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What are policy limits?

What a great question and so few people ever think to ask! A policy limit is the maximum amount of money an insurer will pay out to an insurance policyholder after an insured loss. Policy limits are defined based on what is insured and the kind of kind of policy you hold.

Policy Limits of Amounts in the Case of a Claim

When insuring your property like your home car and other valuables consider what level of coverage you need and are willing to pay for. Make sure all of your items are adequately covered because your level of coverage will affect the policy limit and the amount you receive if you need to report an insurance claim.

The Insurance Information Institute breaks down coverage for property items into three categories each describing what payout can be expected from a claim.

Actual Cash Value: Your insurance covers replacement of the insured item minus the depreciated value. For example your TV is damaged. Your policy is on an actual cash value payout. That means that you will get paid what it is worth today not the amount you originally purchased it for. Depreciation is applied. If the TV is five years old your insurance company would give you the same price as you could buy the same TV at on Kijiji. You may have paid $2500 five years ago but today that TV is listed for $500.

Replacement Cost: Your insurance covers replacement of the item or for the purchase of another item at equal value. Unlike the actual cash value policy limit your policy limit here would be the cost of a new item which is comparable to your old one. For example if that same TV was damaged you’d be reimbursed for a new one of similar quality up to the extent of your policy limits. However if your policy limit is $1,000 and the new TV costs $1,500 your insurance will only cover $1,000 – it’d be up to you to make up the $500 difference.

Guaranteed or Extended Replacement Cost: This “extension” refers to the policy limit. In this case your replacement cost is “guaranteed” meaning that the policy limit does not apply if the cost to replace the item is higher. For example if replacing your TV costs $2,000 your insurance will pay that amount to replace it.

Policy Limits of Liability

Let’s take a quick moment to look at liability insurance policy limits. There are different issues to consider here since the policy limit will not apply to your payout (at least not directly). Rather in the case of your liability insurance the policy limit refers to the maximum amount the insurer will pay out to a third party who has a claim against you.

Let’s use a car accident as an example. Say you rear-end someone during some bad driving conditions. You’re okay but the passenger in the other car has whiplash. They or their insurance company comes after you to make up for medical bills or time off of work. Your insurer steps in and will cover the associated costs such as legal fees and medical or accident benefits. However this is only to a certain amount which will vary depending on your policy. Beyond that amount you would be on the hook for anything additional a court may award.

Your policy limits are a crucial part to your insurance policy. It’s important that you know your limits and understand how they work. Talking to a broker can help as they can help explain the limits to your personal policies and advise if those limits are right for your situation.