What are 'policy limits' in insurance?

'Policy limits' refer to the maximum amount that an insurer will pay for covered losses under an insurance policy. This concept is vital for both insurers and policyholders, as it defines the extent of the financial protection provided by the insurance. When a loss occurs, the insurer's obligation to compensate the insured is bound by these limits, meaning that if the total loss exceeds the policy limit, the policyholder will be responsible for covering the difference.

Understanding policy limits is crucial when selecting an insurance policy because they directly influence the level of risk an insured party is willing to accept and the potential financial exposure in the event of a claim. For instance, a policy with higher limits may offer more peace of mind but could also come with higher premiums, whereas lower limits might be more affordable but could leave a policyholder financially exposed in the case of significant losses.

The other options provided, while related to insurance concepts, do not accurately describe policy limits. For example, the minimum amount of coverage required by law pertains to mandatory insurance requirements, deductibles denote the amount an insured party pays before the insurance kicks in, and the range of coverage refers to the specific types of risks that can be insured against, rather than the limits on payment for those risks.