Contingency insurance, such as event cancellation
cover, is commonly underwritten on the basis that premium is paid
on a minimum and deposit basis (M&D premium). However in our
experience insureds misunderstand the operation and effect of
M&D premium in contingency policies.
M&D premium provides flexibility in pricing contingency
risks by requiring a minimum deposit to be paid by the insured at
the time of taking out the cover based on projected revenue
(typically 75% of the total premium), which is then adjusted at the
end of the policy period once actual revenue is known.
With M&D premium the insured has the peace of mind knowing
that if it does not achieve its anticipated projections it will not
be obliged to pay the full premium. It will only have to pay
some lesser amount calculated according to actual revenue and down
to the minimum premium, which is typically set at 75% of the
original calculated premium. Conversely, the insured would
only ever be required to pay the full premium if it meets or
exceeds its projected revenue for which it took out cover.
We can illustrate how M&D premium is intended to operate by
using an event cancellation policy as an example:
An event organiser seeks cover for a set of three concerts it
is planning to hold;
The event organiser submits a projected estimate of all
anticipated revenue (e.g. ticket sales, food sales, merchandise
sales) it expects to receive from each of the three concerts, being
$1,000,000 per concert and totalling the sum of $3,000,000;
The insurer calculates a $30,000 premium payable based on the
event revenue estimates, but only requires the insured to pay 75%
of this upfront on a minimum and deposit basis, being $22,500;
The insured event holder declares final revenue of $2,500,000,
meaning the final premium payable is $25,000 (less than the
original $30,000 premium that was calculated) and subsequently
requiring only an additional $2,500 to be paid to the insurer.
When issuing cover with M&D premium, an insurer calculates
the premium payable having regard to the projected revenue.
Normally that same projected revenue is also adopted as the limit
An emerging trend from claims submitted by insureds illustrates
that they misunderstand the intended operation of M&D premium
and the limits of liability under the policy. Insureds
sometimes assume that the limit of liability is, like the payment
of premium, flexible and subject to both upwards and downwards
In the event of a claim, an insured cannot obtain indemnity for
a sum in excess of the limit of liability (which was based upon the
projected revenues provided by the insured). This often
arises where an insured was conservative in its projected revenue
or, for whatever reason, it is having a more successful year than
To illustrate this misunderstanding using our example from
above, if the insured's first two concerts exceed forecasted
revenue by $200,000 each and the third event has to be cancelled
due to a weather event, the insured cannot simply pay a greater
premium to increase the cover and limit of liability from the
$1,000,000 provided for the third concert in the schedule of cover.
The insurer's liability will always be capped by the limits of
liability agreed to and provided for in the schedule of
If policies with M&D premium were to operate in accordance
with this misunderstanding, the result would be that an underwriter
could theoretically be writing lines of business with an uncertain
limit of liability that could potentially be in excess of their
individual authorities and lead to unsustainable exposures.
Further, it would lead to (and likely provide incentive for)
underinsurance on contingency risks as an insured could project
lower forecasted revenue to obtain a lower premium and simply pay a
greater premium in the event that any claim on the policy needed to
be made. Of course if an insured intentionally projects lower
forecasted revenue then that may also give rise to issues of
non-disclosure and misrepresentation.
It is important that all insureds properly understand how their
contingency policies operate and have realistic expectations for
what to expect if a claim arises. Brokers can assist insureds by
explaining the operation of M&D premium prior to policy
inception as well as the consequences of failing to provide
accurate project revenues, namely that they will not be covered for
any loss in excess of their projected revenues.
Settling contentious claims without prejudice to liability is an everyday occurrence for most Insurers. The vast majority of claims which are subject to litigation are settled at some point in the course of the proceedings, and the settlement is usually expressed to be without admission of liability.
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