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Umbrella Policies Deserve Careful Review

Some risk and insurance professionals argue that insurance has become little more than a commodity bought and sold according to price. This may be true for some types of standardized insurance, but most insurance purchased by corporations and public entities does not have the characteristics of a commodity. An example is umbrella liability policies, which take many forms. With an infinite number of endorsements, the variations in coverage are staggering. If you have not closely examined your umbrella policy, the following discussion will help you determine whether your umbrella provides the catastrophic protection you need.

While it is unclear where and when umbrella liability insurance first originated, at least one source1 credits Underwriters at Lloyd’s with its introduction in the United States during the middle or late 1940s. Since then, the umbrella has remained the single most important insurance policy for most organizations. When arranged properly, it provides broad coverage and high limits to protect against catastrophic losses.2

Umbrella policies can furnish such protection by providing:

• Limits of liability above the primary limits
• A broader scope of coverage than underlying liability insurance3
• Drop-down coverage when underlying aggregate limits are reduced or exhausted, and in some instances when there is no underlying coverage

Increased Limits

Most liability insurance policies provide relatively low limits of protection (usually $1 million per occurrence and $2 million aggregate). Such limits may be too low for adequate catastrophic protection, even for the smallest organizations.

The amount of loss considered catastrophic may be affected by factors such as the financial condition of the organization and changes in operations. For these reasons, the adequacy of the limit of liability should be periodically reviewed. To know whether the umbrella policy provides the proper level of catastrophic protection, insureds should periodically:

• Define what level of loss would cause severe financial dislocations. Unless the risk manager or insurance buyer is closely involved in the organization’s financial matters, he or she will likely require input from the organization’s chief financial officer.
• Know which policies, limits or self-insured amounts should be scheduled below the umbrella. Many risk managers, agents and brokers focus on the underlying commercial general and automobile liability policies and sometimes overlook other policies, such as those covering aircraft, watercraft and employers liability.
• When arranging adequate limits, it may be necessary to layer one or more excess policies above the primary umbrella. Because few umbrella and excess policies have the exact same terms and conditions, coverage gaps can exist. One way of avoiding such problems is for the excess policy to apply on a following-form4 basis. Be aware, though, that even so-called following-form policies may have their own special terms and conditions or may be amended by endorsement and may not truly provide coverage that is completely following-form.

Broadened Coverage

Because the umbrella’s main purpose is to provide catastrophic protection, the coverage scope of the umbrella should be at least as broad as underlying primary coverage.5 While insurers will eagerly promote the beneficial features of their particular umbrella, an analysis of just how good any given umbrella is requires a thorough comparison with each underlying policy. Because few umbrella policies are exactly alike, comparing multiple umbrellas and excess policies to the schedule of underlying policies can be a grueling and time-consuming task.

The following is a checklist of some of the features umbrellas should provide:

• Defense expenses should be covered excess of underlying insurance or the self-insured retention (SIR). If defense expenses are included in the definition of ultimate net loss (not paid in addition to the umbrella policy limits), consider increasing the umbrella limit. Doing so is necessary because defense expenses erode the limit of liability, resulting in less coverage for indemnity payment.
• The umbrella policy should cover all contracts, not just those that are written, because even oral or implied contracts can be legally binding. Contractual liability coverage also should extend to personal injuries such as libel, slander, false arrest, etc. that may or may not be covered in underlying insurance.
• Learn whether your policy states (clearly) when the insurer’s defense obligation arises and how the policy will respond if the underlying insurer refuses to defend. Also, know whether your umbrella policy indemnifies or pays on behalf of the insured. Look for wording that clarifies the timing of the defense payments.
• Coverage for liability arising out of the care, custody or control (CCC) of the property of others was common under early umbrella policies. Unfortunately, many umbrellas now contain a CCC exclusion either as part of the policy form or added by endorsement. Try to find policies without such exclusions. We have seen some underwriters modify their CCC exclusion to provide varying levels of coverage.
• The definition of occurrence should include events and not be limited to accidents. In addition to bodily injury and property damage, most umbrellas also cover advertising and personal injuries (libel, slander, false arrest, etc.) that may not be accidentally caused.
• Be sure your umbrella covers liability for the loss of use of property not injured or destroyed by an occurrence. Claims involving loss of use of property without actual physical damage to the property are not uncommon. For example, improper site preparation by a contractor might prevent a manufacturer from occupying its plant due to safety concerns. While most general liability policies provide such coverage, some umbrellas do not.
• The definition of persons insured should be broad and easy to understand. It should automatically cover all subsidiaries, affiliates, managed or newly acquired companies. Carefully check for coverage of past and present partnerships and joint ventures. In most instances, unless joint ventures or partnerships are specifically listed, coverage will not apply to these entities. If the insured is a limited liability company (LLC), make sure the
• LLC, its members and managers are covered. Because an LLC is not a corporation, the organization, its members and manager may not fit the policy’s definition of who is insured.
• The definition of personal injury should be broad, encompassing a wide range of injuries including where possible: discrimination, mental anguish, humiliation, fright, shock, and assault and battery. In both the primary and umbrella policy, this coverage should be triggered by an offense, not an accident.
• Avoid umbrellas that exclude punitive damages by way of an outright exclusion or by limiting loss to compensatory damages. Some umbrellas are silent regarding punitive damages and presumably cover such damages if permitted by law and are not otherwise excluded. Some insurers may cover punitive damages on a “most-favorable-jurisdiction” basis. When covered in this way, the state of domicile of the insured, the location of the accident, offense or injury, as well as the state of domicile of the insurance company are all considered when determining whether such damages legally may be paid.
• Many umbrellas contain so-called professional-services exclusions. Because the term professional services is rarely defined, the exclusions can be quite sweeping. The best approach is to avoid policies with such exclusions altogether. Where this is not possible, ask the underwriter to define in writing what is meant by the term and to provide coverage for incidental exposures.
• All underlying policies should have the same effective dates as the umbrella. Nonconcurrent dates can create coverage gaps between primary and excess policies.
• The standard ISO CGL policy provides limited coverage for non-owned watercraft as well as watercraft and aircraft liability assumed under an insured contract. Umbrella policies treat the aircraft and watercraft exposures in a variety of ways. Some exclude the coverage completely; others may provide coverage similar to the CGL. Where known aircraft and watercraft exposures exist, separate policies may be needed. Such policies should be scheduled under the umbrella where possible.
• Although most umbrellas contain sweeping pollution exclusions, this is changing, and many underwriters may be willing to provide limited forms of accidental pollution coverage. Pollution coverage for liability arising out of certain named perils such as fire, lightning, explosion, vandalism, etc. are the most common. Coverage for the unintended release of pollutants when discovered and reported to the insurer within a certain limited period also may be available. Ask your broker or underwriter what options are available. You may be pleasantly surprised.

Drop-Down Provisions

When underlying aggregate policy limits are reduced or exhausted through the payment of loss, or when there is no underlying coverage, the umbrella should become the primary insurance for defense, indemnity and related expenses. Such a feature is called a drop-down provision. Because the wording for achieving drop-down coverage can vary greatly, always:

• Read and understand the drop-down provision. If the drop-down provision is unclear or ambiguous, have the broker or insurer provide clarification in writing.
• Remember that the value of the drop-down provision is limited if the umbrella coverage is not on a basis at least as broad as the underlying. Look for drop-down provisions that provide coverage on a basis that is broader than the underlying policies.
• Remember, most umbrellas do not drop down when underlying coverage is unavailable due to insolvency of the insurer or when the underlying insurer denies coverage due to failure to comply with provisions of the underlying policy.

Consider self-insured retentions as an option to underlying insurance. If your organization can absorb the working layer of loss, it may make sense to self-insure the primary layers of some exposures. It is not uncommon for insureds to self-insure their primary auto and general liability exposures and schedule an appropriate self-insured retention amount under the umbrella.

Conclusion

Although there are many different umbrella liability insurance forms currently available, none are ideal for every insured or circumstance, and even the broadest umbrellas do not cover all exposures. To help ensure you are purchasing true catastrophe protection, start with the recommendations in this article. Remember also that if an insurer’s standard umbrella does not meet the needs of insureds, modifications may be possible, subject to market conditions and the flexibility of the underwriter.

Notes
1 The Umbrella Book, Griffin Communications, Inc.
2 A loss is considered catastrophic when (1) the organization suffers serious financial impairment, (2) the loss is so great that an organization’s stock price is impacted, or (3) its ability to continue operations is in peril.
3 Not all umbrellas provide this desirable feature.
4 The term follow form in this article refers to excess liability insurance policies that provide excess limits above scheduled underlying insurance on the same terms and conditions as the underlying insurance.
5 While an umbrella is rarely following form of primary insurance, it may be at least as broad.

riskVue | The webzine for risk management profesionals
September 1999