Washington State Insurance Practice Exam

What is a common purpose of having "liability limits" in an insurance policy?

1. To control the risk of the insured

2. To determine the premium cost

3. To define the payout cap for claims against the policyholder

4. To provide a standard across insurance policies

The correct answer is: To define the payout cap for claims against the policyholder

Having liability limits in an insurance policy serves to define the maximum amount that the insurance company will pay out for claims against the policyholder. This is crucial because it establishes a clear boundary for both the insurer and the insured regarding the extent of coverage provided. Essentially, liability limits protect the insurer from excessive payouts that could jeopardize their financial stability while also allowing the policyholder to understand the extent of their protection in the event of a covered incident. Understanding these limits is important for policyholders as they can vary significantly based on the type of coverage and the specific policy elected. These limits affect both the risk management strategy for the insured and the risk underwritten by the insurance company. By defining a payout cap, policyholders can make informed decisions about whether they need additional coverage based on their individual risk exposure.