(1) The limit prevents total claim payments from exceeding the insurer’s financial capacity.
(2) In the context of risk, an upper bound to the benefit lessens the risk assumed by the insurer.
(3) Having different benefit limits allows the policyholder to choose appropriate coverage at an appropriate price, since the premium will be lower for lower benefit limits.
In general, the lower the benefit limit, the lower the premium. However, in some instances the premium differences are relatively small. For example, an increase from 1 million to 2 million liability coverage in an auto policy would result in a very small increase in premium. This is because losses in excess of 1 million are rare events, and the premium determined by the insurer is based primarily on the expected value of the claim payments.
As has been implied previously, a policy may have more than one limit, and, overall, there is more than one way to provide limits on benefits. Different limits may be set for different perils. Limits might also be set as a percentage of total loss. For example, a health insurance policy may pay 9 healthcare costs up to 5000, and it may only reimburse for 80% of these costs. In this case, if costs were 6000, the insurance would reimburse 4000, which is 80% of the lesser of 5000 and the actual cost.
