To the uninitiated, an insurance binder sounds like one way of keeping your policies organized. That's not a bad idea, but it isn't how the term is normally used. In practice it has a different meaning: When you apply for an insurance policy, it must be underwritten and a formal contract issued by the insurer. The binder provides temporary coverage during that interval.
Life Insurance Binder
When you apply for life insurance, the insurer evaluates the results of your health questionnaire and medical tests before issuing you a contract. You haven't purchased anything until you accept the contract and pay a first premium, which can be up to 60 days after completing the application. However, if you pay the initial premium with your application, the insurer will extend that coverage on a temporary basis during the underwriting period. You'll receive some form of documentation explaining the temporary coverage, as well as any necessary exceptions or disclaimers. This is called a binder, because the insurer is now obligated to pay in the event of your death.
Other Insurance Binders
A similar process applies to other types of insurance, from health and disability coverage to general lines, such as homeowner's and auto policies. These can be more complex, so the agent must be diligent in spelling out exactly what is and is not covered. A typical binder document specifies the name of the purchaser, the broker and the insurance company. It also specifies the piece of property to be covered, such as a car with a specific Vehicle Identification Number or a home at a specific address. If the property is financed, the name of the lender should also appear on the document.
Errors and Omissions
Doctors pay substantial premiums for malpractice insurance, to protect them against potential lawsuits. The insurance equivalent is referred to as "E & O," meaning errors and omissions. The broker who sells you a policy has a duty to clearly understand its provisions, and not exceed them when issuing a binder. Unfortunately, brokers often deal with a large number of insurers and might not adhere to the guidelines. If you're ever refused a claim under a binder agreement because of a broker's error, you'd be able to recover your losses by bringing suit. The judgement would be covered by the agent's E & O policy.
It's important to remember that with any type of insurance policy, making that first payment and receiving a binder doesn't commit you irrevocably to purchasing the policy. Under state legislation, purchasers of insurance or other services typically have a "free look" period of 10 to 30 days, during which they can decline the policy and receive their money back. After that period, it becomes necessary to purchase alternative coverage, and then cancel the original policy. Never cancel the old policy until the new one is issued, just in case.
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