Excess Judgment Loss

Excess Judgment Loss

Investopedia / Laura Porter

What Is an Excess Judgment Loss?

An excess judgment loss is the additional amount that an insurance company must pay above the policy limit. These judgments are often due to actions on the part of the insurer that a court finds to be in violation of good business practices.

Key Takeaways

  • The additional amount that an insurance company is ordered to pay above a policy limit is known as the excess judgment loss.
  • An excess judgment loss is awarded by a judge in court if the insurance company is found to have acted in bad faith.
  • Excess judgment losses reimburse claimants who have been exploited as well as promote honest practices by insurance companies.
  • The main criticism of excess judgment losses is that they undermine limited liability.

Understanding Excess Judgment Losses

A judge awards an excess judgment loss if it is found that the insurance company acted in bad faith when settling a claim. Insurance companies can act in bad faith in a variety of ways. They may use unreasonable or illegitimate grounds to deny coverage or refuse to pay claims. They may deliberately slow the process of investigating claims or paying damages. They may also use baseless objections as excuses to deny or delay the payment of valid claims.

Excess judgment losses require proving bad faith on the part of insurers, so most claimants should not expect to receive more than their policies' limits.

When underwriting a new policy, insurance companies limit the amount of loss that the policy will cover in the event of a claim. Insurers are paid premiums for coverage up to these limits and use the premiums to make investments to generate profits. Suppose the insurer is able to limit the losses resulting from claims. In that case, it can retain a greater portion of the premiums and increase profits. That creates a financial incentive to limit claims whenever possible.

Benefits of Excess Judgment Losses

Excess judgment losses are gains for claimants and help to promote fair decisions by insurance companies. While insurers have incentives to limit the amount of money they pay out in claims, they are still legally obligated to act in good faith when processing a claim. This requirement may result in the insurer being taken to court. That can happen if a claimant believes that the insurer was negligent or acting in bad faith while settling a claim. After that, a court may determine that the insurer behaved improperly and award the claimant an amount above the policy limit.

An excess judgment loss represents an even deeper loss for the insurance company, but it also provides restitution for claimants and deters bad behavior on the part of insurers. Not only does the insurer have to pay for losses up to the policy limit, but it must also pay for losses above that limit. Essentially, the court recognizes that the insurer acted improperly and imposes a penalty. The existence of such penalties makes it more likely that insurers will pay valid claims without imposing undue burdens or excessive delays on claimants.

Criticism of Excess Judgment Losses

The main issue with excess judgment losses is that they undermine the principle of limited liability. When an insurer sells a policy with a maximum limit of $100,000, the idea is that its maximum possible loss is $100,000. That is quite similar to investors who buy $100,000 worth of stock and (rightly) believe that their maximum possible loss is $100,000. If investors were also liable for misdeeds by the companies, many investments would never take place at all. The existence of excess judgment losses can deter insurers from offering policies at all or simply cause them to charge more.

Example of an Excess Judgment Loss

For example, a business might purchase a liability insurance policy to protect itself from claims made by employees who are injured on the job. The policy provides coverage against losses up to $100,000. During the settlement process, the business believed that the insurer acted in bad faith and sued the insurer. A court then determines that the insurer acted in bad faith and awards the business $150,000. The difference between the claims limit and the award, $50,000, represents the excess judgment loss.

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