Property & Casualty Insurance Exam (National Portion)Property and Casualty Insurance BasicsHard
A business has two separate property insurance policies covering the same building. Policy A has a limit of $300,000, and Policy B has a limit of $200,000. If the building sustains a covered loss of $100,000, how much will Policy B pay under a pro rata liability clause, assuming no deductibles apply?
- A$40,000
- B$20,000
- C$60,000
- D$50,000
Show answer & explanationAnswer & explanation
Correct answer: A. $40,000
Under a pro rata liability clause, each policy pays its proportion of the loss based on its share of the total insurance. Total insurance = $300,000 (Policy A) + $200,000 (Policy B) = $500,000. Policy B's share is $200,000 / $500,000 = 2/5 or 40%. Therefore, Policy B pays 40% of the $100,000 loss = $40,000. (200,000 / 500,000) * 100,000 = 40,000.
Why the other options are wrong
- B. This would be 20% of the loss, incorrect calculation.
- C. This would be Policy A's share of the loss (60%), not Policy B's.
- D. This would be 50% of the loss, implying equal shares, which is incorrect here.
Pro Rata Liability Clause
A policy condition that specifies how multiple insurance policies covering the same loss will share the payment, based on the proportion of each policy's limit to the total insurance coverage.
- Prevents overpayment and moral hazard when multiple policies exist.
- Formula: (Policy Limit / Total Insurance) * Loss.
- Ensures fair distribution of loss among insurers.
Memory trick: Pro Rata: 'Proportionally' 'Pay' for 'Policies'.