Today we are going to explain what “first-loss” cover means in insurance as an alternative to “total value” insurance. We will look at its definition, advantages and disadvantages, and a practical example.
Definition of “First-Loss” Cover
When a policy uses the “first-loss” method of insurance, the insurer covers a specific risk up to an amount agreed in advance, regardless of the total value of the insured property. In the event of a claim, both the insured party and the insurer know with certainty the maximum indemnity that could apply.
Advantages and Disadvantages of First-Loss Insurance
As in almost every case, this type of insurance also has advantages and one main drawback. Below we summarise them, although the final decision will always depend on each person’s circumstances and interests.
Advantages
Main advantages of this type of insurance:
- The certainty it provides. It is possible to know exactly how much the insurance covers from the outset, without needing to apply the proportional rule.
- If someone insures their assets for 100% of their value, the policy will usually be less economical than this alternative.
- Administration with the insurer is much faster. It is not necessary to carry out a strict valuation of each asset, so arranging the policy becomes much simpler.
- It avoids underinsurance. This occurs when the insured sum in a policy is lower than the value of the asset.
Drawback
The most obvious drawback of this type of insurance appears when the cost of the claim is higher than the amount insured in the policy. In that case, the insured party must bear the difference.
Example of First-Loss Insurance
A family has jewellery insured under its home policy with a first-loss amount of EUR 3,000. One day, jewellery is stolen from the home.
Scenario 1
The value of the stolen jewellery is EUR 2,000. The insurer will indemnify the EUR 2,000 covered by the policy without analysing whether there was underinsurance.
Scenario 2
The value of the stolen jewellery is EUR 4,000. The insurer will indemnify EUR 3,000, which is the policy limit, and again will not analyse whether there was underinsurance.
When Is First-Loss Insurance Useful?
As we have seen in the example, first-loss insurance is very practical for certain guarantees in many types of policy, such as jewellery in a home insurance policy.
It is highly recommended for small and medium-sized businesses that need to reduce premiums and simplify valuations in their policies. In addition to being economical, it is easy to understand and provides the certainty of knowing from the beginning the exact amount covered.
It can also be useful for companies that want partial insurance. This may be because they decide to assume part of the risk themselves, or because they consider it practically impossible for a loss to reach 100% of the insured value.
In short, first-loss insurance has both advantages and disadvantages. Depending on the needs of each person or company, it may or may not be the most suitable option. The best approach is to consult specialists before arranging it.