What it means
When you cause an accident, the person you harm can claim compensation from you, and the amounts can be far beyond what most individuals or small firms could pay. Third-party insurance transfers that risk to an insurer, which handles the claim, pays the legal costs and settles the compensation up to the policy limit.
Your own losses, such as damage to your own car or building, are not covered unless you buy a wider policy. In many countries, third-party motor insurance is compulsory, because the law wants injured victims to be able to collect compensation.
Businesses commonly buy public liability cover, which protects against claims from customers and visitors, and product liability cover, which protects against claims from faulty goods. Professional indemnity is a related form that covers claims arising from advice or services.
Policies set a limit of cover, which is the most the insurer will pay for a claim or in total, and often an excess, which is the amount you must pay yourself before the insurer pays. A higher excess usually lowers the premium, because the insurer expects to pay out less often.
Choosing the limit needs care, since a serious injury claim can run to many millions. There are tiers of cover in motor insurance.
Third-party only is the cheapest, third-party fire and theft adds protection for your own vehicle against those two risks, and comprehensive covers most damage to your own vehicle as well. The names and details differ between countries, so the policy wording is the final guide.
For finance teams, the premium is a predictable cost that replaces an unpredictable and possibly ruinous liability. It should be reviewed whenever the business grows, enters new markets or changes activities.
Contracts with customers and landlords often require evidence of cover at a minimum level, so a lapse can also breach a contract.
In practice
Real-world examples.
Example
A plumber carries public liability cover with a $2,000,000 limit. While fitting a boiler, he floods a customer's kitchen and ruins the floor. The insurer pays for the repairs, and the plumber pays only the excess.
Example
A cafe owner holds third-party cover for her premises. A customer slips on a wet floor and breaks a wrist, then claims compensation for medical costs and lost earnings. The insurer defends the claim and pays the agreed amount.
Example
A driver reverses into a parked car in a car park. His third-party motor policy pays for the other car's repair, but not for the dent in his own bumper. He pays for his own repair out of his pocket.
Formula
Calculation
Insurer payout = Lesser of (Loss to the third party, Policy limit) minus the excess, if the excess applies to that claim
Suppose a delivery company has third-party cover with a limit of $1,000,000 and an excess of $2,000. One of its vans damages a shop front, and the repair bill is $18,000. The insurer pays 18,000 - 2,000 = $16,000, and the company pays the $2,000 excess. If a different accident caused $1,500,000 of damage, the insurer would pay the limit of $1,000,000 less any excess, and the company would be liable for the remaining $500,000 plus the excess.Case study
Seen in the real world.
Riverside Events is an illustrative, fictional company that organises outdoor festivals. For its first three years it held a modest public liability policy with a $500,000 limit, because the premium was low and nothing had ever gone wrong.
Before a larger festival, the finance manager asked a broker to review the cover. The broker pointed out that a stage collapse injuring several visitors could easily produce claims above $5,000,000, and that the venue contract demanded a limit of at least $2,000,000. The company raised its limit to $5,000,000, accepting a higher premium of about $9,000 a year.
In this illustrative story, a minor incident occurred during the event, when a barrier fell and injured two guests. The insurer paid the combined $40,000 in claims, and the company's own cash was not affected beyond a small excess. The manager concluded that the extra premium had been inexpensive protection against a risk that could have ended the business.
Watch out
Common mistakes.
- Believing third-party insurance pays for damage to your own property or vehicle, when it covers only losses suffered by other people.
- Choosing a policy limit based on premium alone, without estimating how large a serious claim could be.
- Assuming the cover applies to every activity, when policies often exclude certain work, locations or intentional acts.
Questions
People also ask.
Who are the three parties?
The first party is the policyholder, the second party is the insurer and the third party is the person who suffers loss because of the policyholder.
Is third-party insurance the same as liability insurance?
They are closely related, since liability insurance covers legal responsibility to others, and third-party cover is the common label in motor and personal contexts.
What does the excess do?
It is the portion of a claim you pay yourself, which discourages small claims and keeps premiums down.
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