exception applies and the insurer cannot rely on the exclusion.

Although the obligations on the insurer and insured can be readily distinguished, in practice, the interpretation of the insurance clauses and how they operate causes numerous disputes between insureds and insurers. If an insured event has occurred, or whether an exclusion applies may require evidence of the matters surrounding the claim.

This illustrates the vitality of being familiar with the complete terms of your insurance policy. In an era where information dumps have normalised agreement without understanding, it may save you significant funds and headaches to take the extra few moments and fully evaluate the terms and exclusions of the policy.