What is the primary function of an insurance policy's coverage limits?

The primary function of an insurance policy's coverage limits is to define the maximum amount an insurer will pay for a claim. Coverage limits are crucial because they establish the financial boundaries of an insurance contract. This means that in the event of a covered loss, the policyholder can only claim up to the limit specified in the policy, regardless of the total amount of the loss incurred. This helps both the insurer and the insured manage risk by clearly delineating the insurer's financial liability.

Understanding coverage limits is vital for policyholders, as they need to ensure that their limits are adequate to cover potential losses. It also protects insurers from excessive claims, allowing them to maintain financial stability while providing coverage. Thus, knowing the coverage limits empowers policyholders to make informed decisions regarding their insurance needs and helps insurers manage their risk exposure effectively.