The differences between some kinds of insurance policies are
easy to figure out. For example, auto insurance covers automobiles and home
insurance covers individual houses. However, other terms are not so
self-explanatory.
You should understand the differences between primary and
excess insurance in particular, as you will likely encounter them at some
point. You may have also heard of the term "reinsurance," which you
are less likely to encounter, but should nevertheless know to avoid confusion.
Primary
Insurance is considered primary whenever coverage begins
after a written contract has been signed and a potential liability has been
triggered by some event. For example, if you take out a fire insurance policy
on your home or business, the primary coverage kicks in as soon as the insured
property suffers fire damage.
A primary insurance policy normally imposes a duty on the
insurance carrier to protect against any claims made against the insured party,
such as protecting a car driver who has been hit in an intersection by another
car. There may be some stipulations about timing and circumstance, such as
promptness to report the claim, but generally the insurer's obligations follow
a similar pattern in each case.
Each primary policy has a limit imposed on the amount of
coverage available and normally sets deductible limits for the customer.
Primary policies pay out against claims regardless of whether there are
additional outstanding policies covering the same risk.
Primary insurance has a slightly different structure, or at
least different term usage, when referring to medical insurance. Primary
insurance in medicine normally refers to the first payer of a claim, up to a
certain limit of coverage, beyond which a secondary payer is obligated to cover
additional amounts. This is especially important in the interaction between
Medicare and other forms of medical insurance.
Excess
Excess insurance coverage is a topic of considerable
confusion due to the many different uses of the term "excess" in the
insurance industry. In fact, there have been some significant malpractice
claims against insurance providers that used the term in a confusing or
misleading manner.
In its most basic form, an excess liability policy extends
the limit of insurance coverage to find an existing insurance coverage,
otherwise known as the underlying liability policy. The underlying policy does
not have to be primary insurance; it can be reinsurance or another excess
policy in many circumstances. Often,umbrella insurance policies are the
underlying policies.
However, excess insurance is not necessarily the same thing
as umbrella insurance. An umbrella liability policy is written to cover several
different primary liability policies. For example, a family might purchase a
personal umbrella insurance policy (PUP) from the Allstate Corp. (NYSE: ALL) to
extend excess coverage over both their automobile and homeowners policy. If an
excess policy only applies to a single underlying policy, it is not considered
to be an umbrella insurance policy.
The International Risk Management Institute outlines three
uses of an umbrella excess insurance policy. The first use extends excess limit
coverage to underlying insurance policies after they have been exhausted by
payments of a larger claim. The second use is flexibility, to be used in a
situation where the underlying policies are not sufficient, but upgrading the
entire policy package is too expensive. Finally, an umbrella policy may provide
protection against some claims not covered by the underlying policies.
Reinsurance
Unless you own or work for an insurance company, you are
unlikely to encounter reinsurance on the market. In effect, reinsurance is
insurance for other insurance companies. Each reinsurance agreement commits one
covering insurer, or reinsurer, to protect against potential losses arising
from insurance liabilities issued by the covered insured, or ceding insurer.
The fundamental operating characteristics of reinsurance are
similar to primary insurance. The ceding insurance company pays the premium to
the reinsurer and creates a potential claim against undesirable future risks.
Were it not for the added protection of reinsurance companies, most primary
insurers would either exit riskier markets or charge higher premiums on their
policies.
One common example of reinsurance is known as a "cat
policy," short for catastrophic excess reinsurance policy. This covers a
specific limit of loss due to catastrophic circumstances, such as a hurricane,
that would force the primary insurer to pay out significant sums of claims
simultaneously. Unless there are other specific cash-call provisions, the
reinsurer is not obligated to pay until after the original insurer pays claims
on its own policies.