What Is a Liberalization Clause?

A liberalization clause is an insurance policy provision that allows for adjustments to be made to existing coverage in order to comply with changes to relevant laws and regulations. Property insurance is the most likely place to find a liberalization clause.

Key Takeaways

  • A liberalization clause is added to some insurance policies in order that they can be amended after they are in force to adjust to changes in regulatory rules or laws.
  • The purpose of a liberalization clause is to ensure that existing insurance policies remain valid even as regulations change that would have had them fall out of compliance.
  • A liberalization clause benefits both policyholders and insurers, and can allow for expansion of coverage but will not typically result in a reduction of existing coverages.

Liberalization Clause Explained

In the United States, each state primarily regulates the sale of insurance policies. State laws therefore determine required coverages and limits, set liquidity requirements insurance companies must meet to sell policies, and govern insurer insolvencies.

One recurring issue that insurers must contend with is regulatory change. Amended insurance regulations may result in underwritten policies that suddenly fall out of compliance. Insurers will add a liberalization clause that automatically adapts existing policies to such regulatory changes, even if the changes happen during the policy period.

Including a liberalization clause allows insurers to expand coverage to comply with regulatory changes without issuing a new policy endorsement and notifying the policyholder. This clause enables the insurer to broaden the risks that a policy covers without requiring an additional premium from the policyholder. Regulatory changes only affect existing policies that include a liberalization clause since policies issued after the change will include coverages that match changes in regulation.

Both policyholders and insurance companies benefit from the inclusion of liberalization clauses. Policyholders receive beneficial coverage not bought with the original policy. Also, insurance companies benefit because they do not incur the administrative costs associated with notifying insured parties of new regulations.

Liberalization Clause Example

For example, an insurance company sells a property insurance policy that contains no coverage for damage to storm shutters but does contain a liberalization clause. Later, the state legislature passes a new law requiring insurance policies to include coverage for storm shutters automatically. Because of the added liberalization clause, the insurer automatically extends coverage to existing policies without increasing premiums.

In some cases, changes to insurance regulations may limit existing coverage. For example, state lawmakers may pass new legislation that removes the requirement of storm shutter coverage. This change reduces the coverage that future policyholders will have, but it will not impact existing policyholders. Liberalization clauses do not restrict benefits not already provided as they are considered to be grandfathered in.