Final answer:
An insurance policy with an aggregate limit of $1 million caps the insurer's total payout for claims at $1 million for the policy term. It's a risk management measure that helps maintain the solvency of the insurance company, balancing the payouts for claims against the premiums collected and the company's operational costs and profits.
Step-by-step explanation:
If an insurance policy has an aggregate limit of $1 million, it means that the insurance company will pay a maximum of $1 million in claims during the policy term. This limit is the total amount the insurer will pay for all claims, not just an individual claim. Consider an automobile insurance example where there are 100 drivers. If they all pay a $1,860 premium each year, the total premium collected will be $186,000. This amount is used by the insurance company to cover the costs of accidents for that year. However, if the costs exceed the aggregate limit, the insurance company will not cover the excess and policyholders may have to pay out-of-pocket.
The premiums collected by insurance companies are pooled together to pay for the losses of the few who have claims. Given the unpredictability of risk and the occurrence of claims, the aggregate limit is a risk management tool that ensures the insurance company can remain solvent and continue to provide insurance coverage. The important balance that must be maintained for insurance companies is between the premiums collected, the claims paid out, and the costs of running the insurance business, while also earning profits.