There's a short answer to that question, but it gives no context. Of course, there's a better answer which explains why a policy limit matters, but it's a little long-winded.
It's the most money an insurance company is contracted to pay out for its insured for a specific purpose.
The better, but long-winded answer
In any industry, the jargon and shorthand people in that field use can cause even the sharpest of outsiders' eyes to glaze over. Attorneys are no different, and in fact, we might even be some of the worst offenders. The legal vocabulary can be arcane, confusing, and abstract. Each practice area has its own unique, off-the-wall terms. Policy limit, often referred to simply as “the limits” fits that category.
An insurance policy is a contract. When you purchase insurance, there are different coverages available. For example, in most auto policies, there are several standard coverages: (1) liability – property damage and bodily injury; (2) collision – property damage; (3) uninsured/underinsured (“UM”/”UIM”) – bodily injury and property damage, and (4) personal injury protection (“PIP”). There are many different types of insurance policies with various coverages available.
The policy itself defines what types of events will cause the insurance company to pay its benefits. When one of those events happens, the insurance company is required to pay out benefits. Each of those coverages has a maximum, or limit. Hence, the term “policy limit.” The policy limits are all outlined on a declarations page.
Why do “policy limits” matter?
There are two main reasons. First, the amount of coverage and type of coverage you buy, along with other factors like your driving history, directly influences how much you pay in insurance premiums. If you add coverages or request a higher policy limit, you will pay more than if you got the bare minimum required by law.
Second, depending on the needs of the case, insufficient limits can result in an injured person recovering less than his or her total damages. That will make more sense if you read on.
How does it all work?
This is a dramatic example. Please do not read it as the norm. There are a lot of other ways—including litigation tactics—in which policy limits become important for all different types of cases. Still, we encourage our clients to purchase as much insurance as they can reasonably afford.
Here is the scenario: imagine a forty-year-old gets rear-ended in an auto crash, she is taken to the hospital in an ambulance, and her medical bills are $40,000 just from the day of the accident. Her car—an exotic sports car—is badly damaged, requiring $50,000 in repairs. She suffers a brain injury that prevents her from ever working again. After investigation and follow-up medical care, the woman has medical bills and wage loss over her lifetime of $2,000,000.
Liability is undisputed. The other driver, who has no assets, had a $25,000 bodily injury liability limit and the same property damage limit. The injured woman has a $100,000 UIM bodily injury limit, a $35,000 PIP limit, and a $50,000 property damage UIM limit.
Let's deal with the property damage first. Even though there is $50,000 in damage, the other driver would likely offer $25,000 because that is their policy's limit. The woman's UIM property damage would cover the rest. Because her other damages are so high, she decides to accept a check for those amounts, and pay them toward her future medical care.
The medical bills and wage loss are a little more complicated. Initially, PIP would pay the bills and the wage loss up to the $35,000. But since that's not enough to cover the costs, the balance would have to come out of the $25,000 liability limit of the other driver, which his insurance company would likely offer. Because he has no assets from which to recover, the woman accepts and the at-fault driver is released. After some correspondence with the insurance companies and her lawyer, the woman's UIM would probably offer its $100,000 limits. Because of the way Washington and Oregon insurance law is currently written, PIP and any health insurance costs would probably not have to be paid back in this scenario.
In short, that leaves the injured woman with $50,000 from property damage, $70,000 ($35,000 in wage loss and another $35,000 in medical) in PIP, $25,000 from the other driver's liability insurance, and $100,000 from her UIM insurance. Her total recovery from the insurance companies is $255,000 on a claim that the investigation shows could be worth well in excess of $2,000,000.
The most an insurance company will pay out for a given event is the policy limit. Policy limits matter. We all hope we'll never need to use our insurance, but it is important to be an informed consumer. Knowing what your policy limits are and what they're for is a good start.