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What is a 'reservation of rights'?

As we have said before, an insurance policy is a contract between the policyholder and the insurance company. At the center of the contract is a promise: The insurance company promises to defend and to indemnify the policyholder if there is a claim; in return, the policyholder promises first and foremost to pay the premiums on time. (The policyholder has other duties -- the duty to notify the insurer of a claim, the duty to cooperate with the claim processor, the duty to mitigate damages -- that we will take on in a future post.)

Duty to defend: When someone files a claim against a commercial or residential property owner, the insurance company must defend that claim. So, with liability coverage, if someone slips and falls on your sidewalk and files a claim against you, the insurance company must provide a defense attorney and pay all of the costs associated with defending the claim.

Duty to indemnify: The insurance company is obligated to pay a claim up to the policy limit. If we go back to that slip and fall example above, let's say the injured person's medical bills totaled $250,000. You have purchased a policy with a $500,000 limit. Your insurance company cannot refuse to pay half the claim amount and let you pay the rest out of your pocket. You may have to pay a deductible, depending on the policy, but, after that, the insurance company has a duty to pay up to the $500,000 cap.

Just as there are times when an insurance company can rightfully deny a claim, there are times when an insurance company may not be obligated to defend or to indemnify the policyholder. This is where the reservation of rights comes in.

We'll explain the particulars in our next post.

Source: IRMI, Glossary of Insurance & Risk Management Terms: reservation of rights, accessed Jan. 29, 2016 

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