Insurance coverage is the risk or liability that is covered for an individual or entity by way of insurance services. In turn, a liberalization clause liberalizes a policy, or broadens that coverage, after the issuance of the policy in question. In effect, the insurer agrees to broaden the coverage of the policy.
What Is a Liberalization Clause?
The liberalization insurance clause is an insurance policy provision that supports the adjustments that are made to existing insurance coverage to ensure a policy complies with revisions to one or more existing state laws or regulations. For instance, assume that a Directors and Officers policy that includes a pollution exclusion and a liberalization clause is issued on January 1, 2021. If the insurer removes the exclusion in policies issued on or after March 1, 2021, the existence of the liberalization clause in the policies issued before this date means the carrier would effectively remove the clause from the policy issued on January 1, 2021, as well.
State Regulation and Liberalization Insurance Clauses
In the United States, the individual states regulate insurance policies sold within those states. So, state laws govern a policy's coverages and its limits, set liquidity requirements with which each insurance company must comply before the state allows it to sell policies within its borders and controls and oversees insurer insolvencies.
Due to the state's control of insurance company operations within the state, the insurer must efficiently incorporate a state's regulatory changes in its operations and its policies. The risk is that amended insurance regulations can result in underwritten policies that don't comply with state regulations.
The Design of Liberalization Clauses
To counter the risk of underwritten policies, insurers add a "liberalization clause" that automatically adapts existing policies to relevant regulatory changes, which is critical when the changes occur during a policy period. For existing policies that incorporate a liberalization clause, regulatory changes take effect immediately. In addition, the policies issued subsequent to regulatory changes include the coverages that comply with regulatory changes.
Benefit of Liberalization Clause
By means of the liberalization clause, policyholders receive coverage that exceeds that included in their existing policies. In turn, insurance companies avoid the administrative costs of notifying insured parties of new regulations.
Another benefit of the inclusion of a liberalization clause is that it allows an insurer to expand policy coverage to comply with regulatory changes without the need to issue a new policy endorsement or notify the policyholder. So, the clause allows an insurer to expand the risks that a policy covers without requiring a policyholder to pay an additional premium.
Application of Liberalization Clause
An insurance company can restrict the application of a liberalization clause in a number of ways. For instance, the carrier can state the enhancement is applicable to existing policies only if the coverage enhancement is provided for free to other insureds. In this case, an enhancement that requires an additional premium does not liberalize or broaden the coverage of existing policies.
Example of Liberalization Clause
Assume that an insurance company sells a property insurance policy that does not contain coverage for damage to storm shutters. However, the policy does contain a liberalization clause.
Also assume that after the policy was issued, the state legislature passes a law that requires all property insurance policies to include coverage for storm shutters. Due to the inclusion of the liberalization clause in the policy, the policy's coverage is extended without an increase in the insured's premium.
In other cases, a change in an insurance regulation may limit existing coverage. For instance, new state legislation that eliminates the requirement of storm shutter coverage. While this change decreases the coverage a future policyholder will have, it doesn't impact an existing policyholder.
The coverage of an insurance policy relates to the risk or liability that is covered for an individual or entity by way of insurance services. A liberalization clause broadens the coverage after a policy is issued.