An insurance company is liable for the amount above and beyond the policy limits in such situations because, generally speaking, the insurance company has the exclusive right to settle or not settle claims (though some policies have consent clauses that modifys this right). If an insurance company alone decides whether to settle or not, but had no risk of a judgement beyond the policy limits, insurance companies would have an incentive to take a risk and try every claim — regardless of whether there was a risk of an excess judgment and regardless of whether the insured wanted to settle.

Note, by the way, that an insurance company is only on the hook if it unreasonably fails to settle within the policy limits.

Let us say there is a meritorious claim for the policy maximum. What does it gain the insurer to simply pay it? Almost nothing – if it goes to trial, it might lose, and they would gain, or it might win (as expected) even more, and they still pay ONLY the policy maximum, just as before, but the policy holder is now is a MUCH worse position.

On the other hand, giving the insurer NO control over such settlements encouragages “gaming the system”, where the policy holder could get kickbacks for approving extra-high (but still under policy max) settlements.

Either way, either side has perverse incentives. It’s quite messy.

And why should that be? The insured person has the option to purchase more insurance but chose not to. Why is the insurance company on the hook for a lack of foresight or planning by the insured?

The insurance company cannot put its duty to protect you behind its financial interests.

The insurance company has a responsibility to all its customers, not just a single individual. The insurance company has a legal obligation to its stock holders to keep costs down. If the individual wants to do things that are so horrendous or risky that the amount of insurance they carry is not going to cover whatever damages they may cause, that is not the fault of the insurance company.

Blame the insurance company on this one. They rolled the dice and lost. Say you have a $300k liability insurance policy on your car, and you were involved in an accident where the victim’s leg was broken. Say the victim is willing to settle for the policy limit and you agree, but for whatever reason, your insurance company refuses. The verdict comes in for $1,000,000.00 and is upheld. The insurance company is liable for the amount above and beyond the policy limit. The insurance company cannot put its duty to protect you behind its financial interests.

The bloggers on this site would say that’s terrible, but the insurance company has figured the risk. There are many times that a Plaintiff will demand the policy limit (or other amount) and a trial results in a small award or nothing.