…collectability of Underlying Insurance as listed in the Schedule of Underlying Insurance, or replacements thereof, must be available regardless of the bankruptcy or insolvency of the Underlying Insurers.

 

A common element of such bankruptcy conditions is that the insurer does not assume the coverage obligation of any insolvent underlying insurer or the insured. This limitation is understandable because umbrella coverage is priced based on the exposure in excess of the underlying coverage limits (and any applicable self-insured retention) that are represented as being in force at the time of umbrella policy inception.

 

Even in the absence of a specific policy provision stating that the insurer will not drop down and assume the coverage obligation of an insolvent underlying insurer, many courts have ruled that the insurer has no such duty. A Louisiana court, for example, ruled that because of the nature of excess insurance, no insured could reasonably expect the umbrella insurer to drop down and assume the coverage obligation of an insolvent underlying insurer. The court reasoned that policy wording was irrelevant and found that the umbrella insurer's intent was only to provide coverage in excess of the underlying limits promised at inception (see Louisiana Ins. Guar. Assoc. v. Interstate Fire & Casualty Company, 630 So. 2d 759, 767 (La. 1994)).

 

In addition to the loss of all or some coverage following an insurer's insolvency, there are other problems that can arise. These problems can include the following:

 

1. Difficulty in obtaining payment of claims from insurance guaranty funds in states where such funds are available. Guaranty funds may only provide a limited amount of coverage for each claim or they may only cover certain types of losses.
2. Where a claim involves a continuous and repeated exposure to conditions, several insurers may have provided coverage during the term of exposure. If any of the prior insurers become insolvent, ambiguous wording in an umbrella policy may lead to disputes and possible litigation regarding what obligation, if any, the current insurer may have to assume the coverage obligation of the insolvent prior insurer. 
3. Ambiguous wording in an umbrella policy may require litigation to determine whether the current umbrella insurer has an obligation to assume the cost of defense in situations where underlying or prior insurers are insolvent.

 

Because the insured may be forced to assume the financial obligations of an insurer that becomes insolvent, it is important that the financial strength and claims-paying ability of all insurers providing coverage be thoroughly evaluated. While the insurance broker or outside consultant may be of assistance, it is the insured who has the ultimate responsibility for evaluating the financial strength of insurers.

 

Cancellation

 

All umbrella insurance policies contain some form of cancellation clause. Such cancellation clauses normally contain five basic provisions:

 

1.  Either party may cancel the policy.

 

2.  The insurer must give written notice of its intention to cancel the policy. This notice is frequently required at least 30 days for reasons other than non-payment of premium. The time limit may vary depending on statutory requirements of each state.

 

3.  If the insurer cancels, any refund of premium will be computed pro rata, that is, the full amount of unearned premium will be refunded to the insured.

 

4.  If the insured cancels, any refund of premium will be computed at a rate that may be less than pro rata. (This is usually referred to as a short rate cancellation, that is, the full amount of unearned premium less a penalty charge is returned.) There is some variation in the way the penalty charge is calculated, with the most common charge being approximately 10% of the unearned premium.

 

5.  Premium refund is not required to effect cancellation.

 

As a general rule, insurers that have contractually reserved the right to cancel a policy may do so regardless of the reason, except where such cancellation violates a law or public policy. In addition, the courts may not consider a cancellation to be valid if it conflicts with the insured's reasonable expectation of coverage.

 

In determining if an insured's coverage expectations are "reasonable," the courts often apply the "reasonable expectations doctrine" to determine if "ambiguities exist which are to be resolved in accordance with the reasonable expectations of the insured." In the context of a policy cancellation, if the notice provided by the insurer is vague or ambiguous or if an agent or broker does not clearly communicate the circumstances of the cancellation to the insured, the courts may consider the notice to be "defective" and rule that coverage remains in effect.

 

Insurance laws in many states specifically dictate the terms of cancellation (and/or nonrenewal) to be used in insurance contracts. Usually the cancellation provision in the policy must clearly state the terms of cancellation, the periods of notice required and the method of calculating return premium.

 

In addition to a cancellation clause, some umbrella policy forms also contain a nonrenewal or a "When We Do Not Renew" condition. An example of non-renewal condition wording is shown below from a Bituminous Casualty Company form:

 

     If we decide not to renew this policy, we will mail or deliver to the first Named Insured shown in the Declarations written notice of the non-renewal not less than 30 days before the expiration date.

 

     If notice is mailed, proof of mailing will be sufficient proof of notice.

 

If an umbrella policy does not include a specific cancellation provision as part of the preprinted policy form, the cancellation provision usually is included in an accompanying form or endorsement. In addition, policy endorsements that modify the policy's cancellation or nonrenewal provisions to conform with individual state laws also may be issued.

 

Sometimes a mandatory cancellation notice period is provided by statute. One purpose of a notice-period requirement is to give the insured advance warning of the expiration, termination, cancellation or non-renewal of the policy so that adequate time is provided to renew the policy or to obtain replacement coverage. The courts have reasoned that this concept serves the public good by providing a system under which the insured can avoid an uninsured period of time that may result if no such notice is given.

 

If an insurer fails to comply with policy or statutory cancellation requirements, coverage may continue in force as if the policy was automatically renewed. As an example, the Tenth Circuit Court ruled that a notice of a potential claim mailed one day before the last day required by a notice of non-renewal was deemed as having been given within the policy period even though the policy period had already ostensibly ended (see American Casualty Company v. F.D.I.C., 999 F.2d 480, 483 (10th Cir. 1993)).

 

An insured who receives statutory notification of cancellation cannot argue that a policy should not be canceled until other insured entities also received the required notice. In Massachusetts Bay Ins. Co. v. Photographic Assistance Corp., 732 F. Supp. 1572, 1577 (N.D. Ga. 1990), the named insured argued that the policy could not be canceled until a mortgagee also had received the required notice. The court agreed that the mortgagee was harmed by the insurer's failure to notify it of impending cancellation. However, since the mortgagee had a separate cause of action against the insurer, the cancellation notice was determined to have been valid.

 

Similarly, in Lovy v. State Farm Insurance Co., 117 Cal. App. 3d 834, 868 (1981), the court determined that cancellation-notice requirements do not apply to the deletion of an additional insured. The court reasoned that the term cancellation ordinarily refers to either the entire policy period or to the unexpired portion of the contract. It also ruled that the term cancellation did not apply to amendments, adjustments or modifications to any specific provisions within the policy. Since the additional insured was not afforded the same protection as the named insured, notice to the additional insured was not required.

 

The effectiveness of a cancellation notice also can be influenced by the conduct of the insurer or its agent. In Weyant v. Acceptance Insurance Company, 917 F2d 209 (5th Cir. 1990), a surplus-lines agent told an insured who had received a cancellation notice that everything was okay and that the cancellation notice could be disregarded. The court ruled that the agent's statement effectively retracted the cancellation notice because the statement was made prior to the effective date of the cancellation. The court limited its finding by ruling that its decision did not constitute a renewal or reinstatement of the policy, but simply meant that the policy was allowed to expire as of the original expiration date.

 

If formal notice of expiration is required by statute but not given, or if the notice is defective, even an insured's knowledge of policy expiration may not be enough to overcome the defective notice. Under Mississippi law that required a thirty-day notice of expiration prior to policy renewal, the fact that the insured knew that the policy had lapsed for five months did not matter. Because the correct notice was not given, an insurer was obligated to cover an automobile accident that occurred during the lapsed period.

 

If initiated by the insured, policy cancellation wording normally requires only a specific written request that is communicated to the insurer. Neither the surrender of the policy by the insured nor the return of unearned premiums by the insurer is required to effect the cancellation.

 

Some umbrella policies state that the first named insured shown in the declarations will act as the agent for all other insureds regarding coverage change requests, premium payments and the giving and receipt of cancellation notices. Such clauses are often titled "Sole Agent" or "First Named Insured" conditions, but the wording may also be included as part of a "Cancellation" condition. These clauses frequently state that only the first named insured is authorized to cancel coverage, as in the following example from a Kemper Insurance Company form:

 

     The first Named Insured in Item 1 in the Declarations shall act on behalf of all other Insureds with respect to the giving or receiving of notice of cancellation and the receipt of any refund that may become payable under this policy.

 

When there is more than one named insured, the above wording avoids confusion and establishes who the responsible party is for the giving and receiving of cancellation notice. Under the terms of the above wording, only the insured first named in the policy is authorized to cancel coverage.

 

As a general rule, the insurer and the insured normally are free, subject to any statutory restriction, to arrange the terms of a cancellation provision by private agreement. However, if a statute or the insurance policy provides for a particular notification process, an insurer's failure to comply may result in continuation of the coverage.

 

A defective notice does not necessarily preclude a cancellation. Cancellation notices that are defective in their content generally are treated as if the notice was issued as required by the policy agreement or by statute. For example, a notice that contains a time limitation that is less than that required by statute does not void the notice. Rather, the notice is to be read as though it provides the required time period (see Wetherell v. Sentry Reinsurance, Inc., 743 F. Supp. 1157, 1170 (E.D. Pa. 1990)).

 

If the statute changes during the term of the policy, the operative statute will be the one in effect when the policy was issued (see Gahn v. Allstate Life Insurance Company, 926 F.2d 1449 (5th Cir. 1991)).

 

Policy cancellations can pose a special problem due to the potential difficulty in locating replacement coverage and the insured's need for continuation of coverage. For this reason, many states have enacted or are in the process of enacting legislation to limit the ability of insurers to cancel a policy. Absent such legislation, however, cancellations may not be prevented unless they are a violation of public policy. In some states, when replacement coverage is unavailable, the ability of an insurer to cancel a policy may be limited or prohibited by law.

 

In the event of a wrongful termination of an insurance contract by an insurer, the insured may generally treat the policy as being still in force and continue to pay premiums. In Arkwright-Boston Manufacturers Mut. Ins. Co. v. Calvert Fire Ins. Co., 887 F.2d 437 (2d Cir. 1989), the court ruled that the cancellation of a reinsurance policy for reasons other than non-payment was ineffective without the return of the premiums that had been previously paid.

 

Some umbrella policy forms state that the insurer may cancel a policy after providing only ten days' notice of cancellation for reasons other than nonpayment of premium (e.g., underwriting reasons, adverse inspection reports, etc.). Because it is preferred that a longer notice period be obtained, insureds should request at least a 60-day written notice of cancellation provision. Most underwriters usually will agree to provide such extended notice periods.

 

Liability insurers do not have an unrestricted right to cancel coverage, even if policy provisions appear to give them that right. Statutes may limit the permissible grounds for cancellation. For example, under California law, commercial liability insurers must state the reason for cancellation in a notice to the insured. Cancellation will not be effective unless the reason for cancellation is one of the acceptable reasons enumerated in the statute.

 

Logic dictates that cancellation terms are to be interpreted in a manner consistent with the interpretation of other policy terms. Therefore, the courts have generally felt that an insurer's compliance with a cancellation provision is to be strictly construed. Additionally, policy cancellation provisions are typically subject to the covenant of good faith and fair dealing, as are other terms of the policy.

 

The courts generally interpret ambiguities in the wording of cancellation provisions in the insured's favor. An example is the case of Motors Ins. Corp. v. Bodie, 770 F. Supp. 547, 550 (E.D. Cal. 1991), where an automobile liability policy cancellation clause stated that "similar insurance provided by this policy" would be terminated if the insured obtained other insurance on a covered automobile. In that case, the court resolved an ambiguity in the insured's favor by holding that two policies covering the same vehicle were not similar because each policy contained a different named insured.

 

The courts also have determined that the insured is entitled to a reasonable expectation of coverage. An insurer's actions which are inconsistent with this expectation are seen as exclusionary. This is because the courts tend to view the insurer as trying to restrict coverage in a manner that may not clearly make the insured aware of the consequences. Thus, any inconspicuous or ambiguous cancellation provisions will not be recognized by the courts.

 

Where the period of notice of the insurer's intent to cancel is established by statute, strict compliance with the statute by the insurer is required. For example, Maine law requires that a cancellation notice be received by the insured at least 20 days prior to the effective date of cancellation. A notice containing a shorter time period would be ineffective because of the strict compliance requirement. In California , if an insurer receives both a coverage application and premium and then decides to reject the application, the insurer is not only required to issue a formal rejection of the application but also to communicate that rejection to the insured (by appropriate notice) and to refund any premium that was paid. Failure to do so will result in an inception or continuation of coverage (see Smith v. Westland Life Insurance Company, 15 Cal. 3d 111 (1975)).

 

An insurer may not cancel a policy retroactively unless there is evidence of material misrepresentation, concealment of material facts or some other recognized basis for doing so. In Golden Eagle Insurance Company v. Foremost Insurance Company, 20 Cal. App. 4th 1372 (1993), a California court determined that without such evidence, an insurer could not unilaterally cancel an issued policy simply to avoid liability for a loss that had occurred prior to the cancellation. Similarly in a California case, the court ruled that notice of cancellation for non-payment of premium with an effective date prior to issuance of the notice was not valid. The court rejected the insurer's argument that its notice of cancellation, mailed on August 20, would be effective on July 26 as stated in the notice. The court enforced the statutory ten-day minimum notice period for cancellation for non-payment of premium and ruled that the earliest a cancellation notice mailed on August 20 could be effective would be on August 30. As a result of the court's decision, the insured had coverage for an accident that occurred on August 4 (see National Automobile & Casualty Insurance Company v. California Casualty Insurance Company, 139 Cal. App. 3d 336 (1983)).

 

In the case of policy expiration, compliance with notice of cancellation requirements may be excused. Provisions relating to cancellation of insurance are seen as having no relation to termination of the policy by expiration. Thus, where a liability policy is written for a specific term and not for an indefinite period and automatically expires at the end of the policy term, the insurer is not required to issue a cancellation notice. Expiration is deemed the natural termination of the policy at the lapse of the coverage period set forth in the policy. However, if the policy is forfeited or coverage is suspended for non-payment of premium, notice of cancellation is typically required.

 

Similarly, in Aetna Casualty & Surety Co. v. Merritt, 974 F.2d 1196, 1199 (9th Cir. 1992), the Ninth Circuit Court ruled that an endorsement providing that a policy was not subject to "cancellation, reduction of coverage for nonrenewal" without thirty days' notice to the insured did not apply where the policy's termination was not a nonrenewal, but rather an expiration of the policy period. The court reasoned that the absence of a notice from the insurer in this circumstance would not extend the policy indefinitely unless the insured paid a premium.

 

Even non-payment of renewal premium by the insured may not be sufficient grounds for the insurer to cancel a renewal policy. In Golden Eagle Insurance Company v. Foremost Insurance Company, 20 Cal. App. 4th 1372 (1993), the court determined that the insured's silence following the receipt and acceptance of a renewal policy or renewal certificate served to constitute policy renewal, even though the required premium was not paid. In this case, the insured had wanted to delay premium payment pending the results of a search for a better rate. The insured did not specifically reject the renewal coverage, nor did either the insurer or its agent show that they treated the insured's failure to pay the premium as a rejection of the policy. Since there was no premium due date on either the policy or the renewal certificate, the court ruled that the insured's belief that the policy would be renewed unless the insurer was told otherwise was reasonable.

 

Because of the nature and complexity of issues such as those discussed above, cancellation clauses are litigated frequently. Most insureds, as well as many agents and brokers, often do not understand policy cancellation provisions. Successful remarketing and replacement of an umbrella liability insurance program often requires as much effort, preparation and time as marketing the original umbrella insurance program. The wording of the umbrella policy cancellation provisions should be compared with the wording of underlying policies to determine any inconsistencies in who can give and receive notice of cancellation and the required notice period. Any desired changes should then be requested and made by endorsement.

 

Changes

 

Most umbrella policies contain provisions stating how changes to the policy may be made. While there are minor variations in the way insurers word such conditions, most policies developed prior to 1986 contain wording similar to the following example from Central National Insurance Company of Omaha :

     

     Notice to or knowledge possessed by any person shall not effect a waiver or change in any part of this policy or stop the Company from asserting any rights under the terms of this policy; nor shall the terms of this policy be waived or changed, except by endorsement issued to form a part hereof, signed by the company.

 

In some older umbrella policies, the "changes" condition also identifies those officials of the insurer, by title, who are authorized to sign coverage change endorsements. In other policies the clause simply states that any endorsement must be signed by a representative of the company.

 

In order to clarify who is authorized to make changes to the policy on behalf of the insured, many umbrella policies developed after 1986 incorporate wording that states only the first Named Insured is authorized to request coverage changes, providing the insurer agrees. An example of this wording is shown below from a policy from Century Surety Company:

 

     This policy contains all the agreements between you and us concerning the insurance afforded. The first Named Insured shown in the Declarations is authorized to make changes in the terms of this policy with our consent. This policy's terms can be amended or waived only by endorsement issued by us and made a part of this policy.

 

Insurers always reserve the right to establish the terms and conditions of their policies. As a result, the insurer may reject or accept any change requested by the insured. Changes to the policy must be in writing and in the form of an endorsement attached to the policy.

 

The courts typically view insurance policies in the same light as other contracts. Where the obligations of parties are governed only by contract, there is no restriction on modifying the contracts through free bargaining. For this reason, insurance policies, like other contracts, cannot be modified or changed without the consent of both parties. Insurers therefore may not alter policy terms without the consent of the named insured. A policy cannot, for example, be modified by the issuance of a certificate of insurance that conflicts with the terms of the agreed-upon insurance contract (see Wetherell v. Sentry Reinsurance, Inc., 743 F.Supp. 1157, 1170 (E.D. Pa. 1990); see also American Building Maintenance Company v. Indemnity Insurance Co., 214 Cal. 608, 615 (1932); see also, 13A Appleman, Insurance Law & Practice, Sect. 7602).

 

When an insurance contract is modified, a written agreement between the parties is often required.

 

This is illustrated in the case of Mission Insurance Co. v. Hartford Insurance Co., 155 Cal. App. 3d 1199 (1984). In this case, the court refused to permit an insured to use a hold-harmless agreement between a named insured and a permissive user of an insured vehicle to shift responsibility to the permissive user's insurance company. In reaching its decision, the court ruled that California law required a written agreement between all parties to alter statutory allocations. The court also noted that both policies at issue contained a provision that stated that changes to the policy could be only made by endorsement.

 

Consideration is also required in order to effect changes to insurance contracts. Black's Law Dictionary defines "consideration" as a "cause, motive, price, or impelling influence which induces a contracting party to enter into a contract, a basic, necessary element for the existence of a valid contract that is legally binding on the parties."

 

An exclusion added by an insurer to an existing policy will be deemed invalid if there is no consideration. In a 1993 Arkansas case, a carrier insured an entity for directors and officers liability from 1984 to 1985, and the policy issued did not contain a regulatory exclusion. The plaintiffs paid a premium of $6,377 for the coverage. In 1985 the insurance company renewed the policy but added a regulatory exclusion. The premium was increased from $6,377 to $15,934. The 1986–87 policy, which was again a renewal, continued to contain the regulatory exclusion, and the insurer again increased the premium to $64,584.

 

The court agreed with the insured's contention that no consideration was given for the inclusion of a regulatory exclusion. The exclusion limited coverage, and yet the carrier, rather than giving a premium discount, substantially increased the premium each year upon renewal. In its decision, the court noted that a limiting endorsement to an existing contract of insurance must be supported by consideration (see Slaughter v. American Casualty Company, 842 F. Supp. 371, 373-374 (E.D. Ark. 1993)).

 

In Slaughter, the carrier argued that "consideration" was given since it intended to cancel the policy unless the insured agreed to the regulatory exclusion. However, because it failed to notify the insureds of its intent to cancel in writing, the court ruled that the insurance company could not argue that its forbearance from exercising a right of cancellation provided the consideration that was required for the limiting endorsement regulatory exclusion. In supporting its decision, the court stated, "If an insurer expects to rely on forbearance from cancellation as consideration for limiting endorsement, the intent to cancel must be communicated to the insured." The court also noted that where an endorsement in a renewal policy is deemed void for lack of consideration, the same endorsement in subsequent renewals also may be void.

 

If the nature of the insured's operations changes during the policy's coverage period, the insurer may claim that the insured's failure to inform the insurer of the change is a misrepresentation and grounds for a denial of coverage. However, some courts feel that the insured has no specific duty to inform the insurer of any changes in the risk absent a specific requirement in the policy to do so.

 

Adequacy Of Notice

 

To be considered adequate, an insurer's notice to the insured of any reduction in coverage must be conspicuous, plain and clear. An amendatory endorsement by itself may not satisfy that requirement if it is lengthy and does not contain highlighted language (see Allstate Ins. Co. v. Fibus, 855 F.2d 660 (9th Cir. 1988); see also, National Automobile & Casualty Insurance Company v. Stewart, 223 Cal. App. 3d 452 (1990)). In addition, when renewing a policy, the insurer usually may not change the terms of the policy without first notifying the insured. The majority of courts support the view that an insurer has a duty to call the insured's attention to any coverage changes or conditions of a renewal policy. This view is predicated on the fact that the insured typically is the one who renews the contract with the insurer and who, absent any declared intent to the contrary, is presumed to desire retaining the same coverage as previously held.

 

Insureds who become aware that a renewal policy contains changes in coverage may be obligated to review the policy even if the insurer provides no specific information regarding the changes. In Sutherland v. NN Investors Life Ins. Co., Inc., 897 F.2d 593 (1st Cir. 1990), the court ruled that an agent's claim that a renewal policy was "new and improved" and offered "better coverage for less cost" could not be interpreted as meaning every individual benefit of the prior policy was retained, and so could not excuse the insured from reading the policy.

 

If an insurer accepts an application and issues a policy that provides substantially less coverage than requested, it may be required to provide the requested coverage unless the insured has been advised of the change. In such circumstances, the courts have found that the insured is not obligated to read the policy and can assume policy coverage conforms to the application. As an example, in American Casualty Company v. Glaskin, 805 F. Supp. 866, 872 (D.Colo. 1990), a Colorado court deemed it reasonable for the insured to assume that a renewal policy provided the same coverage as an expiring policy even without reading the renewal policy. However, if a renewal policy contains an added provision or omits a provision, the insured must be notified of the change. The courts also have ruled that an insurer should not be able to take advantage of hidden and unexplained gaps in coverage created by policy changes (see Tower Ins.Co., Inc. v. Judge, 840 F. Supp. 679 (D.Minn. 1993)).

 

When an insurer renews a policy, the insured must be informed of any specific reductions in coverage. Otherwise, the insurer may be bound to provide the broader coverage granted by an earlier policy. Typically, change notices must apprise the insured of any specific reduction in coverage and contain a general admonition to read the policy. In the absence of such specific information, even the provision of a chart comparing coverages under the old and new policies (with no mention of a new exclusion) will not be effective.

 

Information provided by the insurer to the insured regarding policy changes also must be accurate. A new edition of an auto policy accompanied by a letter from the insurer that merely cited a statute authorizing a change in coverage but did not inform the insured of the changes was deemed by the court to be inadequate notice of a significant limitation in coverage. The limitation in question was authorized by an amendment to California Insurance Code 11580.2. The amendment permitted an insurer to exclude bodily injury coverage to the insured in an accident caused by an uninsured motorist unless the vehicle occupied by the insured was an insured motor vehicle. This was a significant decrease in the coverage previously afforded and was not even mentioned in the letter accompanying the new policy. That letter described the most significant change as involving stereo tapes and tape players.

 

Without notification that there have been changes in the restrictions, conditions or limitations of a policy, an insured may justly assume that policy provisions remain the same and that coverage has in no way been lessened. This reasoning is based on principles of legal duty and common fairness (see Taylor v. Omaha Property and Casualty Ins. Co., 739 F. Supp. 1069, 1072 (E.D. Va. 1990)).

 

In Davis v. United Services Auto Assn., 223 Cal. App. 3d 1322, 1332–1333 (1990), the courts determined that where an insurer's renewal policy contained a new exclusion for claims arising out of contract or negligence, a description of the modification and the wording of the "clarification of coverage" section did not clearly apprise the insured that the new policy excluded such losses. As a result, the court ruled the exclusions were ineffective. Further, an insured's instruction to read the entire policy is no substitute for notice of the loss of a benefit. Rather, deletions or exclusions from a renewal policy must be communicated and explained by plain, clear and conspicuous writing. In an amended policy, any question of coverage will be determined by the courts in accordance of the terms of the original policy prior to amendment (see Fields v. Blue Shield of California, 163 Cal. App. 3d 570 (1985); see also Government Employees Ins. Co. v. United States, 400 F.2d 172 (10th Cir. 1968)).

 

An example where an insurer's notice to the insured was considered by the courts to be adequate is the case of St. Paul Fire & Marine Insurance Company v. F.D.I.C., 968 F.2d 695 (8th Cir. 1992). In that case, the court ruled that a renewal letter, renewal application and renewal policy for directors and officers liability insurance, when considered together, constituted conspicuous written notice to the insured of a change in coverage. The letter stated in plain language that the insurer was adding several endorsements to the policy and explained the effect of a challenged regulatory exclusion. The application contained the new endorsements, including the regulatory exclusion. The renewal policy itself contained several pages that expressly referred to changes in coverage, including notice that the policy differed from its predecessor, which also contained a regulatory exclusion.

 

It should be noted that cases analyzing modifications of insurance contracts held to be ineffective because of inadequate notice may be found in 13A Appelman, Insurance Law & Practice.

 

Retroactive coverage changes, even if they reflect the true intent of both the insurer and the insured, may only be recognized by the courts in certain circumstances. For example, in 20th Century Ins. Co. v. Liberty Mutual Ins. Co., 965 F.2d 747 (9th Cir. 1992), a rental company's excess policy originally provided $900,000 coverage for claims in excess of $100,000. After an accident occurred, the insurer issued an endorsement reducing the coverage limit to $300,000, back-dating the endorsement to the effective date of the policy. The insurer then argued that the back-dated endorsement was effective because it was issued to reflect the true intent of the parties and that the lower limits were therefore applicable. The Ninth Circuit Court disagreed, and held that the higher limit applied. The court reasoned that it would not make the retroactive endorsement effective to the accident in question because the accident occurred before the date of the amendment and third parties would be adversely affected by the amendment. The court relied on the legal proposition that there can be no rescission where the rights of third parties would be prejudiced. Thus, the court reasoned that unless amendment of the policy was agreed upon between the parties to correct a mutual mistake, it could not be applied to limit the rights of third parties, such as those involved in the accident that occurred before the effective date of the amendment to the policy.

 

The courts generally do not recognize subsequent modifications made to a policy when construing coverage under the policy prior to such modification. Such evidence is typically excluded because it lacks relevance. Under Federal Rules of Evidence 407 (precluding evidence of subsequent remedial measures), a court may not consider an insurer's subsequent modification of a policy in deciding whether a prior policy affords coverage for a particular incident. For example, a subsequent policy adding specific exclusions for negligent entrustment and negligent supervision were not recognized as evidence that the previous policy terms were ambiguous (see Love, by Smith v. McDonough, 758 F. Supp. 397, 403 (S.D. Miss. 1991)).

 

Incidentally, if language is substantially changed from prior years and there is a question of consideration for the change, the fact of that change may be useful in interpreting the earlier language and/or applying the change to new claims. Furthermore, there are exceptions to the parole evidence rule, for example, inducement to contract.

 

In addition, evidence concerning a primary insurer's internal memoranda and correspondence subsequent to policy revision has been excluded as irrelevant on the issue of whether the primary insurer had a duty to defend (see Pacific Indemnity Co. v. Firemen's Fund Ins. Co., 175 Cal. App. 3d 1191 (1985)). A court also rejected an insured's argument that because an initial policy excluded latent defects and a revised policy added a contractor's negligence exclusion, contractor negligence must not have been excluded under the earlier policy. In Carty v. American States Ins. Co., 7 Cal. App. 4th 399 (1992), the court reasoned that such an argument would violate public policy in that it would discourage remedial action.

 

When coverage for an insured's operations is added during the term of a policy, that coverage usually only applies to losses that occur after the date the coverage was added. An example is a case in which the original policy described the operations of the insured as being detective or patrol agencies, including completed operations and alarm monitoring. Subsequently, an endorsement was issued adding "manufacturing & sales of patrol command system software" to the description of covered operations. The court held that claims resulting from the latter operations were not covered unless they occurred after the inception date of the endorsement (see Sting Security, Inc. v. First Mercury Syndicate, Inc. 791 F. Supp. 555 (D. Md. 1992)).

 

In order to avoid coverage disputes and the potential for litigation, insureds should not rely on oral interpretations of coverage or on unwritten assurances of coverage from their broker or insurer. Any change or clarification should be in the form of an endorsement. However, even endorsements may contain onerous or ambiguous language and should be carefully reviewed to ensure the effect of any coverage changes are fully understood by the insured.

 

Inspection and Audit

 

Most umbrella policies contain provisions allowing the insurer to inspect the insured's property, operations and records that are the subject of the insurance being provided. Umbrella forms developed prior to 1986 often contain "Inspection and Audit" conditions similar to the one shown below:

 

     The company shall be permitted to inspect the insured premises, operations, automobiles and elevators and to examine and audit the insured's books and records at any time during the policy period and any extension thereof and within three years after the final termination of the policy, as far as they relate to the premium bases or the subject matter of this insurance.

 

Some insureds interpreted these older inspection and audit clauses to be an obligation by the insurer to conduct inspections. The courts frequently agreed that inspection clauses like the one above were ambiguous and awarded damages when losses arose out of conditions that could have conceivably been detected by the insurer in an inspection and corrected by the insured.

 

In an attempt to eliminate the ambiguity of the "inspection" wording in primary policies, the clause was reworded by many insurers after 1986 to clarify that the insurer was not obligated to perform inspections, nor was the insurer warranting the safety of the insured's property or operations. An example of this revised condition wording, still used in some modern umbrella forms (like one from Bituminous Casualty Company) is shown below:

 

     We have the right but are not obligated to:

 

A. Make inspections and surveys at any time;

 

B.  Give you reports on the conditions we find; and

 

C.  Recommend changes.

 

     Any inspections, surveys, reports or recommendations relate only to insurability and the premiums to be charged. We do not make safety inspections. We do not undertake to perform the duty of any person or organization to provide for the health or safety of workers or the public. And we do not warrant that conditions:

 

(1) Are safe or healthful; or

 

(2) Comply with laws, regulations, codes or standards.

 

     This condition applies not only to us, but also to any rating, advisory rate service or similar organization which makes insurance inspections, surveys, reports or recommendations on our behalf.

 

Because an insurer is not obligated to conduct an audit, its failure to do so will not prohibit the insurer from denying coverage if the insured provides inaccurate information. In Dalton Buick, Oldsmobile, Pontiac, Cadillac, Inc. v. Universal Underwriters Insurance Co., 512 N.W.2d 633 (Neb. 1994), an insured underreported its updated inventory and paid premium based on the underreported values. The court allowed the insurer to deny coverage for the full value of the insured's inventory even though the insurer did not exercise its right to audit the insured's records. The court simply did not buy the argument put forth by the insured to the effect that in failing to double-check a misrepresentation in the application, the insurance company had thereby waived a policy defense based on the misrepresentation.

 

The "Inspection and Audit" condition was eliminated from the ISO-CGL policy form (both occurrence and claims-made versions) in 1986. The "inspection" provision of this condition was captioned "Inspections and Surveys" and is now located in the ISO-CGL General Policy Conditions form. The "audit" provision of the condition was captioned "Examination of Your Books and Records" and also is now located in the "General Policy Conditions" form.

 

The wording of "inspection and audit" conditions varies in umbrella policies. Some insurers continue to use wording similar to that found in older policy forms. Other insurers use more recent variations or may make no reference to such provisions.

 

Besides reserving the right to audit an insured's books and records, some insurers also reserve the right to conduct an audit following settlement of claims. The following from Harleysville Mutual Insurance Company is an example of such wording:

 

     We may examine and audit your books and records as they relate to this insurance:

 

a.  At any time during the policy period;

 

b.  Up to three years afterward; or

 

c.   Within one year after final settlement of all claims under this insurance.

 

The reference to conducting an audit after final settlement of all claims may have implications for insureds who are on loss-sensitive retrospective or dividend programs. Such a provision may allow the insurer to recalculate the premium based on the final cost of claims. In such cases, the final premium charged by the insurer may be more (or less) than the premium calculated as of any post-expiration time limit.

 

Policies that are silent regarding the insurer's right to inspect the insureds premises and operations and/or audit records tend to favor the insured. Absent an inspection or audit provision, the insurer should be prevented from later claiming such rights. The wording of any "inspection and audit" conditions should be reviewed, however, so that the insured has a clear understanding of the insurer's right and recourse regarding such inspections and/or audits.

 

Loss Payable

 

Knowing when the insurer will actually "indemnify" or "pay on behalf" of an insured loss for which the insured has become liable is important. In umbrella policies, loss-payable conditions state the events and actions that must occur before the policy will respond by making a loss payment.

 

While a few umbrella policies are silent regarding the timing of loss payment, most policy forms developed prior to 1986 contain loss-payable wording similar to the following from Central National

Insurance Company of Omaha :

 

     Liability under this policy with respect to any occurrence shall not attach unless and until the Insured, or the Insured's underlying insurer, shall have paid the amount of the underlying limits on account of such occurrence. The insured shall make a definite claim for any loss for which the Company may be liable under the policy within 12 months after the Insured shall have paid an amount of ultimate net loss in excess of the underlying limits or after the Insured's liability shall have been fixed and rendered certain either by final judgment against the Insured after actual trial or by written agreement of the Insured, the claimant, and the Company.

 

     If any subsequent payments shall be made by the Insured on account of the same occurrence, additional claims shall be made similarly from time to time. Such losses shall be due and payable within 30 days after they are respectively claimed and proven in conformity with this policy.

 

The wording shown above sets forth the requirements that must be satisfied before the umbrella insurer is obligated to respond with a loss payment. These requirements are:

 

1.  Underlying coverage limits (including the insured's self-insured retention) must be paid;

 

2.  The insured's liability must be fixed by court judgment or by a written settlement agreement between the insured, the insurer and the claimant;

 

3.  The insured has 12 months after such judgment or settlement to make a claim against the insurer for payment of any loss for which the insured is liable; and

 

4.  Any subsequent payments for the loss will be paid within 30 days of submission of the claim (and appropriate documentation) by the insured.

 

In addition to requiring the insured, the insurer and the claimant to agree to a settlement amount, some umbrella policies also require underlying insurers to be a party to the agreement.

 

A few umbrella policies contain wording that states the insurer will make loss payments within a specified time frame following the insured's compliance with all terms of the policy and establishment of the insured's liability by court judgment or agreed settlement. An example of this wording from an Aetna Casualty and Surety Company form is as follows:

 

     We will pay all claims within thirty days provided all terms of this insurance are met.

 

     The insured will reimburse us for any payment we make for damages which are within the "retained limit."

 

Umbrella policy forms containing the above wording also require the insured to reimburse the insurer for any payments the insurer makes for amounts within the insured's "retained limit" or self-insured retention. Some umbrella policies also include wording that states the insurer will indemnify the insured for any amounts paid by the insured toward a loss that is covered by the policy.

 

A few umbrella policies developed after 1986 contain the following loss-payable condition wording (from Century Surety Company):

 

     Coverage under this policy shall not apply unless and until the insured, or the insured's underlying insurer, shall be obligated to pay the amount of the "underlying limit" or "self insured retention" on account of "personal injuries", "property damage", or "advertising liability". When the amount of "ultimate net loss" has finally been determined, we shall promptly pay on behalf of the insured the amount of "ultimate net loss" falling within the terms of this policy.

 

     You shall promptly reimburse us for any amount within the "self insured retention" specified in the insuring agreements paid by us on behalf of an insured in settlement or satisfaction of any claim or suit.

 

A variation of the above wording describes the circumstances under which the insured's obligation is determined, as shown in the following example from a Bituminous Casualty Company form:

 

     Our liability for "ultimate net loss" shall not apply until the insured or any "underlying insurer" shall be obligated to pay the "retained limit." When "ultimate net loss" has been determined, the insured may make "claim" for payment under this policy as soon as practicable thereafter. Such insured's obligation to pay any amount of "ultimate net loss" shall have been finally determined either by judgment against the insured after actual trial or by written agreement of the insured, the claimant and us. [emphasis added]

 

The wording shown above benefits the insured because it states the umbrella policy will respond with a loss payment once the underlying insurers have been obligated to pay their coverage limits, rather than requiring underlying coverage limits to actually be paid.

 

Loss-payable clauses in umbrella policies typically provide that the insurer's liability does not attach until the underlying insurer or the insured has paid or been held liable to pay the underlying coverage limits.

 

The courts have supported the insurers' position. As an example, in a Texas case, a loss-payable clause provided the insurer had no liability for umbrella coverage unless and until payment of the $1 million underlying limit of liability was made by or on behalf of the insured, or until the insured paid the self-insured retention limit of $25,000. The court held the umbrella insurer had no duty to provide coverage in the absence of the required payment under the underlying policies. This was so even though the underlying insurer was declared insolvent (see Warren v. American National Fire Insurance Company, 826 S.W.2d 185 (Tex. App. 1992)).

 

Many umbrella policies contain loss-payable wording that states the policy applies in excess of underlying coverage limits, whether or not those underlying limits are available or collectible. When not contained in a "loss-payable" or "action-against-the-company" provision, such intent may be expressed in the wording of bankruptcy "Bankruptcy of Underlying Insurer" or "Financial Impairment" condition.

 

Disputes sometimes arise over an umbrella insurer's payment obligation when an underlying insurer or the insured becomes bankrupt or insolvent. In the absence of clear policy language to the contrary, the courts generally have ruled that the umbrella insurer has no obligation to drop down and assume the payment obligations of either an insolvent underlying insurer or insured. In addition courts have taken the position that no insured could reasonably expect such coverage from an excess insurer in light of the nature and purpose of excess insurance coverage.

 

In an Oregon case, the court noted that the "loss-payable" provision in the umbrella policy provided that liability would not attach unless and until the insured or the underlying insurer paid the underlying limits, on account of a covered occurrence. In interpreting the term "amount recoverable" with regard to the loss-payable provisions, the court ruled that the term could only reasonably apply to the amount that could be recovered under a primary insurance policy (i.e., the policy limit of that primary policy).

 

Accordingly, it also ruled that the excess carrier was not liable where the amount of the covered loss was below the applicable policy limits, notwithstanding the fact that the underlying insurer was insolvent (see Hoffman Construction Co. v. Fred S. James & Co., 836 P.2d 703, 710 (Or. 1992)).

Similarly, in Playtex FP, Inc. v. Columbia Casualty Company, 622 A.2d 1074 (Del. Super. 1992), the Delaware Superior Court held that the purpose and language of a comprehensive general liability policy, read as a whole and in light of expert testimony concerning policy construction, precluded an excess umbrella liability insurer from dropping down and paying claims of an insolvent lead umbrella liability insurer. The court noted that in a majority of cases in which a policy used the phrase "amount recoverable," the courts had ruled that the policies, when read as a whole, were unambiguous in precluding insolvency dropdown.

 

Amounts payable under umbrella policies may be reduced by the amount available to the insured from other insurance. For example, in California Casualty Indemnity Exchange v. Maritzen, 860 P.2d 259 (Or. App. 1993), the court enforced a policy provision reducing the loss payable under uninsured motorist coverage by the amounts paid under any applicable workers' compensation law. The Oregon Court of Appeals affirmed the trial court's ruling that the policy thus required amounts received by the insureds in the underlying action as a result of a collision with an uninsured motorist to be offset against the policy limits.

 

An umbrella policy's obligation to pay after underlying limits have been paid may apply to defense costs as well as indemnity. In a Texas case, a primary insurer sued an excess carrier for contribution and indemnity. Under Texas law, the excess carrier was not obligated to participate in the cost of defense until primary policy limits were exhausted. The court rejected the plaintiff's claim that the policy was ambiguous, reading the first paragraph of the "ultimate net loss" definition in light of the policy's loss-payable clause (see Texas Employers Ins. Assoc. v. Underwriting Members of Lloyd's, 836 F. Supp. 398 (D.D. Tex. 1993)).

 

Similarly, the Tenth Circuit Court considered whether defense costs incurred by the insured, which were included in calculating the limits of liability in the primary policy, also should be considered in calculating the attachment point of an umbrella policy. The court rejected the umbrella insurer's "subjective intent" and held the policy unambiguously provided that the limit was calculated in a manner following the underlying policy (see Coleman Company, Inc. v. California Union Insurance Company, 960 F.2d 1529 (10th Cir. 1992)). Also, where an excess policy did not attach until plaintiff or its primary insurer paid the underlying limits, the court ruled that excess coverage could only be triggered by payment of claims dollars. The court rejected the insured's contention that the limit was calculated by considering dollars paid on claims and paid on out-of-pocket (administrative) expenses (see Harnischfeger Corp. v. Harbor Ins. Co., 927 F.2d. 974 (7th Cir. 1991).

 

The insured's need for a loss-payable condition may appear to be greater when coverage is on an indemnification rather than a "pay-on-behalf" basis. If the insurer is obligated to pay on behalf of the insured, the insurer then has an obligation to pay the claimant. The insured need do nothing. However, when coverage is on an indemnification basis and when there is no reference in the policy to the timing of loss payment, it may be unclear when the insurer is obligated to pay. The insured may have to pay the loss and wait some indefinite period of time before being indemnified by the insurer. In the event of a large loss or where the insured is thinly capitalized, the necessity of fronting loss payment, even for a short period of time, may pose a financial burden.

 

As a practical matter, the lack of a loss-payable condition in an indemnity umbrella policy is rarely a problem. Most insurers obligated to indemnify do so promptly. Also, many insurers will respond to an insured's obligation to pay without requiring the actual payment of the self-insured retention or underlying coverage limits.

 

Maintenance of Underlying Insurance

 

Most umbrella policies contain provisions requiring the insured to maintain underlying insurance both in effect and for specified limits during the umbrella's coverage period. These provisions usually are found in the condition captioned "Maintenance of Underlying Insurance." Understanding the variations in such provisions is important as they can effect how the policy responds to the payment of loss. The following is an example from American International Specialty Lines of such a provision:

 

     During the Policy Period, you agree:

 

1.  to keep Scheduled Underlying Insurance in full force and effect;

 

2.  that the terms, definitions, conditions and exclusions of Scheduled Underlying Insurance will not materially change;

 

3.  that the total applicable limits of Scheduled Underlying Insurance shall not decrease, except for any reduction or exhaustion of aggregate limits by payment of Loss; and

 

4.  that any renewals or replacements of Scheduled Underlying Insurance will provide equivalent coverage to and afford limits of insurance equal to or greater than the policy being renewed or replaced.

 

     If you fail to comply with these requirements, we will be liable only to the same extent that we would have you [sic] fully complied with these requirements.

 

Under the above condition wording, if underlying coverage limits are not maintained, the umbrella policy still will provide coverage, but only for an amount in excess of the limits that the underlying policies were supposed to provide.

 

Even if an umbrella insurer fails to include a proper schedule of underlying coverages (along with names of insurers and policy numbers) in the policy, the insured still is required to maintain underlying coverage. In Seats, Inc. v. Nutmeg Insurance Company, 504 N.W. 2d 613 (Wis. App. 1993), an insured sued its umbrella insurer for failure to defend. The umbrella policy required the insured to maintain underlying coverage, but used allegedly ambiguous wording in referring to the schedule of underlying insurance. Despite the wording used and the fact that the schedule failed to identify the underlying policies, the court did not feel that the wording of the underlying insurance requirement was ambiguous and ruled that the insured nonetheless had an obligation to maintain underlying insurance coverage.

 

Some umbrella policies require that the insurer be notified when underlying coverage limits are exhausted, underlying coverage is canceled or changed or if any underlying policy is replaced. An example of such a requirement includes the following from Bituminous Casualty Company:

 

     You must notify us immediately of any changes in the terms of any "underlying insurance" policies. We may make adjustment of premium charges under this policy from the effective date of such changes to the term of any "underlying insurance" policies.

 

Some maintenance-of-underlying-insurance provisions are even more stringent and require the insured to immediately make efforts to reinstate exhausted underlying limits. This requirement is illustrated by the following example from Nationwide Mutual Insurance Company:

 

     If the aggregate limit of insurance of any policy of underlying insurance is reduced or exhausted, you must immediately make all reasonable effort to reinstate such limit. You must give us written notice as soon as practicable of any change in the limit of insurance, scope of coverage or of the termination of any underlying insurance.

 

Overly restrictive requirements to report or replace reduced aggregate underlying limits can pose serious problems for both the insured and the insurer. In the second example above, it may not be clear what the insurer will consider to be a "reasonable effort" by the insured to reinstate exhausted underlying aggregate limits. If the underlying limits are depleted prior to the expiration of the umbrella policy, it might be reasonable for the insurer to expect the insured to purchase replacement underlying coverage for the remaining umbrella policy term. What the insurer expects the insured to do if aggregate limits of underlying insurance are exhausted after the current annual period or expiration of both policies also is unclear.

 

Also, because liability claims may take years to be reported, investigated and settled, it is possible that the insured will not know of the exhaustion of underlying aggregate limits until long after expiration of the umbrella policy. For this reason the aggregate reinstatement requirement should be deleted from the umbrella policy whenever possible.

 

Another potential problem with requiring the insured to notify the insurer of any changes in underlying coverage limits is that the requirement may mean that the insurer expects to be notified each time a loss payment reduces the underlying aggregate coverage limit. Even an increase in a primary insurer's claim reserves might require notice to the umbrella insurer. For this reason it is preferred that the maintenance-of-underlying-insurance condition only require underlying coverages to be maintained during the period of the umbrella and state that an insured's failure to do so will neither prejudice nor invalidate coverage provided by the umbrella policy.

 

The requirement that the insured must maintain underlying coverage sometimes leads to a question over what happens if an underlying insurer becomes insolvent and cannot provide the coverage promised. Some insureds have argued that the umbrella policy should drop down and assume the obligation of an insolvent underlying insurer. However, the courts have generally disagreed. In Playtex FP, Inc. v. Columbia Casualty Co., 622 A.2d 1074 (Del. 1992), a Delaware court determined that the intent of an underlying insurance condition is not to force the insurer to drop down and provide coverage when an underlying insurer becomes bankrupt. Rather, such a condition is intended to obligate the insured to maintain the underlying coverage that was represented as being in place when the umbrella policy was purchased. The court recognized that umbrella insurers rely on such representations in evaluating (and pricing) the risk.

 

A similar interpretation was reached by a Pennsylvania court which ruled that the wording of an underlying insurance clause was clear in requiring the insured to maintain underlying coverage and in stating that the insured's failure to do so would result in applying the policy as if the underlying policies had been maintained. The court felt that the intent of the insurer was also clear—no coverage was provided by the umbrella policy until underlying limits became exhausted. Using this reasoning, the court ruled that the umbrella insurer was not obligated to provide coverage even though the underlying insurer had become insolvent (see Kinderman & Sons, Inc. v. United National Insurance Co., 593 A.2d 857 (Pa. 1991).

 

The presence of a maintenance-of-underlying-insurance condition in an umbrella policy also emphasizes the need for the insured to retain, or at least be able to document the existence of, all primary and excess liability insurance policies indefinitely. A claim may arise from an occurrence that happened many years ago, and a prior umbrella insurer may require notification when underlying limits are exhausted. Also, claims that involve a long-term exposure to harmful conditions and that develop over a period of years may require notification of several primary and umbrella insurers.

 

Any policy provisions that require the insured to monitor and report the status of underlying coverage should be avoided because any failure of the insured to conform with such requirements could jeopardize coverage. The wording of any maintenance-of-underlying-insurance condition should be carefully reviewed and any unfavorable or ambiguous provisions clarified or corrected by endorsement prior to policy inception.

 

Notice of Occurrence

 

"Notice of Occurrence" requirements are contained in umbrella policies for the purpose of giving the insurer advance warning of occurrences that are likely to result in a claim. Most umbrella policies developed prior to 1986 contain notice-of-occurrence wording similar to that used in 1955, 1966 and 1973 ISO-CGL forms. The following wording from Allianz Underwriters Insurance Company is representative of that used in these older policy forms:

 

     Whenever the Insured has information from which the Insured may reasonably conclude that an occurrence covered hereunder involves injuries or damages which, in the event that the insured should be liable, are likely to involve this policy, notice shall be sent to the Company as soon as practicable, provided, however, that failure to give notice of any occurrence which at the time of its happening did not appear to involve this policy but which, at a later date, would appear to give rise to claims hereunder, shall not prejudice such claims.

 

Because an "occurrence" may or may not result in a claim or lawsuit, reporting requirements like the above can be confusing. It is not clear in many instances whether the insurer requires notice of all occurrences or just those that were likely to result in injuries or damages covered by the policy. While such wording has largely been replaced in modern umbrella forms, older forms that contain wording similar to the above may still be available.

 

While notice provisions vary, many umbrella policies now use wording similar to that contained in the "Duties in the Event of Occurrence, Offense, Claim or Suit" condition of the ISO-CGL policy forms. That wording requires the insured to provide notice of not only occurrences, but also of "offenses," a term often associated with personal and advertising injury coverages. The information required from the insured is stated in the condition, along with an explanation of the insured's duties regarding assistance and cooperation with the insurer in defense of the claim or suit. The ISO-CGL provision also states that the insured shall not make any payments nor assume any obligation with regard to the claim or suit without the insurer's consent.

 

The required timing of notice of an occurrence also varies among umbrella policies. Most umbrellas require that notice be given "promptly" or "as soon as practicable." Such a requirement allows the insured some discretion as to when the occurrence must be reported. However, some policies require "immediate" notice of an occurrence. A few umbrella policies are silent regarding when notice must be given and may not require reporting within any specified time frame.

 

Nearly all insurers require the immediate forwarding of documents related to lawsuits that arise out of an occurrence. It is imperative that the insured comply with the immediate notice requirement if a lawsuit is received. Failure to comply could prevent the insurer from filing an answer to the lawsuit in a timely manner.

 

If immediate notice is required by the policy but not given, the insurer's ability to defend the suit may be jeopardized and the insurer could conceivably deny coverage. Denial might occur even if the insured did not itself receive immediate notice of an occurrence, such as if the insured's legal department became aware of an occurrence and failed to report it to the risk manager, insurance buyer or the broker. Coverage also might be denied if an occurrence were not reported to the insurer because the insured felt the umbrella coverage was not likely to be triggered.

 

Many umbrellas also contain cooperation provisions within the notice condition or within a separate "Cooperation and Assistance" (or similarly worded) condition. These additional provisions require the insured to cooperate with any underlying insurer(s) and to comply with the terms of underlying coverage. The following from Century Surety Company is an example of a typical cooperation provision:

 

     The insured shall cooperate with us and with the underlying insurers as required by the terms of the underlying insurance and, upon our request, assist in making settlements in the conduct of suits and in enforcing any right of contribution of indemnity against any person or organization who may be liable to the insured because of "personal injuries", "property damage" or "advertising liability" with respect to which insurance is afforded under this policy; and the insured shall attend hearings and trials and assist in securing and giving the evidence and obtaining the attendance of witnesses…

 

Additional requirements also may be included in the notice condition. As illustrated by the above, some insurers require the insured to pursue all rights of contribution and to preserve the insurer's rights of indemnity. The purpose of this requirement is to maintain the insurer's ability to subrogate and to pursue reimbursement for the cost of claims. Other insurers add wording to the effect that they do not want the insured to make any admission of liability. Such an admission could jeopardize the insurer's ability to defend or deny a claim. A few umbrella policies require the insured to notify the insurer if underlying limits are reduced or exhausted through payment of claims.

 

Because the term insured is often broadly defined in the policy as including officers, directors, employees, real estate managers and others, it may not be clear who actually is responsible for reporting occurrences, claims or suits to the insurer. Use of a vague or broad insured definition in a policy may lead to disputes over exactly who in the named insured's organization must be aware of an occurrence before the obligation to report it is triggered. It is suggested that the requirement to give notice of an occurrence apply only when an officer of the company or member of the risk management (or legal) department becomes aware of such occurrence. Once notice is received by an insurer, that notice is regarded as if given on behalf of all parties in interest, including additional insureds (see City of Northglenn v. Chevron USA, Inc., 634 F. Supp. 217 (D. Colo. 1986); see also 8 J. Appleman, Insurance Law & Practice § 4738; Monguso v. Pietrucha, 210 A.2d 81; Royal Indemnity Co. v. Pearson, 246 So2d. 652 (Ala. 1971)).

 

It should be noted that notice of an occurrence can be sufficient to trigger coverage even if such notice is not given by a named insured. In Casualty Insurance Co. v. E.W. Corrigan Construction Co., Inc., 617 N.E.2d 228 (Ill. App. 1993), the court ruled that any "responsible person" may give notice, so long as the notice is reasonable. Moreover, timely notice will satisfy the notice provisions with regard to all policies issued by the same insurer to a particular insured. Thus, adequate notice of an occurrence with reference to a workers' compensation policy would be deemed notice with regard to a general liability policy issued to the named insured or any additional insured under that policy.

 

In some states, if the insured has not complied with the notice provisions specified in the policy, the insurer may be able to deny coverage. In Bolivar Country Board of Supervisors v. Forum Insurance Co., 779 F.2d 1081 (5th Cir. 1986), an insurer denied coverage because an insured failed to comply with a policy provision that expressly provided that notice was to be given "as soon as practicable" and that such notice was "a condition precedent to [the insured's] rights under this policy." In applying Mississippi law, the court ruled that the insured's delay in giving notice was inexcusable and permitted the insurer to deny coverage.

 

In other states coverage may be denied only in certain circumstances. For example, under Michigan law, late notice to an insurance company does not eliminate an insurer's obligations under a policy unless the insurer demonstrates that it has been prejudiced by late notice. Prejudice will be found if a delay "materially impairs the insurer's ability to contest its liability to the insured or its ability to contest the liability of the insured to a third party (see Action Auto Stores, Inc. v. United Capitol Ins. Co., 845 F. Supp. 428 (W.D. Mich. 1993))." Although the question of timeliness of notice may be a factual one, coverage obligations of the insurer can be decided as a matter of law where the facts are undisputed (see Chesapeake & Ohio Railway Co. v. Certain Underwriters at Lloyd's London, 834 F. Supp. 456 (D.D.C. 1993); cf. Norfolk & W.Ry. Co. v. Accident & Casualty Ins. Co., 796 F. Supp. 925 (W.D. Va. 1992)).

 

In determining whether an insurer's duty to provide coverage is excused by late notice, Oregon courts

apply a two-step approach. The court will first determine if the insurer was prejudiced by the insured's failure to give earlier notice of the occurrence. Then it will determine if the insured acted unreasonably in failing to give timely notice. If the insured's delay is found to have been reasonable, the insurer still will be required to provide coverage. However, in Louisiana , an insurer was not able to deny coverage based on the insured's delay in reporting a loss. In this particular case, the insurer argued to invoke state law, which viewed timely notice as a condition precedent to coverage. The court ruled that despite the law, the insurer failed to show that it had been prejudiced by the late notice. Thus, the insurer was required to provide coverage for the loss (see Peavey Co. v. M/V ANPA, 971 F.2d 1168 (5th Cir. 1992)). In New York, the courts ruled that an insurer had waived its right to deny coverage for a loss based on notice of occurrence provisions when it disclaimed coverage on several other grounds without invoking the notice provisions (see State of N.Y. v. Amro Realty Corp., 936 F.2d 1420 (2d Cir. 1991)).

 

Insurers have a valid reason for requiring timely notice of an occurrence, claim or suit. If notice is not timely, the insurer's ability to investigate and defend the claim may be hampered. Evidence may be lost, witnesses may no longer be available or may forget important facts, or damages may increase.

 

In most states the insured's failure to report an occurrence or claim in a timely manner is not sufficient to preclude coverage unless the insurer is in fact prejudiced by such late notice. Whether it is the responsibility of the insurer to prove that it was prejudiced, or the responsibility of the insured to prove that the insurer was not prejudiced, may be dependent on the facts of the case or state law. In Kentucky , the courts have reasoned that the insurer has the burden of proving prejudice because it is in a better position with regard to facts that establish whether or not it was prejudiced. If the burden of proof were on the insured, the insured would be forced to prove that the insurer was not prejudiced. However, the insurer need only establish "reasonably probable" prejudice in order to avoid its coverage obligation.

 

Similarly in Louisiana , an insurer must establish precisely how it was prejudiced where the insured's failure to provide timely notice of a claim prevents an insurer from investigating and/or participating in the defense. In a 1991 case, because an insurer failed to offer this evidence, the court found there was a triable issue as to whether it had indeed been prejudiced by a four-year delay in reporting a claim. For this reason, a summary judgment in the insurer's favor was precluded (see Gulf Island IV v. Blue Streak Marine, Inc., 940 F.2d 948, 956 (5th Cir. 1991)).

 

In contrast, Wisconsin statutes require an insured to establish an absence of prejudice if notice to an insurer is unreasonably late. In the case of Maryland Casualty Co. v. Wausau Chemical Corp., 809 F. Supp. 680 (W.D. Wis. 1992), an insured was found to have met the burden of proof where in the eight years following the submission of a claim to the insurer, the insurer made no effort either to investigate the claim or to interview possible witnesses.

 

In Fireman's Fund Ins. Co. v. Valley Manufactured Products Co., 765 F. Supp. 1121 (D. Mass 1991, a Massachusetts court ruled that a thirteen-year delay in reporting a tank leak and a seven-year delay in reporting the closure of water wells was unreasonable as a matter of law and constituted prejudice because crucial evidence relating to the accident was no longer available. The policy in question required written notice of occurrence "as soon as practicable."

 

Similarly, an Oregon court found that an insured's delay of 15 or 16 years in notifying an insurer of a diesel-fuel spill caused substantial prejudice to the insurer. The court reasoned that the delay deprived the insurer of the opportunity to investigate the spill and the extent of damage until a time when circumstances had changed and memories of witnesses had faded (see Terminal Transfer, Inc. v. Truck Insurance Exchange, supra 1398, 1399)). In New York, the court ruled an insured's failure to transmit copies of all litigation documents served upon it constituted non-compliance with relevant portions of the applicable insurance policies (see Asbeka Industries v. Travelers Indemnity Co., 831 F. Supp. 74 (E.D.N.Y. 1993)).

 

Illinois law does not require a showing of prejudice where a policy provision requires prompt or immediate notice. However, in Highlands Insurance Company v. Lewis Rail Service Company, 10 F.3d 1247 (7th Cir. 1993), the Seventh Circuit Court found that a delay of eight years in reporting an accident had in fact prejudiced the insurer. In that case, notice to the insurer was given after investigations of the accident scene, discovery and preliminary settlement negotiations. The court ruled that the late notice left the insurer unable to "successfully craft a defense" to a six-year-old lawsuit.

 

Notice provisions in excess policies generally do not require immediate notice of all claims, but only of those claims that are reasonably likely to exhaust the underlying limits and implicate the excess policy. Thus, notice provisions in excess policies may be interpreted by the courts as giving the insured some discretion as to when the claim should be reported. However, where an excess insurer required notice "as soon as practicable" and immediate notice of the filing of a lawsuit, an insured's failure to comply with the latter provision was sufficient to excuse the excess insurer from its coverage obligations (see Highlands Ins. Co. v. Lewis Rail Service Co.; supra)). When more than one umbrella or excess policy provides coverage and may be triggered, the insured may be required to comply with the notice requirements of all policies. In American Home Assurance Co. v. Republic Insurance Co., 788 F. Supp. 214 (S.D.N.Y. 1992), a New York court determined that both first and second layer excess insurers were entitled to notice of a potential claim. The court felt it was reasonably necessary to notify all of the excess insurers because the claim was likely to involve both of the excess policies.

 

The requirement to report occurrences under a claims-made umbrella policy may be similar in some respects to those under occurrence-based policies. But an occurrence that takes place during the policy period may not result in a claim or suit until after policy expiration. This can result in the claims-made policy under which the occurrence took place not providing coverage.

 

Some insurers add language to the notice condition that allows the insured to report occurrences likely to result in a claim and to trigger coverage under that policy for resulting claims even after the policy expiration. Alternately, the definition of claim may be broad enough to allow occurrences likely to give rise to a claim to trigger coverage should a claim arise. Regardless of how a claims-made policy is worded, it should contain a procedure for reporting of occurrences or incidents that do not meet the definition of claim, but which might reasonably give rise to a claim.

 

The requirement for the insured to give notice of every occurrence or incident that might result in a claim can create a dilemma. Some insureds believe that if every occurrence is reported (whether a claim actually results or not), the insurer will cancel the policy or increase premiums. In reality, however, most insurers simply file away such notice reports until some action is required.

 

The real danger for the insured lies in failing to report an occurrence to the insurer. Not reporting an occurrence could be costly if a claim subsequently materializes. Agents and brokers should stress the importance of complying with the notice requirement as set forth in the policy.

 

Other Insurance

 

All umbrella policies contain provisions regarding how other insurance available to cover a loss affects loss adjustment. Such provisions are intended to limit an insurer's liability when additional coverage for the same loss can be established. Other-insurance clauses can generally be classified into one of three categories: pro rata, excess or escape/non-liability clauses.

 

Pro-rata other-insurance conditions apportion the amount of the loss between insurers in the same ratio as each insurer's policy limits bear to the total policy limits of all available insurance. While pro-rata other-insurance provisions do not appear frequently, the following wording, taken from an old policy form, is representative:

 

     When both this insurance and other insurance apply to the loss on the same basis, whether primary, excess or contingent, the company shall not be liable under this policy for a greater proportion of the loss than that stated in the applicable contribution provision.

 

Excess other-insurance provisions are the most common and state that coverage applies only in excess of other insurance available to pay for the loss. Insurance purchased to be excess of the umbrella is not subject to the excess provision as indicated by the following sample wording from American International Specialty Lines.

 

     If other valid and collectible insurance applies to damages that are also covered by this policy, this policy will apply excess of the Other Insurance. However, this provision will not apply if the Other Insurance is specifically written to be excess of this policy.

 

Escape/non-liability clauses are intended to relieve the insurer of any obligation to pay if there is other insurance available to pay for the loss. If the limits of the policy with the escape clause are greater than the limits of other available insurance, the coverage provided by the policy with the escape clause is excess of the other insurance, to the extent of policy limits. The use of escape clauses, even in older policy forms is rare, possibly due to the onerous language and the courts' dim view of such clauses. The following wording is an example of an escape/non-liability provision from an early umbrella policy:

 

     With respect to a loss covered hereunder, if the Insured has other insurance, whether on a primary, excess or contingent basis, there shall be no insurance afforded hereunder as respects such loss; provided, that if the applicable limit of liability of this Policy is greater than the applicable limit of liability provided by the other insurance, this Policy shall afford excess insurance over and above such other insurance in an amount sufficient to give the Insured, as respects the layer of coverage afforded by this Policy, a total limit of liability equal to the applicable limit of liability afforded by this Policy.

 

While the above categories are generally recognized as the three main types of other-insurance provisions, the courts also have noted that innumerable variations exist within them.

 

A few older umbrella policies contain wording designed to clarify the insurer's intent when multiple policies and conflicting other-insurance provisions are involved in the same insurance program. An example of such wording is the following from a Cigna commercial umbrella liability coverage form:

 

     If other valid and collectible insurance is available to the insured for a loss we cover under this policy, this policy is excess of and will not contribute to the other insurance except if the other insurance is written as excess insurance over the insurance provided by this policy. When both this insurance and the other insurance apply to a loss on the same basis, whether primary, excess, contingent, or any other basis, then we will share with that other insurance by the following method:

 

a.  If all of the other insurance permits contribution by equal shares, we will follow this method also. Under this approach, each insurer contributes equal amounts until it has paid its applicable limit of insurance or none of the loss remains, whichever comes first.

 

b.  If any of the other insurance does not permit contribution by equal shares, we will contribute by limits. Under this method, each insurer's share is based on the ratio of its applicable limit of insurance to the total applicable limits of insurance of all insurers.

 

Some umbrella policies may not contain a specific other-insurance condition. Rather, these policies state that all insurance (other than coverage specifically purchased to apply in excess of the umbrella) is considered underlying insurance. Such a statement usually is contained in the "Limits of Liability" section of the policy or in the definition of "Retained Limit" or "Underlying Limit."

 

If there is only one umbrella policy, the other-insurance provision is applied according to its terms. However, when conflicting other-insurance provisions are encountered, such as when two or more umbrella or excess policies are involved, the courts must often determine which provision controls the apportionment of liability.

 

Under the so-called "majority rule," most courts consider the terms of an excess clause to prevail over that of a pro-rata clause. The policy containing the pro-rata clause is deemed primary and coverage under that policy must be exhausted before the policy with the excess clause is triggered. In contrast, some courts follow the "minority rule" and hold that any conflict between other-insurance clauses renders them mutually repugnant and unenforceable. These courts typically find that the loss must be shared proportionately by the insurers (for example, see Lamb-Weston, Inc. v. Oregon Auto Ins. Co., 341 P.2d 110 (Or. 1959); see also Lamastus & Associates, Inc. v. Gulf Insurance Co., 260 So.2d 83 (La. App. 1972)). Similarly, when a Louisiana court found that the "excess" and "pro-rata" clauses contained in two respective policies were mutually repugnant, it effectively pro-rated the loss between two medical- malpractice insurers (see Penton v. Hotho, 601 So.2d 762 (La. App. 1992)). In another Louisiana case, however, the court resolved a conflict between an excess clause in one policy and a pro-rata clause in another policy by giving effect to the excess clause, thereby rendering the policy with the pro-rata clause primarily responsible for the loss.

 

In some cases, however, neither the "majority rule" nor the "minority rule" is applied. For example, in applying Utah law, the Tenth Circuit Court refused to adopt the majority rule that "excess" clauses also will prevail over "escape" and "excess-escape" clauses. The court also rejected the minority rule that wherever other-insurance clauses directly conflict, neither is enforced and the loss is shared by the respective insurers on a pro-rata basis. Rather, the court explained that under the law, it must look to the wording of the clauses and give effect to the plain meaning of their respective language (see Utah Power & Light Co. v. Federal Ins. Co., 983 F.2d 1549, 1561 (10th Cir. 1993).

 

Minnesota courts resolve conflicts between pro-rata and excess clauses by requiring application of a "total policy insuring intent" or "closeness to the risk analysis." The former examines the primary policy risks and the primary function of each policy, while the latter considers which policy describes the accident-causing event most closely, which premium reflects a contemplation of greater exposure and which policy covers the risk primarily as opposed to secondarily (see CPT Corporation v. St. Paul Fire & Marine Insurance Company, 515 N.W.2d 747 (Minn. App. 1994)).

 

In Connecticut , the purpose of uninsured motorist statutes is to provide an insured with full indemnification for injuries caused by an uninsured motorist. Thus, the courts are required to protect an injured insured's right to full indemnification where multiple policies provide uninsured motorist coverage with competing set-off provisions. In Blevio v. Aetna Casualty and Surety Company, 844 F. Supp. 849 (D. Mass. 1993), the court ruled that where the other-insurance clauses conflicted in two excess policies, both insurers were deemed primary carriers and were required to share the loss on a pro-rata basis to the extent of the respective coverages. Similarly, a Maryland court held that where two competing automobile policies provided primary coverage but contained conflicting pro-rata clauses, the insurers were to share liability proportionately in the absence of other provisions limiting liability (see Nolt v. USF&G Company, 617 A.2d. 578 (Md. 1993)).

 

Where two policies contained other-insurance clauses and each attempted to disclaim liability by way of an excess clause in one policy and an escape clause in another, a Rhode Island court resolved the conflict by requiring both insurers to pay on a pro-rata basis. The court reasoned that while the respective clauses were not "mutually repugnant," any ruling that exonerated either insurer in full would only contribute to a "battle of the drafters," resulting in more complicated policies at the expense of both policyholders and the courts (see Brown v. Travelers Insurance Company, 610 A2d 127 (R.I. 1992)).

 

In American Economy Insurance Company v. Motorists Mutual Insurance Company, 593 N.E.2d 1242 (Ind. App. 1992), uninsured motorist coverage was provided by two corresponding policies, one of which provided primary coverage, while the other purportedly provided excess coverage. The Indiana Court of Appeals ruled that a trial court erred by pro-rating coverage between the two insurers. The appellate court held that absent conflicting and mutually repugnant provisions, the language of the policy should be given effect as stated. Thus, one carrier was held responsible for primary coverage while the other was held responsible for excess coverage.

 

However, where one policy is primary and the other is a true excess policy, the respective "excess" and "other-insurance" clauses are not mutually repugnant so that the true excess policy does not provide coverage until the limits of the primary coverage are exhausted (see Penton v. Hotho, supra, 601 So.2d at 768-769; see also Truehart v. Blandon, 884 F.2d 223 (5th Cir. 1989)).

 

There is a split of authority concerning self-insurance, with most courts holding that self-insurance is not to be considered insurance for the purposes of defining "other insurance." While most umbrella policies are silent as to whether other insurance includes a self-insured retention (SIR), a few policies do make specific reference to such retention. The following excerpt from Chubb is an example of such a reference:

 

     We will pay only our share of the amount of loss, if any, that exceeds the sum of the total:• amount that all other insurance would pay for the loss in the absence of this insurance; and• of all deductible and self-insured amounts under all other insurance…

 

Policies that do not make specific reference to an insured's self-insured retention in the other-insurance condition may, however, do so within the definition of "Ultimate Net Loss" or within the "Limit of Liability" or "Underlying Insurance" sections of the policy.

 

Most court jurisdictions distinguish traditional insurance from self-insurance on the basis that traditional insurance involves a contractual relationship between a third-party insurer and its insured. These jurisdictions include Alabama, California, Florida, Indiana, Missouri, New Jersey, Ohio, Pennsylvania and Texas . Some jurisdictions do follow a minority rule and consider self-insurance to be merely a subspecies of insurance, but only for limited purposes. These jurisdictions include California, Minnesota and New Jersey . Thus, for example, both California and New Jersey find self-insurance not insurance for "other insurance" purposes, but do find self- insurance "insurance" in the context of the financial responsibility laws regarding auto insurance.

 

Some policies refer specifically to self-insurance in their other-insurance clauses. For example, in Nabisco, Inc. v. Transport Indemnity Company, 143 Cal. App. 3d 831 (1983), Nabisco was covered by two policies, the first of which contained a $50,000 deductible that was viewed as self-insurance. The second policy had an other-insurance clause expressly rendering its coverage excess to "other insurance or self-insurance." The court held that since Nabisco clearly understood its deductible to be self-insurance, the self-insurance component of the second policy's other-insurance clause must be given effect.

 

However, unless a carrier includes self-insurance in its other-insurance clause, it is unlikely to be able to apportion self-insurance the way it would otherwise be able to apportion other insurance. For example, in Wake County Hospital System v. National Casualty Company, 804 F. Supp. 768 (W.D. N.C. 1992), the court determined that the self-insured retention was not "other insurance," as the insurer easily could have protected itself against the dilemma created by not including language in its policy that its coverage was excess over any other valid and collectible insurance or self-insurance.

 

One exception to this point of view in California has to do with the statutory requirements regarding auto insurance. The state's financial-responsibility laws require motorists to purchase auto liability policies, but permit satisfaction of this requirement by filing a certificate of self-insurance. Thus, California has taken the minority approach on this question and holds that for statutory apportionment, a self-insurance certificate is a policy of automobile insurance, thereby making this the exception to California 's law on self-insurance.

 

However, under Wisconsin law, a self-insured retention constitutes "other collectible insurance," so that a self-insured company was considered by the court to be primary insurer (see Hillegass v. Landwehr, 499 N.W.2d 656 (Wis. 1993)). Similarly, in National Farmers Union Property and Casualty Company v. Bang, 516 N.W.2d 313, 319 (S.D. 1994), a South Dakota court determined that coverage provided by a self-insured employer constituted "other insurance" so that primary liability for uninsured motorist coverage fell with the employer. The coverage was considered to be "other insurance" subject to the same provisions and requirements imposed on commercial insurance carriers.

 

Under Michigan law, self-insurance, when certified by the Secretary of State, is the equivalent of commercial insurance. An automobile-leasing company's self-insured retention, therefore, was considered by the court to constitute "other collectible insurance" as that term was defined in a policy issued to an individual who injured a pedestrian while driving one of the leasing company's vehicles (see Allstate Insurance Company v. Elassal, 512 N.W.2d (Mich. App. 1994)).

 

Similarly, in Provost v. Unger, 949 F.2d 161 (5th Cir. 1991), a self-insured auto-leasing agency was held to be a primary insurer despite its argument that it was self-insured and, therefore, provided no insurance within the meaning of the "other-insurance" clauses contained in other policies at issue in the case. The court reasoned that the agency's self-insured retention was, in reality, merely a deductible. In contrast, in Wake County Hospital System v. National Casualty Co., 804 F. Supp. 768 (E.D.N.C. 1992), a federal court ruled that the "plain and ordinary" definition of insurance contemplated a written contract issued by an individual or entity to compensate another for loss in consideration of premium. Thus, under North Carolina law, a hospital's self-insured retention did not constitute "other insurance" as defined in a professional liability policy. The court acknowledged there was a split of authority among states that had considered this question, but followed what it deemed the majority rule.

 

A coverage issue also could arise when a loss occurs during the period when two or more umbrella policies provide overlapping coverage (i.e., one policy's inception date precedes another's cancellation date), and both policies contain the same other-insurance condition. In this case, the problem would be in determining which policy should respond first. Coverage would likely be prorated using a formula developed by the court based on the facts of the case.

 

Many of the problems regarding conflicting other-insurance conditions can be avoided at the outset. Whenever an insured enters into a contractual relationship requiring another party to provide insurance and/or indemnity, the insured has advance warning that a loss may be covered by more than one policy. To avoid confusion, each policy could be endorsed to specifically state which coverage is primary and which is to be excess, depending on the requirements of the underlying contract.

 

In an excess program involving multiple layers of coverage, the other-insurance provision of each policy should be carefully reviewed to determine how these provisions interact and might be interpreted. Where the other-insurance provisions of the policies conflict (e.g., one policy contains a "pro-rata" clause and another policy contains an "excess" clause), each policy should be modified by endorsement to clarify which applies first.

 

Prior Insurance and Noncumulation of Liability

 

Though now rarely used, "prior-insurance" conditions first appeared in some primary and excess liability forms issued during the 1960s. These provisions act to reduce the policy limits available to pay loss by the amount of coverage available from other insurance in effect prior to inception of the current policy. An example of such a provision from American Home Assurance Company is the following:

 

     It is agreed that if any loss covered hereunder is also covered in whole or in part under any other excess policy issued to the Insured prior to the inception date hereof, our limit of liability as stated in the Declarations shall be reduced by any amounts due the Insured on account of any loss under such prior insurance.

 

Prior-insurance conditions are sometimes confused with other-insurance conditions, but they differ in two important ways. Other-insurance conditions describe how coverage limits are intended to apply (e.g., excess, pro rata, etc.) in relation to either underlying or other available coverage. Prior-insurance conditions apply to coverage that was in effect before the inception of the current umbrella policy and which may provide coverage for a loss that is also covered by the current policy. The other way they differ is that an other-insurance condition does not reduce the amount of coverage available under the current policy, while a prior-insurance condition acts to reduce the limits of liability available under the current policy.

 

Several major court decisions regarding the applicability of prior-insurance provisions since 1981 were based on the "exposure" theory of liability for losses resulting from "repeated or continuous exposure to conditions." The "exposure" theory holds that all insurers providing coverage during the period of exposure should share in the payment of the loss. This is in contrast with the "manifestation" theory, which holds that only the insurer(s) providing coverage when the loss is recognized (e.g., injury symptoms appear) should be held liable for payment of the loss.

 

Under the "exposure" theory, if loss occurs over a period covered by more than one policy, all policies in effect during that exposure period are deemed to provide coverage. If, however, the most recent policy subject to an exposure theory loss contained a prior-insurance condition, the coverage limits available to pay for the loss would be reduced by the amount of coverage available from the prior policy(ies). Thus, the prior-insurance condition can reduce or even eliminate current coverage for which the insured has paid a premium. Full policy limits would be available, however, for losses not covered by any prior insurance.

 

Possibly to avoid litigation or possibly to clarify the insurer's intent to provide coverage for losses that extend beyond the policy term, some insurers added the following paragraph (from a Central National Insurance Company of Omaha umbrella policy) to the prior-insurance condition wording cited above:

 

     Subject to the foregoing paragraph and to all the other terms and conditions of this policy, in the event that personal injury or property damage arising out of an occurrence covered hereunder is continuing at the time of termination of this policy, the Company will continue to protect the insured for liability in respect of such personal injury or property damage without payment of additional premium.

 

Such wording extends the coverage period beyond the expiration date of the policy in the case of a "repeated or continuous exposure" loss, without requiring the payment of additional premium.

 

Most umbrella insurers no longer include a prior-insurance condition in their policies and may instead be relying on the courts to determine how to allocate payment for losses involving multiple insurers and coverage periods. It also is possible that removal of the condition was prompted by bad-faith litigation following insurers' attempts to deny claims (or reduce available coverage limits) on the basis of other available coverage.

 

Representations (Declarations)

 

All umbrella policies contain specific provisions governing information provided to the insurer by the insured in the coverage application. These provisions are often captioned "Representations," "Declarations" or "Agreements and Representations."

 

The following examples from Allianz Underwriters Insurance Company and Bituminous Casualty Company are representative of "Declarations" provisions used in umbrella policies issued prior to and subsequent to the introduction of the 1986 ISO-CGL policy form, respectively:

 

     By acceptance of this policy the Named Insured agrees that the statements in the application and the declarations, and in any subsequent notice relating to underlying insurance are its agreements and representations that this policy is issued and continued in reliance upon the truth of such representations and that this policy embodies all agreements existing between the Named Insured and the Company or any of its agents relating to this insurance.

 

     By accepting this policy, you agree:

 

a)  The information shown on the Declarations Page is accurate and complete;

 

b)  The information is based upon representations you made to us in your application(s) for this policy; and

 

c)   We have issued this policy in reliance upon your representations.

 

While the above examples differ slightly, the effect is the same; specifically, that the insurer has issued the policy based on information (representations) provided by the insured.

 

A "representation" is a description, account or statement of facts. Black's Law Dictionary defines "representation" as "a statement or implication of fact, oral or written, as made by one party to induce another to enter into a contract." In the context of insurance, "representation" is defined as "a statement or answer to a question in an application for insurance." A representation is "material" if it is "a fact or statement which tends to influence an underwriter to accept or reject an application." It is important to ensure that material representations are correct because the underwriter relies on those representations when deciding whether to write or modify coverage and in determining the premium to be charged.

 

Misrepresentations may be intentional or they may be made out of carelessness or ignorance. An intentional misrepresentation (especially if it is a material misrepresentation) is generally considered by the courts to be a fraudulent act committed by the insured and may result in voiding of the policy. If a misrepresentation is not material and was made out of carelessness or ignorance, coverage usually will not be affected, as confirmed by the following wording (from Harleysville Mutual Insurance Company) added to the representations condition in some umbrella policies:

 

     Your failure to disclose all hazards existing as of the inception date of the policy shall not in itself prejudice the coverage otherwise afforded by this policy, providing such failure to disclose all hazards is not intentional.

 

If the insured is not asked by the insurer to provide particular information regarding the risk, failure to provide that information usually is not considered by the courts to be a misrepresentation. However, if the insurer does ask, the insured is obligated to provide an answer that is substantially accurate. If the information given by the insured later proves to be inaccurate, it is generally up to the insurer to prove the misrepresentation was material in order to rescind the policy or attempt to otherwise restrict coverage.

 

Whether a statement in an application must be literally true often depends on whether the statement is construed as a warranty or a representation. Warranties must be literally true in order to preserve coverage. Any misstatement in a warranty made by the insured could void the policy, if the insurer so chooses. In contrast, a representation usually will not void a policy as long as it is substantially true and not material to the risk.

 

Insurers usually treat statements made on a coverage application to be "representations" rather than "warranties." A "warranty" is defined as "an agreement made by the insured that certain facts, statements or descriptions are or shall be true, or that certain acts shall be done as to the risk assumed." Warranties typically relate to an existing fact or promise of some future act or conduct of the insured.

 

A warranty may be express, implied, affirmative or promissory. An expressed warranty is a written agreement that certain facts, circumstances or conduct are or will be true. An implied warranty need not be in writing, but affects the insured as though it were expressed. An example of an implied warranty is that the insured's products are suitable for use as intended.

 

An affirmative warranty is an agreement between the insured and the insurer that if a stated fact is (or becomes) untrue, there is no coverage under the policy. An example of an affirmative warranty is a promise by the insured that a fire-suppression system in a warehouse will be kept in operative condition. Promissory warranties are statements that certain obligations will be performed by the insured, such as notifying the insurer if a sprinkler system is shut down for an extended period of time.

 

The courts typically interpret any ambiguity between representations and warranties in favor of the insured. However, the presence of a representations condition in an umbrella policy makes it important that insurance applications be carefully reviewed. The insured's operations should be properly and accurately described and all questions answered as truthfully as possible. It also is important that the insurer be informed of any claims or occurrences likely to result in claims, even though such information may not be specifically requested in the application. The insured has a good-faith duty to disclose claims information and failure to do so may result in the insurer's attempt to deny coverage for claims resulting from those occurrences.

 

Some brokers will attempt to assist the insured in preparing and completing the coverage application. The insured should never assume the broker has completed a coverage application correctly. Risk managers and insurance buyers should review any coverage application completed by the broker before it is submitted to the insurer. Similarly, when a coverage quotation is received, any required warranties appearing in the policy or application should be reviewed carefully to be sure they are acceptable and any desired changes to wording of the warranty should be made prior to accepting the policy.

 

Subrogation

 

"Subrogation" is defined in Black's Dictionary as "the substitution of one person in the place of another with reference to a lawful claim, demand or right, so that he who is substituted succeeds to the rights of the other in relation to the debt or claim and its rights, remedies or securities." Generally, while an insured is primarily liable to one or more third-party claimants, an insurer is primarily liable to protect the insured and to pay or defend against the third party's claim. An insurer who has paid a loss on behalf of its insured then has a right to "step into the shoes" of the insured and to seek recovery from the party or parties responsible for the loss. The insurer can initiate recovery proceedings on behalf of the insured, on its own or in association with the insured and/or other parties.

 

Subrogation provisions in umbrella policies are normally captioned "Recovering Damages From A Third Party," "Transfer Of Rights of Recovery," "Our Right To Recover From Others" or simply "Subrogation."

 

Many umbrella policies state that the insurer has the duty or right to associate with the insured or other interests in the pursuit of subrogation. Some policies, however, are silent with regard to control of the pursuit of subrogation. Other policies provide that the right to control subrogation is determined "by agreement between the parties." When subrogation provisions are vague or ambiguous, disputes and possible litigation between the various parties, including the insured, can result. Because such proceedings can be costly, a clear understanding of each party's role in such litigation is important, especially where a large deductible or retention is involved.

 

While umbrella insurers most often exercise their subrogation rights when seeking recovery from third parties, it is not unusual for them to seek reimbursement from primary insurers under principles of either legal or equitable subrogation. Differences in policy wording regarding how recoveries will be distributed may result in conflicts that are often only resolved through litigation. Issues can arise concerning an umbrella insurer's duty to pay and right of reimbursement, as well as the underlying insurer's obligation to reimburse the umbrella insurer. In evaluating subrogation rights, the courts consider such factors as policy wording, state laws, specific facts of the case and other legal or applicable concepts.

 

Legal subrogation principles apply once the insurer has performed its contractual duty by paying a loss on behalf of the insured under the provisions of the insurance contract. When a primary insurer has fulfilled its obligation (i.e., policy limits are exhausted), the umbrella insurer becomes "secondarily liable" on the risk and may seek recovery of any sums it paid in fulfillment of its own obligation. The legal subrogation concept is the basis for most subrogation actions against third parties responsible for the loss.

 

An insurer also may have rights under the principles of equitable subrogation. The equitable doctrine of subrogation applies where the insurer pays an obligation for the insured despite having no contractual obligation to do so. Essentially a legal fiction, equitable subrogation is premised on an assumption of fact made by most courts and is dependent upon the specific circumstances of the case. The principles of good faith and fair dealing, avoidance of unjust enrichment and similar concepts are considered by the courts in determining an insurer's subrogation rights under equitable subrogation.

 

Equitable subrogation often is the basis of litigation between insurers on the same risk. For example, where primary and excess insurers both are involved in the same insurance program, it is incumbent upon the primary insurer to try to settle a claim within its own limit of liability. If it fails to do so when given the opportunity and there is a judgment that exceeds primary policy limits, the excess insurer may have a right of subrogation against the primary insurer after it pays its own portion of the judgment. However, if the primary insurer never had an opportunity to settle within policy limits, an excess carrier would have no equitable subrogation rights against the primary insurer since there would be no valid cause of action.

 

A primary insurer may resist an excess insurer's subrogation action on the grounds that the excess insurer made a "voluntary" payment. However, even when there is no specific duty to pay, excess insurers who have made payments of amounts that exceed their contractual obligations can be entitled to reimbursement if such payments were made in good faith and to protect their rights or interests. In North Carolina Insurance Guarantee Association v. Century Indemnity Co., 115 N.C. App. 175, 444 S.E.2d 464 (N.C. App. 1994), an excess insurer paid $200,000 toward a settlement following the primary insurer's insolvency, then filed a subrogation action against the North Carolina Guaranty Association. The Association claimed that the excess insurer had an obligation to drop down and defend the claim. However, because the excess insurer had no obligation to pay all of the funds that it contributed and because it made the payment to protect the insured, the court ruled that the doctrine of equitable subrogation gave the excess insurer the right to recover $100,000 back from the Guaranty Association. In reaching its decision, the court noted that the doctrine of equitable subrogation could be applied if the obligation of another was paid for the purpose of protecting a real or supposed right or interest of the payor.

 

An excess insurer can be equitably subrogated to the rights of the insured because both it and the insured desire the primary insurer to settle a claim within policy limits (see American Centennial Ins. Co. v. Canal Ins. Co., 843 S.W.2d 480, 483 (Tex. 1992)). If the primary insurer fails to do so and the excess carrier pays more than its contractual obligations, an equitable subrogation action could be filed against the primary insurer to recover any amounts the excess insurer paid that were in excess of its contractual obligations.

 

Because an excess insurer usually is not liable until the full extent of primary coverage is exhausted, the primary and excess insurers are not secondarily liable and no right of subrogation exists on behalf of the primary insurer against the excess insurer. Thus, in Simon v. Bloom, La. App. 1994, 631 So.2d 1296,1298, a Louisiana court held a primary carrier could not subrogate against an excess insurer under the facts of that particular case. The court noted that since the primary carrier's uninsured motorist coverage was not exhausted, there was no obligation on the part of the excess carrier to contribute toward either a settlement or a judgment.

 

Sometimes primary insurers raise an affirmative defense to an equitable subrogation action by asserting that the excess insurer's payment was voluntary. This defense usually will fail unless there are unusual facts to support it. If an excess carrier usurps the primary insurer's role of controlling the defense and settles the case around everyone else, a primary insurer might be able to successfully argue that the payment was "voluntary" and thereby defeat a subrogation action by the excess carrier. Otherwise, the courts have implied that an excess carrier's payments are not voluntary simply because the excess insurer is secondarily liable on the risk (see Argonaut Ins. Co. v. Allstate Insurance Co., 869 S.W.2d 537,542 (Tex. App. 1993); see also American Centennial Ins. Co. v. Canal Ins. Co., 843 S.W.2d 483 (Tex. 1992)). Thus, to plead an adequate cause of action under Texas law, an excess carrier had to only plead that it was an excess carrier and that it had satisfied the entire final judgment. Even though both the excess and primary insurers had negotiated the settlement agreement, the court ruled that the primary carrier had not met its burden of showing, as a matter of law, that the payment of the excess carrier was voluntary.

 

In applying theories of unjust enrichment and alluding to equitable subrogation principles, a South Dakota court ruled that an excess insurer was entitled to reimbursement from a primary insurer for legal fees incurred in performing its secondary duty to defend insureds from the time the primary insurer was notified of the claim until the time it actually undertook its defense obligations. In reaching its decision, the court noted that denying reimbursement would unfairly punish the excess insurer and unjustly enrich the primary insurer (see Church Mutual Insurance Co. v. Smith, 509 N.W.2d 274 (S.D. 1993)).

 

In Hartford Ins. Co. v. Commerce & Industry Ins. Co., 864 S.W.2d 648 (Tex. App. 1993), an excess insurer that contributed to the settlement of a claim brought an action against a primary insurer. The action was based on a subrogation clause in the excess policy and contended the primary insurer should have paid an additional $1 million under a second policy issued to the insured. However, because the second policy did not provide coverage for the loss as a matter of law, the court entered a summary judgment in the primary insurer's favor, finding that the excess carrier had no right to enforce additional payments under that policy.

 

In subrogation actions, insurance policy provisions are reviewed by the courts to determine whether an insurer has a duty or obligation to defend the insured, or whether it merely has a right to associate with the insured. If a primary policy states that the insurer has a right to associate with the insured in defense of a claim, an excess insurer may have no right of equitable subrogation against the primary insurer. In National Union Fire Ins. Co. v. CNA Ins. Cos., 28 F.3d 29 (5th Cir. 1994), the insured had a significant self-insured retention followed by several excess insurance policies, the first two of which were written by a CNA subsidiary, Columbia Ins. Co. Both of the Columbia policies gave control of defense to the insured, with the insurer having the right to associate with the insured in the defense of a claim. The third-level excess insurer, National Union, filed suit based on equitable subrogation, claiming that Columbia had a duty to settle within the limits of the primary policies and that National Union had the right to recover defense costs it had paid from Columbia. The court, however, denied National Union's claim. Since Columbia had no duty to the insured under Texas law, the court reasoned it also had no duty to higher level excess insurers under the principles of equitable subrogation.

 

An excess carrier's efforts to impose liability on a primary insurer for breach of the covenant of good faith and fair dealing also was rejected by the court. Because there was no contractual relationship between the insurers, the court found there was no independent duty of good faith. It further noted that while an excess insurer may be entitled to sue a primary insurer for breach of the implied covenant by way of subrogation to the insured's rights, two essential elements of equitable subrogation were missing in this case. First, the insured had released the primary insurer from all claims so that there was no presently existing cause of action that could be asserted on the insured's behalf against the primary insurer. Second, the excess insurer had not been damaged as a result of the act on which the primary insurer's liability depended (see Fireman's Fund Ins. Co. v. Maryland Casualty Co., 21 Cal. App. 4th 1586 (1994)).

 

Many umbrella insurers recognize the problems that can arise when there are other insurers on the risk. As a result, their forms state that they "shall participate with the insured and any underlying insurer in the exercise of all the insured's rights of recovery." Or, the policy may state that the umbrella insurers will "act in concert with all other interests (including the Insured) concerned, in the exercise of the Insured's rights of recovery."

 

Absent wording such as the above and because there is normally no contractual relationship between the various insurers, it sometimes becomes necessary for the courts to determine the individual rights and duties of each insurer. For example, when two or more policies contain different or ambiguous language regarding the distribution of recoveries, a primary insurer may argue that it should be afforded the first right of recovery. Even if the policies do not contain similar wording, however, an umbrella or excess insurer usually is entitled to be reimbursed first. In Century Indemnity Co. v. London Underwriters, 12 Cal. App. 4th 1701 (1993); see also 16 Couch on Insurance, 2d (2d Ed. 1983) § 61:49 p. 133, an excess insurer contributed $600,000 to the $1.1 million settlement of a claim against its insured, while the primary insurer paid $500,000 toward the settlement. Subsequently, the insured recovered $500,000 in indemnification from a third party. In applying the subrogation clauses contained within the respective policies, the court found that they were reconcilable and called for the excess insurer to be reimbursed. The court observed that "where the insurers' coverage is in the nature of layers, the excess carrier should recover under subrogation before primary insurers can be reimbursed. One can look at a subrogation recovery as reducing the net loss in which case the excess carriers would not be obligated to pay the loss."

 

Because any monetary recovery from a third party reduces the total cost of the loss, and in order to avoid confusion over the order of reimbursement most umbrella policies issued after 1986 provide that the various interests to the loss—the insured, any underlying insurer(s), the umbrella insurer and any excess insurer(s)—will be reimbursed in the following order:

 

1.  Interests (including the insured) that have paid any loss amount in excess of the umbrella insurer's payment are reimbursed first, to the extent of their payment.

 

2.  The umbrella insurer is then reimbursed for the amount it has paid

.

3.  Any other interests (an underlying insurer, an insurance guaranty fund, or the insured) divide the balance of any recovery.

 

The recovery-distribution provision in most umbrella policies includes references to those parties who have paid sums in excess of the umbrella policy limits. However, not all policies have such a reference, as in the following example from Fireman's Fund:

 

     Any recoveries shall be distributed as follows:

 

a.  First, we shall be entitled to recover to the extent of our payment; and

 

b.  Next, any remaining amounts shall be paid to the Primary Insurers or any other party to the extent of their payment.

 

c.   The expenses of the recovery will be distributed in the proportion to the share of each party's recovery. But, if we conduct the recovery proceedings by ourselves:

 

(1)  We will pay all expenses; and

(2)  If we make a recovery, we will be reimbursed in full from the recovery for our expenses before the recovery is distributed.

 

Under the above wording, the umbrella insurer is claiming the first right of recovery, then leaving it to any other insurers to apportion any recovery amounts in excess of the umbrella's payment. Unlike the above, however, some policies are altogether silent regarding the distribution of recoveries, as illustrated by the following particular example:

 

     If an insured has rights to recover all or part of any payment we have made under Coverage B, those rights are transferred to us. An insured must do nothing after loss to impair them. At our request, an insured will bring suit or transfer those rights to us and help us enforce them.

 

Whenever no reference is made to the parties involved in paying the loss, an issue as to how subrogation recoveries are to be distributed can arise. If the dispute leads to litigation, the resulting delay in reimbursement could present a hardship to any insured having a large deductible or self-insured retention. It is therefore important that the wording of the recovery apportionment provision for each policy be carefully reviewed.

 

Another potential problem for the insured involves the payment of subrogation expenses in the event there is no recovery. Once again, if the insured has a large deductible or retention and has paid a significant portion of the expenses, litigation resulting from ambiguous expense apportionment provisions may result in the insured suffering undue financial hardship. Fortunately the subrogation condition in many umbrellas policies provides that if the insurer undertakes subrogation proceedings that result in no recovery, it will bear all the expenses associated with those proceedings.

 

Most umbrella policies provide that the expenses of subrogation proceedings will be apportioned among all interests "in the ratio of their respective recoveries as finally settled." Some umbrella policy forms, however, state that expenses will be apportioned among all interests in the ratio of their respective losses "for which recovery is sought." Apportionment of expenses can lead to disputes when only a partial recovery is made. The primary insurer and/or insured may not receive any reimbursement, but might still be required to pay a portion of the subrogation expenses. Most umbrella insurers seem to agree that it makes more sense to apportion expenses on the basis of final recoveries.

 

In addition to the issues discussed above, a dispute may arise when umbrella and underlying insurers each require the insured to surrender all rights of recovery. Unless all policies contain similar provisions, confusion and/or disagreement can result over the duties and obligations of each party. Fortunately for the insured, conflicts and issues such as the above that arise out of subrogation actions usually develop after a loss payment, and it is for the insurers and the courts to resolve the matter.

 

For businesses having a large self-insured retention, however, it is desirable to have as little litigation as possible. While not all litigation can be avoided, the likelihood of litigation regarding conflicting policy subrogation provisions can be reduced. The subrogation provisions of all primary and excess policies should be reviewed and compared to determine similarities and differences. An attempt should then be made to eliminate any differences by endorsement.

 

Underlying Insurance

 

Nearly all umbrella policies contain a condition which requires the insured to keep underlying insurance in effect for the full term of the umbrella policy. This condition is usually captioned "Maintenance of Underlying Insurance." Although individual policy wording may vary, the following from Harleysville Mutual Insurance Company is an example of underlying-insurance condition wording:

 

     You shall maintain the insurance afforded by each policy listed in the Schedule of Underlying Insurance in the Declarations for the full term of this insurance. The terms, conditions and endorsements of "underlying insurance" will not materially change and renewals or replacements of "underlying insurance" will not be more restrictive in coverage. Limits of "underlying insurance" will not be reduced except for any reduction or exhaustion of the aggregate limit(s) of insurance due to the payment of claims or defense.

 

     If you fail to comply with the above, this insurance will not be invalidated. However, in the event of a loss, we will pay only to the extent that we would have paid had you so complied.

 

Another example of underlying insurance condition wording (from Fireman's Fund) is shown below:

 

     While this policy is in effect you agree:

 

1.  To maintain Primary Insurance in full force, except for the reduction of limits of insurance due to the payment of judgments or settlements

 

2.  The terms and conditions of Primary Insurance will not materially change; and

 

3.  Renewals of Primary Insurance will not be more restrictive in coverage.

 

     If you fail to comply with the above this policy shall apply as if Primary Insurance had been so maintained.

 

The last sentence in the examples above probably are the most important provisions from the insured's standpoint. If underlying policies are not maintained, the umbrella will respond, but only in excess of amounts which the underlying insurers were to cover.

 

Some insurers also require that they be notified of the exhaustion of underlying coverage limits, cancellation or changes in the terms of underlying coverage or the replacement of any underlying policy. An example of this wording from Bituminous Casualty Company is shown below:

 

     You must keep the "underlying insurance" described in the Schedule of Underlying Insurance on the Declarations Page of this policy, or renewal or replacement policies not more restrictive in their terms and conditions, in full force and effect during the policy period of this policy.

 

     The limits of insurance must be maintained without reduction other than by payment of losses. You must also inform us within 30 days of any cancellation of any policy of "underlying insurance," or replacement of any policy of "underlying insurance" by the "underlying insurer" or any other insurer.

 

     Your failure to comply with the foregoing shall not invalidate this policy, but in the event of such failure, we shall be liable under this policy only to the extent that we would have been liable had you complied with these obligations.

 

The maintenance-of-underlying-insurance condition emphasizes the need to retain the originals of all primary and excess liability insurance policies indefinitely. Claims may arise from occurrences that happened many years ago. Also, the umbrella insurer may require notification when underlying aggregate limits are exhausted, even after expiration of the umbrella policy.

 

Some umbrella policies contain additional requirements for notice and reinstatement of primary limits. The following example illustrates these additional requirements:

 

     Upon notice that any underlying aggregate limit has been exhausted, the named insured shall immediately make all reasonable efforts to reinstate that limit. The named insured shall notify the company in writing as soon as practicable of any change in the scope of underlying coverage or in the limits of insurance available under any underlying policy, and of the termination of any coverage or exhaustion of underlying aggregate limits.

 

The problem with the above condition wording is that it is not clear exactly what is considered to be a "reasonable effort" to reinstate exhausted underlying aggregate limits. If the underlying aggregate limit were depleted before expiration of the underlying and umbrella policies, it might be reasonable to expect the insured to purchase replacement coverage until the end of the umbrella policy period. However, it is unclear what the umbrella insurer expects the insured to do if aggregate limits of underlying insurance are exhausted after the current annual period or expiration of both policies. Most liability claims take time to be reported and settled. It is unlikely that the insured will know of the exhaustion of aggregate limits until after a policy's expiration. An attempt should be made to delete any reinstatement requirements from an umbrella policy.

 

Requiring the insured to notify the insurer of any changes in the scope of underlying coverage, limits available, termination of coverage or exhaustion of aggregate limits may mean (if interpreted literally) that the insured must notify the umbrella insurer when any underlying loss payment reduces (but does not necessarily exhaust) an underlying aggregate limit. Even an adjustment to a primary insurer's loss reserves might require notice to the umbrella insurer. It is preferred that this condition only requires that underlying coverages be maintained during the period of the umbrella, and that failure to do so will not prejudice nor invalidate the umbrella's coverage.

 

Another potential underlying insurance problem involves sublimits. Usually, only the principal underlying policy limits are shown on the umbrella declarations or schedule of underlying insurance. Sublimits that apply to underlying coverages are not shown. For example, the fire legal liability coverage sublimit in a general liability policy is typically $50,000 or $100,000. Whether the umbrella will respond to a fire legal liability claim in excess of the underlying sublimit is questionable. While most umbrella policies do not contain an exclusion for the fire legal liability exposure, some insurers may specifically exclude such coverage by endorsement.

 

If the umbrella is intended to provide coverage excess of a sublimit in underlying coverage, the applicable underlying coverage sublimit should be added to the umbrella policy's schedule of underlying insurance.

 

Defense Coverage

 

General

 

Defense coverage under liability insurance policies is a contractual obligation. In the absence of an affirmative promise by the insurer to provide defense coverage, no such duty normally exists. While most umbrella policies contain provisions for an affirmative duty to defend the insured, the specifics of that duty can vary. Some excess liability policies, on the other hand, may not contain a duty to defend. The following discussion is generally limited to defense issues under occurrence umbrella policies where the insurer has expressed an affirmative duty to defend.

 

Liability insurers typically have two separate financial obligations: (1) to defend the insured for covered claims and (2) to pay loss. The courts have determined that if an insurer is fully liable for indemnity, it is also fully liable for defense costs. When and how defense coverage applies is often clearly stated in the policy, but also can be influenced by the facts of the case.

 

All umbrella policies contain provisions that set forth the insurer's rights and obligations to defend, or to participate in the defense of, any claim or suit that is likely to involve the umbrella policy. These rights and obligations to defend the insured not only apply to civil lawsuits, but, in most instances, to alternative dispute resolution proceedings (such as arbitration and pretrial mediation) as well. Variations in the wording used by insurers to express the scope of defense coverage can have a significant financial impact on the insured.

 

Most umbrella policies contain a separate and distinct section outlining the insurer's rights and specific obligations regarding defense coverage. Some policies, however, include the insurer's defense obligations within the "Insuring Agreement," "Limits of Liability" section, "Assistance and Cooperation" condition, or as part of the definition of "Ultimate Net Loss."

 

Regardless of the approach taken, most umbrella policies cover defense costs and related expenses for (1) claims in which damages exceed the coverage limit of underlying policies and (2) claims for which damages may be covered by the umbrella, but are not covered by underlying insurance. These features are illustrated in the following specimen defense provision from Kemper Insurance:

 

A. We shall have the right and duty to defend any claim or Suit seeking damages covered by the terms and conditions of this policy when:

 

(a) The applicable limits of insurance of the underlying insurance policies listed in the Schedule of Underlying Insurance and the Limits of Insurance providing coverage to the Insured have been exhausted by payment of claims for Occurrences that take place during the policy period; or

 

(b) Damages are sought for Bodily Injury, Property Damage, Personal Injury, or Advertising Injury by this policy but not covered by any Underlying Insurance listed in the Schedule of Underlying Insurance or any other insurance providing coverage to the Insured.

 

As a general rule, defense coverage under excess liability policies normally applies only for claims in excess of underlying coverage limits.

 

Defense Costs in Addition to or Within Policy Limits

 

Costs incurred in the defense of the insured usually apply in one of the following ways:

 

•    All defense costs are considered loss or damages under the policy and reduce the policy limits of liability.

 

•    Defense costs incurred following assumption of defense by the umbrella insurer due to exhaustion of underlying limits reduces the policy limits of liability. Expenses incurred in the defense of claims not covered by underlying policies do not reduce the policy limits of liability.

 

•    Defense costs do not reduce the limits of liability.

 

The obvious advantages of the last approach stated above is that the cost of providing the insured with a defense does not erode the limit of liability available to pay loss. Because defense expenses alone can exceed policy limits, such a feature is extremely desirable.

 

Most policies are clear regarding how defense payments affect policy limits. But under some policies, a close reading is necessary to determine the insurer's intent. For example, some umbrella defense provisions do not directly address the effect of defense payments on policy limits, but define the term "ultimate net loss" to include defense expenses. Because the payment of "ultimate net loss" reduces policy limits, any payment of defense expense will likewise reduce policy limits.

 

Some umbrella policies may be ambiguous regarding how the payment of defense expenses affects policy limits. For example, an umbrella policy may state that the insurer will pay "all expenses we incur" in defense of claims, yet define "ultimate net loss" to include defense expenses. Where such a conflict occurs, it also may be unclear whether the insurer intends to pay defense costs after the policy "per-occurrence" or aggregate limit of liability is exceeded by loss payments.

 

Because coverage for defense is a fundamental element of catastrophe protection for most insureds, it is crucial that the scope and any limitations of such coverage are fully understood. For this reason, any ambiguity or uncertainty regarding the application and mechanics of defense coverage should be clarified or corrected by endorsement. Determining adequate limits where defense expenses act to reduce the limit of liability also can be tricky. Remember, defense expenses can exceed indemnity payments. In most cases this means considering the purchase of much higher limits of liability.

 

Appeals Expenses

 

The "appeals" condition in most umbrella policies contains provisions that give the insurer the right to appeal unfavorable judgments rendered against the insured. When an insurer elects to appeal a judgment, the cost of that appeal often is paid by the insurer in addition to the policy limit of liability.

 

A few umbrella policies do not contain a specific "Appeals" condition. Under such policies, the appeals expense provisions are often contained within the "Limits of Liability" or "Duty to Defend" section of the policy. If the policy is silent regarding appeals, or if the wording of the "Duty to Defend" provisions is ambiguous or unclear regarding appeals expenses, the courts may rule that the insurer is obligated to pay for the appeal of an adverse judgment. For example, in Iacobelli Construction Company v. Western Casualty and Surety, 343 N.W.2d 517 (Mich. App. 1983), a Michigan court found that the insurer had a duty to appeal an adverse judgment on behalf of the insured based on a broad "duty to defend" clause and absence of clear policy language providing otherwise.

 

The insurer's duty to defend the insured, in some circumstances, also includes a duty to appeal any adverse judgment. In the absence of an adverse judgment, however, the insurer has no obligation to make an appeal on behalf of the insured, notwithstanding any other defense obligation. This concept is supported by the case of Crist v. Insurance Company of North America, 529 F. Supp. 601 (C.D. Utah 1982), in which the insured sought to recover the cost of prosecuting appeals of both a preliminary and permanent injunction. But because the court found no adverse judgment on a litigated damage claim and no duty on the part of the insurer to defend injunctive claims, the court ruled in favor of the insurance company.

 

Most umbrella insurers pay expenses they incur during the appeal of judgments in addition to the policy limit of liability. Some umbrella policies, however, provide for payment of appeals expenses within policy limits. The following examples, one from Fireman's Fund and the other from Century Surety Company, illustrate both approaches:

 

     If any Primary Insurer elects not to appeal a judgment in excess of the amount of the Primary Insurance or Other Insurance, we may elect to appeal. If we appeal, we will pay the expenses of such appeal. Such payments will not reduce our Limits of Insurance.

 

     …but in no event shall our liability for "ultimate net loss" exceed the amount set forth in Insuring Agreement II for any one (1) occurrence, and in addition, the cost and expense of such appeal.

 

A review of the policy definition of "Ultimate Net Loss" may, in many instances, also reveal whether appeals expenses are paid within or in addition to policy limits. If the definition of "Ultimate Net Loss" does not include the cost of appeals, appeals expenses will normally be considered to be defense expenses and paid in the same manner as those expenses.

 

Even if an umbrella policy provides for the payment of appeals expenses in addition to the limit of liability, it may not always be clear whether the insurer will pay additional judgment amounts that may be awarded following an appeal by the insurer, which may exceed the umbrella's limit of liability. Some policies clarify the insurer's intent by clearly stating that the limits of liability will not be increased following an appeal, as in the following example taken from the "Appeals" condition of an umbrella policy from Cincinnati Insurance Company:

 

If the insured or any insurer who provides the applicable "underlying insurance" elects not to appeal a judgment which exceeds the "underlying limit", we may elect to do so at our own expense. We shall be liable for the taxable costs and disbursements and interest incidental thereto, but in no event shall this provision increase our liability beyond our applicable limits of liability for all "ultimate net loss" plus the expense of such appeal.

 

However, the wording of the appeals clause in some umbrella policies is ambiguous as to whether the insurer will pay additional judgment amounts that may be awarded following an appeal. Consider the following example from Markel American Insurance Company:

 

If the insured or an "underlying insurer" elects not to appeal a judgment which exceeds the "retained limit," we may elect to do so. If we do so, we shall be liable, in addition to the Limit of Insurance, for all costs, taxes, expenses, and interest on judgments incidental to such an appeal. We shall also be liable for all such costs, expenses and interest on appeals in connection with our right and duty to defend the insured under SECTION II-DEFENSE AND SUPPLEMENTARY PAYMENTS.

 

The terms "costs" and "expenses" used in the above example are not defined terms, and it is unclear whether the insurer intends to pay all of an additional judgment amount or only that portion within the policy limit of liability (plus the appeals expenses).

 

Policy provisions that include appeals expenses within policy limits should be avoided because each expense payment reduces the limit of liability available to pay future loss. Such provisions increase the insured's risk of having to pay expense or judgment amounts that exceed the coverage limit because that limit has been eroded.

 

It is important for the broker and insured to review not only the wording of the "Appeals" condition, but also the "Limits of Liability" and defense provisions of the policy. The definition of "Ultimate Net Loss" also should be reviewed to determine the extent of appeals expense coverage. Any provisions that could result in the insured having to pay appeals expenses or additional judgment amounts should be removed, and ambiguous wording clarified by endorsement.

 

Supplementary Payments

 

Most umbrella policies cover the expense of "supplementary payments" in addition to the cost of defense. Expenses covered as supplementary payments are usually found in the defense provisions section of the policy. Some policies, however, enumerate the covered supplementary payments in the "Insuring Agreement," "Limit of Liability," or "Duty to Defend" section of the policy, or "supplementary payments" may be incorporated into the definition of "defense expenses."

 

A typical grant of coverage for supplementary payments is illustrated in the following example from Harleysville Mutual Insurance Company:

 

e.   We will pay with respect to any claim or "suit" we defend…:

 

(1) All expenses we incur.

 

(2) The cost of appeal bonds and bonds to release attachments, but only for bond amounts within the "applicable limit of insurance." We do have to furnish these bonds.

 

(3) The cost of bail bonds up to $3,000. We do not have to furnish these bonds.

 

(4) All reasonable expenses incurred by the insured at our request to assist us in the investigation or defense of the claim or "suit," including actual loss of earnings because of time off from work.

 

(5) All costs taxed against the insured in the "suit."

 

(6) Pre-judgment interest awarded against the insured on that part of the judgment we pay. If we make an offer to pay the "applicable limit of insurance," we will not pay any pre-judgment interest based on that period of time after the offer.

 

(7) All interest on the full amount of any judgment that accrues after entry of the judgment and before we have:

 

     (a) paid, or offered to pay; or

 

     (b) deposited in court;

 

     the part of the judgment that is within the "applicable limit of insurance."

 

     These payments will not reduce the limits of insurance.

 

Some umbrella policies cover all expenses related to defense, presumably including any supplementary payments, within the policy limit of liability. Each payment of a supplementary expense, therefore, will reduce the coverage limit available to pay future loss and expenses. Even when an umbrella policy provides defense, settlement and other supplementary payments in addition to policy limits, payment of these costs may cease once the policy aggregate limit of liability has been exhausted. A frequent exception is post-judgment interest.

 

The insurer's right to terminate defense and supplementary payments upon exhaustion of policy limits is sometimes supported by statute. For example, a federal court applied Wisconsin law in ruling that an insurer had no duty to defend its insured after the policy limit of liability was exhausted by payment of arbitration expenses. The courts also have supported the insurer's right to terminate payment of supplementary expenses (including pre-judgment interest) once policy limits have been exhausted by the payment of claims, or by payment of both claims and expenses when expenses are included within policy limits.

 

Most umbrella policies contain a provision that states that the insurer may elect (but is not obligated) to participate in the defense of claims involving underlying coverage or claims within the insured's self-insured retention (SIR). When the umbrella insurer elects to participate in the defense of such claims, expenses related to the insurer's participation are usually paid by the insurer in addition to policy limits. The wording of some policies, however, is ambiguous as to whether supplementary payments are considered to be "defense costs."

 

A few umbrella policies state that if the insurer elects to defend a claim that is within the insured's SIR, the insured is required to reimburse the insurer for any defense costs incurred. Some policies that operate in this fashion are silent or ambiguous regarding supplementary payments and it may be unclear whether the insurer will make such payments at its own expense. Coverage for supplementary payments usually is excluded to the extent they are covered by underlying insurance.

 

The following are brief discussions of expenses normally considered to be supplementary payments.

 

Supplementary payments usually include expenses related to the purchase of bail, attachment and appeals bonds. The limit available for payment of bond premiums varies, but is usually limited to $1,000 or less. When not made part of the defense provisions of the policy, coverage for appeals bond expenses sometimes can be found in the "Appeals" condition. Payment for the bond premium usually is made to the insured, who is then responsible for purchasing the bond.

 

Most umbrella policy forms provide for payment of certain expenses incurred by the insured at the insurer's request. These can include costs incurred for attending legal proceedings to assist the insurer in the defense of a claim or suit. The insured is usually reimbursed for out-of-pocket expenses, and the insured's employees compensated for loss of earnings. Salaries of the insured's employees and fees of insured's counsel on retainer almost always are excluded from coverage. Many umbrella policies limit loss of earnings coverage by imposing a maximum amount payable and by excluding the salaries of officers.

 

Damages awarded by the courts sometimes include interest charges that are payable to the plaintiff in addition to the amount of any judgment. The interest may begin to accrue as of the date of the loss or as of the date the lawsuit was filed.

 

In most umbrella policies, supplementary payments include any pre-judgment interest that may be awarded in addition to the judgment amount. The amount of coverage available to pay pre-judgment interest usually is subject to the coverage limit of liability available under the policy.

 

Whether the insurer is obligated to pay pre-judgment interest in addition to awarded damages also may be determined by statute. However, in North Carolina, as evidenced by the case of Sproles v. Green, 407 S.E.2d 497 N.C. 1991), the absence of any statutory provisions requiring the payment of interest on judgments means that a liability insurer's obligation to pay judgment interest is dependent upon policy wording. This reasoning also was used by the court in the case of Baxley v. Nationwide Mutual Insurance Company, 430 S.E.2d 895 (N.C. 1993), where the court ruled that policy language which promised payment of "all damages" up to the policy limit obligated the insurer to pay pre-judgment interest.

 

Even when an umbrella policy specifically defines damages to include pre-judgment interest awarded against the insured, the courts have taken the position that the insurer is not liable for all pre-judgment interest, but only the amount of damages (including interest) that are within the policy limit of liability.

 

Post-judgment interest sometimes is awarded by the courts and, like pre-judgment interest, is payable in addition to the amount of any judgment. When post-judgment interest is awarded, it normally accrues from the date of the judgment until the date it is paid. Interest charges also can accrue while appeals are being pursued by the insurer. When interest charges are added to a claimant's award for damages, the interest usually applies to the entire judgment, not just that portion of judgment within the policy's coverage limit.

 

Some umbrella policies that include post-judgment interest as a supplementary payment also provide that the insurer's duty to pay interest ends upon an offer by the insurer to pay that portion of a judgment not exceeding policy limits. Under Louisiana law, such clauses have been interpreted to apply only to post-judgment interest. The Louisiana courts also have determined that under such policy provisions, supplementary payments are not available if the insurer tenders policy limits prior to trial. Because of this, an insured was unable to argue that pre-judgment interest was payable even when post-judgment interest was not.

 

Post-judgment interest provisions in most umbrella policies usually state that the insurer will pay "all of the interest on the full amount" of the judgment. Under such wording, even if the amount of post-judgment interest causes the total loss to exceed the umbrella policy limit, the insured might argue that the insurer is responsible for paying the full amount of the interest.

 

Most umbrella policies also include "costs taxed against the insured" as supplementary payments. While the term "costs" is not defined, it generally means any out-of-pocket expenses the insured may incur with respect to the litigation, and which are ultimately payable by the insurer. Examples of such "costs" include parking and transportation costs and fees advanced by the insured in an arbitration proceeding. In Alaska , costs taxed by the court against the insured have been found to include the opposing party's attorney's fees, although the courts in other states may take a different position.

 

In Buckhannon-Upshur City Airport v. R & R Cole, 413 S.E.2d 404 (W. Va. 1991), the court determined that pre-judgment interest was not a "cost taxed against the insured," but rather was to be considered a form of compensatory damages because the interest was intended to make a party "whole" for loss of funds.

 

In some instances, whether the insured is prosecuting or defending a suit may determine whether costs related to such action are included within a policy's supplementary-payments provisions. For example, in applying Alaska law, the Ninth Circuit Court ruled that fees and costs incurred in defending a wrongful death suit and which were awarded to the contractor in an indemnity suit against a dam owner constituted "damages" rather than "costs." "Costs" were not included within the supplementary payment provisions contained in the dam owner's primary liability policy. However, as interpreted by the court under the law, fees and costs incurred by the contractor in prosecuting a contract indemnity action against the dam owner did constitute "fees and costs" covered by the dam owner's policy.

 

Whenever defense costs and supplementary payments reduce the umbrella policy's limit of liability, higher coverage limits should be considered. This is because such costs can be substantial and can quickly erode, if not exhaust, the policy's limit of liability.

 

Preferred Defense Provisions

 

There can be much variation in the coverage grant for defense and related expenses. But regardless of how defense provisions are worded, most insureds benefit from the following features:

 

1.  An affirmative duty of the insurer to defend any claim or suit that is covered by the umbrella policy, but not by underlying insurance;

 

2.  An affirmative duty of the insurer to defend any claim or suit in excess of underlying coverage limits;

 

3.  A provision to drop down and assume the defense obligations (and associated costs) of the underlying insurer when underlying coverage limits are exhausted or where the underlying insurer becomes insolvent;

 

4.  A provision that the insurer will pay all defense expenses (including the cost of appeals and supplementary payments) it incurs in addition to policy limits for claims covered by the policy, whether or not those claims are covered by underlying insurance; and

 

5.  A provision that the insurer will pay all costs associated with the defense of claims that are subject to the insured's self-insured retention, without requiring the insured to provide reimbursement to the insurer for these expenses.

 

Because of the importance of policy defense provisions, it is essential that they be reviewed carefully and understood by both the broker and the insured. Any ambiguous wording should be clarified by the insurer, preferably by endorsement.

 

Duty to Defend

 

Umbrella policies serve the dual purpose of providing a higher limit of liability for losses typically covered by underlying liability policies as well as coverage for less common losses not typically covered by standard liability policies. Within this framework, an insurer's obligation to defend its insured against third-party claims or suits is dependent on specific policy defense provisions, how allegations contained in a claim or suit are styled, statutory law, and the facts of a particular case.

 

In general, there are two methods of determining whether an insurer has a duty to defend. One method is to compare the allegations in the claim or suit with the wording of the policy. If the allegations are assumed to be true and the policy would provide coverage, the insurer has an obligation to defend the insured. If none of the allegations, even if true, were covered by the policy, the insurer would probably not be required to provide a defense. For example, if a lawsuit alleged only economic damages and the policy clearly did not cover such damages, the insurer may not be required to defend the suit even if the insured were liable for the loss.

 

The other method for determining whether the insurer must defend the insured is to consider not only the allegations in the complaint and the coverage provisions of the policy, but also the specific facts of the case. If an examination of the facts leads to the conclusion that such facts support a no-coverage position, even if the allegations are true and the policy would otherwise provide coverage, then the insurer may not be required to provide a defense. For example, consider a scenario where allegations contained in a lawsuit are true and the policy clearly provides coverage for the damages claimed. If the facts show that the occurrence that gave rise to the damages took place after the policy had expired, then the insurer will likely have no duty to provide a defense.

 

Most umbrella policies contain provisions stating that the insurer has the right and obligation (or duty) to defend claims that exceed exhausted underlying coverage limits and claims that are covered by the umbrella but not by underlying policies. In addition, most umbrella policies state that the insurer has the right to participate with underlying insurers in the defense of any claims that could potentially trigger coverage. An example is the following wording from a Kemper Insurance policy:

 

C.  Except as provided in Insuring Agreement II.A, Defense, we will not be obligated to assume charge of the investigation, settlement or defense of any claim made, Suit brought or proceeding instituted against the Insured. We will, however, have the right and shall be given the opportunity to participate in the defense and trial of any claims, Suits or proceedings relative to any Occurrence which, in our opinion, may create liability on our part under the terms of this policy. If we exercise such right, we will do so at our own expense.

 

While all insurers pay their own expenses when they exercise their right to participate in the defense of claims involving underlying coverage, a few policies specifically state the umbrella insurer will not contribute to any defense costs incurred by the underlying insurers. Such a failure to contribute has no financial impact on the insured, but results in the underlying insurer having to pay all of its own defense costs.

 

A few umbrella policies state that if the insurer elects not to exercise its right to defend a claim, the insurer will reimburse the insured for any out-of-pocket defense expenses incurred. A reimbursement situation might occur where the insurer initially determines that there is no coverage, but later assumes the defense and reimburses the insured for defense costs paid by the insured up to that point. As a practical matter, most umbrella insurers choose to participate in the defense of claims covered by underlying insurance if it appears the claim has any potential of involving the umbrella coverage.

 

An insurer who has expressed an affirmative duty to defend the insured is usually required to do so when any claim or suit contains allegations or damages potentially within the scope of coverage provided. However, the insurer is only required to pay for damages when those damages are covered by the policy.

 

The following is a typical example (from Crum & Forster Insurance Company) of an insurer's affirmative duty to defend:

 

     We shall have the right and duty to defend the "Insured" against any "Claim" or "Suit" seeking damages…covered by the terms and conditions of this policy, even if the allegations are groundless, false or fraudulent, when:

 

1.  the applicable limits of "Underlying Insurance" and "Other Insurance" have been exhausted by payment of judgments or settlements; or

 

2.  damages…are sought which are not covered by the terms and conditions of "Underlying Insurance" or "Other Insurance".

 

Where an insurer promises a defense for claims that are within the scope of policy coverage, the courts generally will interpret that duty broadly. As stated by the California Supreme Court in Gray v. Zurich Insurance Co. 65 Cal.2d 275 (1966), "the carrier must defend a suit which potentially seeks damages within the coverage of the policy" [emphasis in original]. In this case, the court based its decision on the fact that the policy in question promised to defend the insured "even if any of the allegations of the suit are groundless, false or fraudulent."

 

An insurer cannot, however, base its decision to defend a suit solely on the allegations of the third-party pleading, but must consider both the language of the policy and the allegations of the complaint to determine whether the potential of a covered claim exists. Thus, a duty to defend may exist even if it ultimately results that there is no coverage under indemnity provisions of the policy.

 

This position was confirmed in a 1993 case in which the California Supreme Court again cited the principle, first articulated in Gray, that a duty to defend will arise when facts extrinsic to the complaint and which are gathered from the insured or other sources suggest a potential of a covered claim.

 

However, in another 1993 case, Montrose Chemical Corp. v. Superior Court, 6 Cal. 4th 287 (1993), the California Supreme Court recognized, apparently for the first time, that facts extrinsic to the complaint could also negate a duty to defend. The court held that insofar as such facts could create a duty to defend, they could, under the same reasoning, negate that duty as well. In reaching its decision, the court rebuffed the insurer's efforts to tie the duty to defend to a "reasonable possibility of coverage" and, instead, affirmed that the duty to defend exists if there is a bare "potential" of coverage.

 

Duty to Defend Where Indemnity Is Excluded

 

An insurer's duty to defend may be triggered even where an indemnity payment is ultimately excluded under the policy. This is so because the duty to defend is broader than the duty to indemnify and is determined when the claim is tendered. For example, in Capitol Reproduction, Inc. v. Hartford Ins. Co., 800 F.2d 617 (6th Cir. 1986), the Sixth Circuit Court affirmed a policy provision that afforded defense for any suit against the insured arising from an occurrence covered under the policy. As a result, the court required the insurer to defend a surveyor against an engineer's third-party claim. In reaching its decision, the court determined that the claim that was for loss in value due to misplacement of sewer lines was sufficient to constitute a claim for property damage within the policy, even though the general liability insurer argued that there was no damage to tangible property.

 

     The duty of the insurer to defend the insured depends upon the allegations in the Complaint of the third party in his or her action against the insurer. This duty is not limited to meritorious suits and may even extend to actions which are groundless, false or fraudulent, so long as the allegations against the insured even arguably come within the policy coverage. An insurer has a duty to defend, despite theories of liability asserted against the insured which are not covered under the policy, if there are any theories of recovery which fall within the policy.

 

Many umbrella policies contain an exclusion for punitive damages. When the insurance policy does not contain a punitive damages exclusion, the insurer may attempt to rely on public policy to avoid providing a defense for suits seeking punitive damages only. And, although public policy may preclude indemnification of punitive damages, an insurer may not rely solely on public policy to avoid furnishing a defense with regard to punitive damages, at least in situations where other allegations against the insured are sufficient to trigger coverage. Thus, in Ohio Casualty Insurance Company v. Hubbard, 162 Cal. App.3d 939 (1984), the court ruled that an insurer could not disclaim its defense obligations in the absence of conspicuous policy wording that specifically excluded defense for punitive damages.

 

Defending a claim that is potentially outside the scope of policy coverage can create a dilemma for insurers to the extent that the providing of a defense could be deemed by the courts to be a waiver of being able to later deny coverage. In recognition of the potential harm inherent in this situation, courts have held that the provision of a defense subject to a "reservation of rights" (to assert defenses in the event of a judgment against the insured) will solve the problem. Thus, an insurer can protect itself either through a non-waiver agreement with its insured or, more commonly, by issuing a reservation-of-rights letter.

 

But by issuing a reservation-of-rights letter, the insurer may create a conflict of interest between the insurer and the insured, especially when the policy defenses are such that an insurer would be tempted to elicit facts that would support a finding of no coverage. For this reason, an insurer generally will be required to provide the insured with independent counsel whenever such a conflict arises.

 

In some instances where defense costs are incurred by the insured before an insurer formally tenders defense, the insured may not be able to recover defense costs. In the Crist case noted previously, the court held that pre-tender costs could not be recovered even if the insurer ultimately and wrongfully denied coverage. The court noted that it was the insured's duty to notify the insurer of the claim prior to tendering a defense. The reason for this is "the insurer's duty to defend corresponds to the insured's duty to relinquish control of the defense, and one cannot arise without the other." Further, "no breach of a duty to defend occurs until the insured tenders the defense the insurer in some way fails to accept that duty."

 

The insured argued that since the carrier wrongfully failed to defend in any case, it can't now complain that the tender was untimely. However, the court noted that the responsibility of promptly notifying the insurer and tendering to it the defense rested with the insureds, and any "windfall" would, on the contrary, result from requiring the defendants to bear the burden of the defense prior to their knowledge of the action.

 

There may be a very different result where a carrier is held to have unreasonably, as well as wrongfully, failed to defend. Further, in California there is a line of cases that hold that if the insured establishes some compelling reason for failure to tender earlier (for example, having to immediately respond to a third-party suit), this may excuse the general rule that pre-tender fees are "voluntary payments" and thus not covered under the policy.

 

While the duty to defend may be broad, it is not unlimited. Generally a duty to defend only exists with regard to claims within the nature and kind of risks covered by the policy. If the alleged claims cannot be brought within that scope, many courts have ruled that the insurer has no duty to defend. For example, in Insurance Company of the West v. Haralambos Beverage Co., 195 Cal. App.3d 1308 (1987), a California court held that there could be no duty to defend a breach of contract action involving a dispute over payment from the manufacture and sale of two trailers. Because the policy at issue covered only claims for bodily injury and property damage and because the complaint did not potentially seek to recover for such damages, the court reasoned that no potential for coverage could exist. Because of this, the insurer had no duty to defend a breach of contract claim.

 

Where the potential for coverage under a policy is "tenuous and far-fetched," there usually will be no duty on the part of the insurer to defend. An anti-trust action alleging only economic losses did not give rise to a duty to defend under a policy that provided coverage for property damage. Similarly, physical injuries and emotional stress arising out of non-covered investment losses could not trigger defense coverage under a comprehensive general liability policy.

 

When a policy contains a clear and unambiguous exclusion of coverage for the allegations contained in a third party's claim, the insurer usually has no obligation to defend the claim. In a 1985 New York case, the court held that an umbrella insurer had no duty to defend fraud claims under a policy that provided coverage for claims arising out of personal injury, property damage or advertising liability. In reaching its decision, the court relied on the fact that fraudulent conduct by the insured was within the scope of "losses intentionally caused by or at the direction of [the insured]" and was therefore excluded from coverage. Because the policy exclusion appeared clear, the court entered a summary judgment in the insurer's favor after similarly rejecting the insured's claims of waiver and estoppel.

 

Similarly, in Giddings v. Industrial Indemnity Company, 112 Cal. App.3d 213 (1980), the California Court of Appeals held that claims of fraud, securities law violations and other misconduct, all of which resulted in economic injury, did not trigger coverage under policies that limited coverage for loss to tangible property. Accordingly, neither the primary nor excess insurer had any duty to defend under their respective policies. Even though the duty to defend is broader than the duty to indemnify, the court noted in this case that any potential of a covered claim would have been "speculation or conjecture" so that no duty to defend could arise.

 

Another example where an excess insurer had no duty to defend because of exclusionary wording in a policy is a case where the policy excluded coverage for certain pollution claims. In applying Ohio law, a federal court held that both the pollution exclusion (including its "sudden and accidental" exception clause) and the "alienated premises" clause in the excess liability policy were clear and unambiguous, precluding coverage under the policy.

 

Excess insurers are not always obligated to provide a defense for the insured when an underlying insurer withdraws a defense. The courts have found that the mere fact that a primary insurer withdraws a defense is not sufficient to trigger the duty on the part of an excess insurer to defend unless there is a "contractual undertaking" on the part of the excess insurer to do so.

 

Sometimes a dispute arises over the obligation of the insured to reimburse an insurer for defense costs if it is ultimately determined that the insurer had no duty to defend. As determined in the case of Western Employers Ins. Co. v. Arciero & Sons, Inc., 146 Cal. App.3d 1027 (1983), if both parties (i.e., the insurer and the insured) agree to a reimbursement provision, the insurer's right of reimbursement exists.

 

In the absence of any agreement, however, the insurer's right to reimbursement may not exist. In St. Paul Mercury Insurance Company v. Ralee Engineering Company, 804 F.2d 520 (9th Cir. 1986), the court held an insurer liable for defense costs incurred prior to the date that it asserted non-coverage. In this case, however, the court based its decision primarily on a reservation-of-rights letter that informed the insured that a further defense might be withdrawn at any time.

 

Whenever a policy includes defense payments within the limit of liability, the insurer has no further obligation to defend once policy limits are exhausted. However, even when defense payments are paid in addition to policy limits, most umbrella forms state that the duty to defend ends when the policy limits have been exhausted. Whether or not an insurer's defense obligation continues after the policy limit of liability has been paid is sometimes disputed and becomes the subject of litigation. In reaching their decisions, the courts look carefully at the relevant policy language.

 

Some courts have determined that an insurer's defense obligation can continue even after the policy limit of liability has been exhausted. However, if an excess policy contains no provision for the payment of defense costs, the insurer cannot be charged with having to contribute to any pro-rata allocation of such costs.

 

An opposing viewpoint was expressed in the case of ACandS v. Aetna Casualty & Surety Co., 764 F.2d 968 (3d Cir. 1985), where the court held that it is unrealistic to require an insurer to provide defense indefinitely when the policy only promised a defense "with respect to such insurance as offered by" the policy. Under this reasoning, once policy limits are exhausted, all coverage under the policy, including defense obligations, ceases. A similar conclusion was reached in Commercial Union Insurance Company v. Pittsburgh Corning Corporation, 789 F.2d 214 (3d Cir. 1986), in which the court ruled that an insurer was not obligated to continue defense payments once it had satisfied its duty to indemnify (i.e., had paid policy limits) and had made an "orderly withdrawal" from the defense.

 

A few umbrella forms, however, state that the insurer's obligation to defend ends upon either payment or tender of policy limits. This raises an important issue. Can an insurer faced with a major loss that is certain to involve considerable defense expenses simply tender policy limits and walk away without paying defense costs? Under policy wording that states the defense obligation ends upon payment or tender of policy limits, this is a possibility. However, the manner in which the courts in any given state respond to such a tactic varies.

 

In California , the courts have generally taken the position that the insurer has a continuing duty to defend, even after policy limits have been tendered. In other states, however, there are two philosophies with regard to cases involving defense provided under older (pre-1966) ISO-CGL policy forms. The so-called "pro-insured" decisions hold that the wording of the defense provisions in the older CGL forms is ambiguous or that the defense and indemnity duties of the insurer are separate. These decisions conclude that the insurer's defense obligation continues even though policy limits are exhausted. The "anti-insured" decisions note that coverage is only provided as respects insurance afforded by the policy and state that this language applies to the insurer's defense duty as well as to its indemnity duty. These decisions suggest that the defense duty is terminated once the indemnity limits of the policy have been paid.

 

In Diamond Heights Homeowners Association v. National American Insurance Company, 227 Cal. App.3d 563 (1991), the Court held that tendering limits does not extinguish the defense obligation. Indeed, the court concluded that if an insured's potential liability exceeds primary limits and invades excess coverage, and the primary insurer is willing to pay the primary limits to the excess insurer, the primary insurer may not as a matter of right tender defense of the action to the excess insurer or otherwise relieve itself of a duty to defend. The primary insurer's duty to defend is not extinguished until settlement or payment of judgment. This was the case where a primary carrier attempted to extricate itself from the future expense of continuing to defend a case that would undoubtedly exceed its policy limits. The primary carrier also tried to set up the excess carrier by tendering limits in the hope that the excess carrier would then assume the defense obligation.

 

The reason why primary carriers cannot extricate themselves from their ongoing defense obligations under these circumstances is that the defense obligation is not defined by the policy limits. There are policies where defense costs do erode limits, and these policies would be interpreted very differently. However, the standard ISO-CGL policy forms provide a certain limit of liability for indemnity payments, but an unlimited amount of funds to defend covered claims. Since there is an obligation to defend, the obligation continues even where limits are tendered and the tendered funds do not settle the case. Thus, there is a continuing obligation to defend.

 

This is the case even when there is an umbrella insurer who might have a drop-down provision with some defense obligations contractually bargained for. This is because the umbrella insurer's defense obligations apply only when there is no defense provided by the primary insurer. When a general liability insurer has an unlimited duty to defend, the obligation to defend continues even where the primary insurer tenders its limits. The obligation to defend also continues when there is an umbrella insurer with drop-down provisions in its policy.

 

Whether or not an excess or umbrella insurer has an obligation to assume the defense once underlying coverage limits are paid or tendered, may depend upon the wording of the defense provisions contained in an excess or umbrella policy. For example, in Aetna Casualty & Surety v. Certain Underwriters at Lloyd's, 56 Cal. App.3d 791 (1976), the court concluded that the defense duty continues even after the limits of liability are exhausted. However, in this particular case, there was a first layer excess carrier which the court found also had a defense obligation. Since both the primary and excess carriers had an obligation to defend, the court ruled that the excess insurer was obligated to take over the defense once the limits of the underlying primary insurance had been paid.

 

The California courts reached a somewhat different conclusion in Signal Companies v. Harbor Insurance, 27 Cal.3d 359 (1980). In this case, the insured had a $25,000 primary policy and a $10 million first-layer excess policy. When the primary insurer settled a multi-party action for $35,000, the excess insurer paid the $10,000 amount that was in excess of the primary coverage limit, but refused to pay any portion of defense costs. Ultimately the court did not prorate the defense costs. Its decision was based on case law that supported the proposition that a primary insurer must continue to defend without contribution from excess insurers even if a successful settlement or defense relieves them from liability.

 

In California , the duty to defend is a separate obligation which most general liability policies state does not reduce the available policy limits. Thus, when defense expenditures do not reduce the available coverage limits, the mere tendering of those limits generally does not eliminate a primary insurer's obligation to defend. Notwithstanding a primary insurer's defense obligation and where there are excess carriers over the original primary carrier, unless the excess policies specifically preclude defense obligations, tendering excess policy limits will not eliminate an excess carrier's obligation to participate in the defense.

 

In Arkansas , however, the courts have determined that if a policy contains a specific provision that there is no further obligation to defend once coverage limits are paid, those limits can be successfully tendered and the insurer relieved of any further defense obligation. Other courts have either not allowed insurers to avoid a duty to defend simply by tendering limits, even where such language appears to be in the policy, or will permit them to do so only under certain circumstances. For example, in Aetna Casualty & Surety v. Sullivan, 597 N.E.2d 62 (Mass. App. Ct. 1992), a Massachusetts court found that an insurer may not discharge its duty to defend by tendering policy limits to the claimant unless a release of the insured's liability is secured. In this case, the insurer's policy stated, "Our duty to settle or defend ends when we have paid the maximum limits of coverage under this policy." The court held that the fair meaning of this language is that the insurer would be discharged from its duty to defend if it should make a payment equal to the maximum policy limits, either to settle the case against the insured or in total or partial satisfaction of judgment against the insured at the conclusion of the litigation. Unless litigation was terminated by a successful defense or settlement, the court reasoned, insurers would have an incentive to tender policy limits whenever they anticipated the costs of defense would exceed the amount of the insured's coverage. Thus, any duty to defend would be nullified.

 

An insurer may be precluded from contesting coverage if it fails to do so at the time it becomes aware of a coverage issue. An example is a California murder case in which the survivors of a murder victim filed an action against the killer's insurer. The state Supreme Court ruled that the insurer, which did not defend the claim, was bound by the damages asserted in the underlying wrongful death action. The court reasoned that the insurer had ample opportunity to contest the underlying judgment when it was entered and, thus, could not relitigate the issue of damages in a subsequent third-party claim.

 

In some states, the manner in which the insurer defends a claim where coverage is questionable is subject to statute. In Illinois , for example, if coverage is unclear, an insurer must either defend the suit under a "reservation of rights" or seek a judicial declaration of no coverage from the court. If an initial defense is withdrawn, a no-coverage declaration must be obtained. The insurer will be prevented from raising non-coverage as a defense later and may be required to defend or possibly to pay the claim.

 

Because an insurer's failure to defend a claim or suit on behalf of its insured can result in a bad-faith action filed by the insured, insurers usually act conservatively and undertake the defense of any claim that has the potential of being within the scope of policy coverage. However, there are many reasons why an insurer might not defend a claim. Clearly, an insurer would deny defense if it believed there was no coverage under the policy. Sometimes, however, an insurer fails to defend because of an error in interpreting coverage, poor claim handling, misinterpretation of the facts of the claim or internal disorganization (such as staff turnover or perhaps the claim file being misplaced by someone).

 

If the insured or the broker believes the insurer's defense is not being properly provided, the matter should be brought to the insurer's attention immediately and a decision regarding the insurer's position regarding defense obtained, preferably in writing.

 

Other Defense Considerations

 

An insurer's obligation to participate in the defense of a claim or suit when more than one insurer is involved often depends on the wording of the Other Insurance clauses of each policy and the specific facts of the case. However, if one policy is clearly an excess policy, the Seventh Circuit Court of Appeals has held there is no duty on the part of the excess carrier to defend claims that are within the limits of the underlying primary policy. In Western Casualty & Surety Co. v. Western World Insurance Co., Inc., 769 F.2d 383 (7th Cir. 1985), the court held that the insurer which had issued coverage to a city for claims arising out of discrimination was required to defend a claim arising out of the city's failure to permit construction of low-income housing. In contrast, a second insurer which issued the city a policy that covered "wrongful acts" was deemed to be an excess carrier pursuant to its "Other Insurance" clause. In other words, the second insurer's "Other Insurance" clause made its policy excess whenever the loss is covered by another carrier and held that since the respective policies designated one carrier as primary, the excess carrier was not required to provide a defense for a discrimination claim against the insured.

 

Most umbrella policies do not specify how costs are to be shared among insurers that jointly defend a suit. But some policies do state that the insurer will pay its "share" of defense costs or will pay its defense obligation "as agreed in writing." In a case where there were multiple insurers responsible for defending an insured, the California Court of Appeals held that the cost of defense was properly apportioned among them based on their relative limits of liability. While the court noted that in this case the policies did not contain any provision for such apportionment, it recognized that similar decisions would have to be made on a case-by-case basis.

 

Defense fees and costs may be allocated between insurers on a pro-rata basis as a result of the language of the defense provisions in the various policies. In American Excess Ins. v. MGM Grand Hotel, 729 P.2d 1352 (Nev. 1986), an excess policy provided a second layer of umbrella coverage as part of ultimate net loss. Additionally, the policy provided for a pro-rata contribution to all costs incurred by its insured.

 

In other cases where two insurers have both been found to be liable on a risk, their defense obligations may have to be shared equally, rather than on a pro-rata basis. In Emons Industries, Inc. v. Liberty Mutual Ins. Co., 481 F. Supp. 1022 (S.D.N.Y. 1979), for example, a New York court ruled that although an insurer had provided coverage for only one year out of a total of the 19 years during which a plaintiff was exposed to a hazardous chemical, its defense obligations co-existed with the obligations of another insurer on the risk. The court rejected the first insurer's argument that it should only be liable for one-nineteenth of the defense costs because of the proportional amount of time it was on the risk. Other courts, however, may reach a different conclusion in similar situations.

 

An apportionment of defense costs between the insured and insurer(s) may occur in some circumstances, such as when an insured is required to bear a portion of defense costs that relate to an uninsured period of time. In Porter v. American Optical Corp., 641 F.2d 1128 (5th Cir. 1981), an insured claimed asbestos injury that occurred over a period of several years. In rejecting the "manifestation theory" of injury, the 5th Circuit Court apportioned the defense costs among all involved insurers during the time the "injurious exposure" occurred.

 

A few umbrella policies specifically provide for the payment of defense costs to be apportioned in the same ratio that the policy's proportion of the ultimate loss "as finally adjusted," bears to the total amount of ultimate net loss. Such a provision can be particularly troublesome for insureds when claims are litigated extensively and the total amount of the loss is not determined for several years. The insurer might refuse to pay defense costs until its proportionate share has finally been established. This may require the insured to pay defense costs up front and to seek reimbursement from the insurer at a later date. Having to fund defense costs prior to reimbursement could pose a considerable burden, particularly if the financial resources of the insured are limited. As a practical matter, however, most insurers do pay defense costs as those costs are incurred, even when liability may not be fully established.

 

As a general rule, if any allegation triggers an insurer's duty to defend, the insurer must offer a defense to the entire action. If, however, the cost of defense can be apportioned among various insurers or other parties involved in defending an action, the courts may feel it appropriate to do so. When apportionment of defense costs is sought by the insurers, the insurers usually have the burden of proof on the issue.

 

The presence of a contractual or other agreement between parties may be required to obtain reimbursement for attorney fees in situations involving more than one insurer. For example, in reasoning that the duty to defend was a personal matter between insurer and insured and because there was no agreement between insurers, a Florida court refused to allow the insurers to subrogate against each other in an attempt to recover attorney fees paid in defending a mutual insured.

 

The incidence of insurer insolvency reached a high point during the 1980s. In addition to the obvious problems associated with a primary insurer going broke, there was the question of how umbrella policies would respond when faced with claims and requests to provide defense. Some umbrella policies at the time contained specific drop-down provisions and paid first-dollar defense costs where the insurer was insolvent. Other policies were ambiguous or made no reference to underlying insolvency. Many insureds brought actions against their umbrella and excess insurers seeking defense and indemnity. Due to the ambiguity of some of the policies or the specific facts of the numerous cases being litigated, many umbrella insurers were forced to drop down and fill the gap created by the insolvent underlying insurer.

 

In recent years, insurers have attempted to avoid disputes over underlying insurer insolvency by building provisions into the policy that clearly state the insurer has no obligation to drop down due to insolvency or bankruptcy of an underlying insurer. Most umbrella policies will pay on the basis that the underlying coverage is valid and collectible even though the insurer may be financially incapable or prevented from paying loss or providing a defense. The courts have supported the position of insurers who do not drop down to assume the obligations of an insolvent underlying insurer. In U.S. Fire Ins. v. Capitol Ford Sales, 355 S.E.2d 428 (Ga. 1987), a Georgia court ruled that an excess insurer whose policy distinguished between underlying (primary) coverage and other insurance had no duty to drop down and assume the defense obligation of the insolvent primary insurer.

 

Based on reasoning that the insurer's duty to defend is a creation of contract, many courts have ruled that an excess insurer may be obligated to defend an action from the outset, even when the policy provides coverage over an insured's self-insured retention (SIR). However, this reasoning may be affected by a number of decisions that hold that a self-insured retention is not "other insurance" as the term is defined in the typical excess coverage provisions.

 

For example, in a 1988 Ohio case, the court applied the traditional view that insurance was an assumption of the risk of losses from the public at large, while self-insurance constituted a retention of risk by the one to whom it would normally fall as a matter of law or contract (i.e., the insured).

 

Similarly, in the 1992 case of Wake County Hospital System v. National Casualty Co., 804 F. Supp. 768 (E.D.N.D. 1992), a North Dakota court relied on the traditional distinctions between insurance and self- insured retention and also looked to rulings from ten other states in holding that a hospital's self-insured retention did not constitute "other valid or collectible insurance" as defined in a professional liability policy covering one of the hospital's nurses. This decision was affirmed by the 4th Circuit Court in 1993.

 

This same reasoning was applied by the Eighth Circuit court to a case involving pooled liability funds in St. John's Regional Medical Health Center v. American Casualty Co., 980 F.2d 1222 (8th Cir. 1992). Although the hospital participated in a "multi-state network of non-profit hospitals" rather than maintaining its own individual self-insured program, the court nevertheless held that the hospitals as a whole were self-insured through the program.

 

Some umbrella policies state the insurer will pay defense expenses related to claims that are subject to the insured's self-insured retention (SIR), providing the insurer feels the claim has the potential of triggering the umbrella's coverage. When the umbrella policy pays defense expenses for claims within the insured's SIR, the insured usually is not required to reimburse the insurer for the defense costs. A few policy forms, however, do require the insured to reimburse the insurer for defense costs related to claims within the SIR, and still other policies are silent regarding payment of these costs.

 

It is important for the insured to know whether only loss payments are subject to a self- insured retention or whether both loss payments and defense costs are subject to the SIR. Defense costs can be substantial, and when added to a large SIR, the total expense could become a severe financial burden.

 

When it is unclear whether an umbrella policy provides coverage for a particular claim or suit, the insurer will often issue a "reservation-of-rights" letter. Such letters often state that the insurer will provide an initial defense of the claim or suit but reserves the right to withdraw defense in the future. Sometimes reservation letters state that the insurer is suspending a decision regarding defense until it determines whether a defense obligation exists. While there is much variation in the way reservation-of-rights letters are drafted, they specify the insurer's reasons for (1) providing initial defense subject to withdrawal of the defense later or (2) delaying a decision regarding defense until further facts are developed.

 

By issuing a reservation-of-rights letter, the insurer accomplishes two objectives. Because some courts have held that the act of initially providing a defense prevents an insurer from denying coverage at a later date, such letters give the insurer time to investigate the allegations contained in the claim or suit, evaluate the coverage provided by the policy and then to decide if a defense obligation exists. Second, by formally reserving the right to make a defense decision at a later date rather than to simply deny coverage for a claim outright, the insurer may reduce the likelihood of a bad-faith lawsuit being brought by the insured for failing to defend.

 

Although some courts have taken the position that a reservation of rights is only effective with the insured's consent, most courts have considered a "unilateral" reservation to be valid even if the insured does not agree to it. Under this reasoning, a California court ruled that an insurer had not waived its right to dispute coverage by unilaterally reserving the right to do so at a later date. However, in this case, the court also held that the reservation-of-rights letter did not enable the insurer to obtain reimbursement of settlement costs paid on the insured's behalf. Under some circumstances, the insurer may be entitled to reimbursement of defense expenses incurred during the time defense was provided under a reservation of rights.

 

If an insurer properly reserves the right to deny coverage for a portion of a claim or suit based on several coverage defenses, the California courts have enforced the reservation even when the insurer stated in its reservation letter that it was assuming defense for the entire action. Thus, if it is later determined that coverage defenses are valid, the insurer is entitled to withdraw its defense.

 

Reservation-of-rights letters may contain specific reasons for the reservation being given (this can include citing a policy provision excluding coverage for the damages claimed), or the letter may be more general and reserve "all rights" the insurer may have under the policy. The insurer's right to issue a general reservation of rights was supported by the courts in the Haralambos case, mentioned previously. In this case, however, the court held that even if the insurer's reservation had been determined to be inadequate, the reservation was recognized because the insured had failed to plead, waiver or estoppel as affirmative defenses in answer to the insurer's declaratory relief action that sought a judgment of non-coverage.

 

The courts have expressed opposing opinions regarding an insurer's right to reimbursement for costs incurred in defending a claim or suit under a reservation of rights, particularly when coverage under the policy is at issue. Some courts have taken the position that the insurer may unilaterally provide for reimbursement in the reservation-of-rights letter, while others have held that for a reimbursement provision to be valid, both the insurer and the insured must agree to the provision.

 

There is some case law to support an insurer's reservation of rights to deny its duty to defend and to later recover attorneys fees incurred during the initial provision of defense. However, under the theory of equitable restitution, an insurer who is uncertain whether coverage is provided under a policy and undertakes the defense under a reservation of rights is doing so in part to protect itself from a subsequent bad-faith claim from the insured. The initial assumption of the defense by the insurer under a reservation of rights may benefit the insured, but it is not primarily undertaken for the insured's benefit. Because of this, some courts have ruled that the insurer is not entitled to a right of reimbursement under equitable restitution. Using the same reasoning, the California courts have gone so far as to rule that an insurer providing defense under reservation of rights for a claim involving questionable coverage is not entitled to reimbursement of attorneys fees even if it is ultimately determined that there is no coverage for the claim.

 

There also are differing opinions regarding the insurer's right to reimbursement when such right is specifically stated in a reservation-of-rights letter. In some states the courts have ruled that an insurer is entitled to reimbursement for attorney fees incurred under a reservation of rights as long as the reservation letter contains a reimbursement provision. Also, if an insured accepts a defense based upon a reservation-of-rights letter that states the insurer's right to reimbursement, some courts have held that the insured's acceptance of the defense constitutes an acceptance of the reimbursement provision.

 

In California , however, the courts have ruled that a unilateral reimbursement provision in a reservation-of-rights letter will preclude the insurer's right to reimbursement. These courts have taken the position that even if it is determined that no coverage exists under the policy, any provision for reimbursement by the insured of the insurer's defense costs must be jointly agreed upon by both parties. If such an agreement is reached, the insurer is then free to seek reimbursement.

 

As expressed by the court in the case of Travelers Insurance Company v. Lesher, 187 Cal. App.3d 169 (1986), a reservation-of-rights letter that did not include a statement regarding the insurer's intent to seek reimbursement of defense fees did not entitle the insurer to such a recovery even after it was ultimately determined that no coverage existed. The court also rejected reimbursement based on quasi-contractual or restitutionary grounds because the defense under the reservation of rights was primarily intended to benefit the insurer by shielding it from a potential bad-faith action by the insured.

 

Sometimes the insured only may be required to reimburse an insurer for a portion of defense costs incurred under a reservation of rights. In a 1986 case, the 9th circuit court held that the insured did not have to reimburse the insurer for defense expenses incurred under a reservation-of-rights letter because the letter stated that further defense may be withdrawn at a later date.

 

Coverage disputes often result in a conflict of interest between the insurer and the insured. For this reason, the courts generally require the insurer to furnish the insured with independent counsel in coverage dispute situations. Such a conflict is not created, however, if an insurer merely denies coverage for punitive damages. In the case of Pennbank v. St. Paul Fire & Marine Insurance Company, 669 F. Supp. 122 (W.D. Pa. 1987), a federal court in Pennsylvania reasoned that if coverage for punitive damages was found, the interests of the insured and insurer would not be in conflict since both the insurer and the insured would be subject to a loss under the policy. Additionally, the courts have held that an insurer may not subsequently limit the scope of a reservation of rights in order to negate a duty to provide independent counsel to some insureds.

 

An insured is not entitled to independent counsel simply because an insurer is defending a claim or suit under a reservation of rights. The right to independent counsel at the insurer's expense only applies when a potential conflict of interest between the insured and insurer is created. The courts have reasoned that insurers defending claims under a reservation of rights may be tempted to develop facts that would support a finding of no coverage for the claim, thereby harming the interests of the insured.

 

Whenever an insurer issues a reservation-of-rights letter, it provides a signal to the insured that the policy may contain a "gap" in coverage. Upon receipt of such letters, the insured and broker should carefully review the policy to determine if the insurer has taken a reasonable position and that the desired coverage is provided by the policy. Any potential coverage deficiencies should be questioned and the policy corrected by endorsement, if needed. In addition, whenever defense provisions in insurance policies are unclear as to the rights and duties of the insurer and the insured, clarification should be obtained from the insurer, preferably in writing.

 

Definitions

 

Completed Operations

 

Nearly all umbrella policies include a definition of "completed operations" or "completed operations hazard." In many forms, the definition is discussed within the definition of "products liability" or "products hazard." The definition is intended to clarify that coverage applies to bodily injury and property damage resulting from the insured's products and/or work, but not damage to the insured's products or work. Coverage for damage to the insured's products or work is usually excluded in general liability and umbrella policies, although coverage is often extended to work performed on the insured's behalf by others. (See also discussion of "Owned Property, Products and Completed Operations" exclusion.)

 

Most umbrellas contain definition wording similar to the wording of the "completed operations" portion of the "products-completed operations hazard" in the 1986 and subsequent versions of the ISO-CGL policy form. The following wording, taken from a Fireman's Fund umbrella form, is an example:

 

     PRODUCTS-COMPLETED OPERATIONS HAZARD…includes all Bodily Injury and Property Damage occurring away from premises you own or rent and arising out of Your Product or Your Work except:

 

10. Products that are still in your physical possession; or

 

11. Work that has not yet been completed or abandoned.

 

     Your Work will be deemed completed at the earliest of the following times:

 

12. When all of the work called for in your contract has been completed;

 

13. When all of the work to be done at the site has been completed if your contract calls for work at more than one site; or

 

14. When that part of the work done at a job site has been put to its intended use by any person or organization other than another contractor or subcontractor working on the same project.

 

     Work that may need service, maintenance, correction, repair or replacement, but which is otherwise complete, will be treated as completed.

 

Under the above definition, coverage applies to the insured's liability for bodily injury and property damage arising from its completed work that occurs away from premises owned or rented by the insured. Coverage extends to work that may need service, maintenance, correction, repair or replacement, but which is otherwise complete. The insured's work is deemed to be completed when all work called for in the contract has been completed or the work at a site has been completed if the contract calls for work at more than one site.

 

Any part of the insured's work will be considered completed once it has been put to its intended use by any person or organization other than another contractor or subcontractor working on the same project.

 

The term completed operations also is defined because losses arising from this hazard often are subject to aggregate limits that apply to products and completed operations coverage. Most umbrella forms apply such an aggregate limit if underlying coverage is also subject to an aggregate limit.

 

A few older umbrella policies also include wording within the definition that refers to …operations for which the classification stated in the policy or in the company's manual specifies "including completed operations." Such wording is onerous and should be removed for two reasons. First, umbrella policies do not contain a schedule of classifications or exposures. Second, policy coverage should not be subject to an unknown, such as what the company's manual specifies. An umbrella policy should be complete and self-contained, except where it follows the wording of underlying insurance. Most umbrella forms in use today, however, omit the reference to the "company's manual."

 

Property Damage

 

All umbrella policies contain a definition of the term property damage. In many older policies, and some newer forms, the definition is similar to the following:

 

12. Property damage means:

 

a.  Physical injury to tangible property, including all resulting loss of use of that property. All such loss of use shall be deemed to occur at the time of the physical injury that caused it; or

 

b.  Loss of use of tangible property that is not physically injured. All such loss shall be deemed to occur at the time of the occurrence that caused it.

 

With the 2001 ISO CGL revision, wording was added to the property damage definition to clarify that electronic data is not tangible property, regardless of the content of the data or the nature of the computer hardware or software in which the data is contained. Many umbrella insurers also modified their policy forms to conform to the revised ISO CGL definition. An example of this revised definition from an umbrella policy is shown below:

 

20. "Property damage" means:

 

a.  Physical injury to or destruction of tangible property including all resulting loss of use. All such loss of use shall be deemed to occur at the time of the physical injury or destruction that caused it; or

 

b.  Loss of use of tangible property that is not physically injured. All such loss of use shall be deemed to occur at the time of the "occurrence" that caused it.

 

For the purposes of this insurance, "electronic data" is not tangible property.

 

The 2007 version of the ISO Commercial Umbrella form and some newer umbrella policies further expand the property damage definition to not only clarify what is considered to be "electronic data," but also how coverage applies with respect to pollution incidents related to autos covered by the policy. An example of this expanded definition is shown below:

 

12. Property damage means:

 

a.  Physical injury to tangible property, including all resulting loss of use of that property. All such use shall be deemed to occur at the time of the physical injury that caused it; or

 

b.  Loss of use of tangible property that is not physically injured. All such loss shall be deemed to occur at the time of the occurrence that caused it.

 

     With respect to "covered autos", property damage also includes "pollution cost or expense", but only to the extent that coverage exists under the "underlying insurance" or would have existed but for the exhaustion of the underlying limits.

 

     For the purposes of this insurance, electronic data is not tangible property.

 

     As used in this definition, electronic data means information, facts or programs stored as or on, created or used on, or transmitted to or from computer software (including systems and applications software), hard or floppy disks, CD-ROMS, tapes, drives, cells, data processing devices or any other media which are used with electronically controlled equipment.

 

Under the above wording, the policy will pay for expense resulting from an auto-related pollution incident, but only if the underlying policy also provides coverage for the incident.

As is the case with many policy definitions, the more specific the definition, the more restricted is the coverage. The property damage definition should be carefully reviewed to make sure coverage is not overly restrictive.

 

Insured Contract

 

Umbrella policies typically provide coverage for liability the insured assumes and contracts or agreements entered into as part of its business (i.e., "insured contracts"). Coverage is usually restricted to the insured's tort liability for occurrences or offenses that take place after execution of the contract or agreement. While coverage for contractual liability usually parallels that provided under standard commercial general liability policies, few umbrella policies define the term "insured contract." A definition of contract or insured contract in an umbrella policy is restrictive because it usually limits coverage to only the types of contracts specified in the definition.

 

The definition of insured contract in general liability policies typically encompasses a wide range of business contracts, including indemnity agreements entered into by the insured in connection with its business activities. Unless otherwise specified, written, oral and implied contracts are all encompassed by the definition of insured contract.

 

When an umbrella policy contains a definition of insured contract, the wording may be similar to that shown below from a Fireman's Fund policy.

 

     INSURED CONTRACT under Coverage B, means that part of any contract or agreement pertaining to your business under which any Insured assumes the tort liability of another pay for Bodily Injury, Personal Injury, Advertising Injury or Property Damage to a third person or organization. "Tort liability" means a liability that would be imposed by law in the absence of any contract or agreement.

 

Coverage for contractual liability may be found in the umbrella policy insuring agreements or as an exception to a contractual liability exclusion. An example of an umbrella insuring agreement from a Crum & Forster Insurance Company policy that incorporates contractual liability coverage is shown below:

 

     We will pay on behalf of the "Insured" those sums in the excess of the "Retained Limit" which the "Insured" by reason of liability imposed by law, or tort liability assumed by the "Insured" under contract prior to the "Occurrence", shall become legally obligated to pay as damages for…

 

Umbrella coverage also may be provided by way of exception to a contractual liability exclusion, as in the following example from Bituminous Casualty:

 

     This insurance does not apply to:

 

a.  "Bodily Injury" or "property damage" for which the insured is obligated ot pay damages by reason of the assumption of liability in a contract or agreement. This exclusion does not apply to liability for damages:

 

(1) That the insured would have in the absence of the contract or agreement; or

 

(2) Assumed in a contract or agreement that is an "insured contract," provided the "bodily injury" or "property damage" occurs subsequent to the execution of the contract or agreement…

 

A few umbrella forms exclude coverage for contractually-assumed liability, but give back the coverage where provided by underlying insurance, as in the following example from St. Paul Fire and Marine:

 

     Contract Liability. We won't cover injury or damage for which the protected person has assumed liability under any contract or agreement.

 

     But we won't apply this exclusion to the protected person's liability for damages:

 

•    assumed under contract; and

 

•    covered by your Basic Insurance.

 

When present in an umbrella policy, the definition of insured contract may vary in the following ways:

 

1.  Some older umbrella forms provide contractual liability coverage for any contract or agreement, but limit coverage by specifically listing the persons who may create an insured contract. These persons may include the named insured and its officers, directors, stockholders or partners acting in their capacity as such. Use of this wording effectively excludes coverage for liability that is contractually assumed by employees or others who are not listed in the definition. Such wording should be avoided unless the definition of insured or named insured is broad enough to encompass employees and others who may have responsibility for executing contracts.

 

2.  A few older umbrella forms extend coverage to "any written or oral contract or agreement entered into by the insured in the usual course of the insured's business operation, except a labor union contract or agreement." One reason an insurer might exclude labor union contracts would be to prevent the umbrella from becoming an excess group medical policy under the provisions of certain labor agreements. Also, by limiting coverage to written or oral contracts, the umbrella insurer provides no coverage for implied agreements.

 

3.  Some policies initially exclude "liability assumed under any agreement," then give back coverage for written contracts which may be defined in the policy to include: (a) indemnification of employees for "fellow employee" injuries, (b) authorized use of owned or hired autos, and (c) agreements to indemnify any non-employee or organization for bodily injury or property damage. Agreements under both (a) and (b) may be entered into before or after a loss while agreements under (c) must be made before a loss occurs. This language is also undesirable because it means that coverage appears to be precluded for personal injuries, medical payments and/or advertising injuries, as well as for oral or implied contracts.

 

4.  A few umbrella policies use wording similar to that found in the ISO-CGL definition of insured contract, but specifically exclude coverage for oral and implied contracts. Such limitation is undesirable.

 

5.  A few umbrella policies, use insured contract definition wording similar to that found in the ISO-CGL forms, but exclude contractual liability related to injury to employees, benefits payable in excess of any workers' compensation, disability benefits law or similar laws, or damages excluded by virtue of the wording of the "Who is an Insured" section of the policy. This wording is basically an incorporation of the work-related injury exclusions found in the ISO-CGL policy forms and does not appear to restrict umbrella coverage.

 

Contractual liability coverage provided by an umbrella policy should be at least as broad as the contractual liability coverage provided by underlying general liability policies. It is important that the umbrella policy provide coverage for:

 

1.  liability assumed by the insured under a contract or agreement and for which the insured would be liable in the absence of any contract or agreement (this provision is usually found in the policy insuring agreement); and

 

2.  written, oral and implied contracts. When an umbrella policy provides excess and umbrella coverage, it is important to review both the contractual liability coverage provided by the underlying general liability policy (as respects the excess coverage) and the umbrella policy's contractual liability exclusion or definition. Because the wording of the insured contract definition in underlying general liability policies may vary, this review must be made in light of the insured's operations and contractual liability coverage needs. Whenever the coverage provided by the umbrella is more restrictive than coverage provided by underlying insurance, the wording of the umbrella policy should be broadened by endorsement.

 

Occurrence

 

There is no standard definition of occurrence in umbrella policies. However, the definition of occurrence is important in determining the scope of coverage provided by the policy.

 

Some umbrella forms use occurrence definition wording similar or identical to that appearing in the 1986 and later ISO-CGL policy forms. Under the ISO-CGL definition, occurrence means an accident, and includes a continuous or repeated exposure to harmful conditions.

 

For coverage to apply, the bodily injury and/or property damage must be caused by an occurrence that takes place during the policy period and within the policy territory. In some umbrella policies, personal and advertising injury coverage is also triggered by an occurrence; the trigger is the event that actuates policy coverage.

 

Under the ISO-CGL policy forms, however, personal injury and advertising injury coverage is triggered by an "offense" rather than by an "occurrence." This is because personal and advertising injuries (libel, slander, misappropriation of advertising ideas, etc.) are not caused by "accidents." While the term "offense" is not defined in the ISO-CGL or umbrella policy forms, the acts to which the term applies are usually enumerated within the exclusions and definitions applicable to personal injury and advertising injury. Covered offenses may also be listed in the umbrella's personal injury and advertising injury insuring agreements.

 

Some umbrellas substitute the word event for accident in the definition of occurrence. Use of the word "event" may appear to broaden coverage because the accident (unintentional) restriction is eliminated. However, since most of these umbrellas word the definition of event the same as the definition of occurrence in other policies, and because most umbrellas also contain an intentional acts exclusion, there is little, if any, difference in the ability to trigger coverage.

 

Several current umbrella forms follow the ISO-CGL concept of using both the terms occurrence and offense. In these forms, an occurrence is the trigger for bodily injury and property damage coverage, while an offense is the trigger for personal injury and advertising injury coverage. An example from Fireman's Fund is shown below:

 

8.  Under Coverage A, means the same meaning as has the term "occurrence" contained in Primary Policies. But with respect to personal injury or advertising injury as defined in Primary Policies, the term means a personal injury or advertising injury offense.

 

9.  Under Coverage B, means an accident, including continuous or repeated exposure to substantially the same general harmful conditions. With respect to Personal Injury or Advertising Injury, the term means an offense which causes such injury.

 

Whenever bodily injury is included within the definition of personal injury, the requirement that personal injury be triggered by an "accident" should be removed. Such removal will help avoid any potential coverage disputes over whether or not a personal injury claim was caused by an "accident." Even if bodily injury and personal injury are defined separately in the policy, the personal injury insuring agreement should be reviewed to make sure coverage is triggered by an "offense."

 

Use of "accident" wording in the definition of occurrence may also prevent the triggering of employer's liability coverage under the umbrella policy. If the definition of occurrence is limited to "accidents," a dispute may arise, for example, over coverage for a claim arising from a work-related illness.

 

Personal and Advertising Injury

 

The offenses that trigger personal and advertising injury coverage are listed in most umbrella policies. Prior to the late 1990s, umbrella policies typically contained separate Personal Injury and Advertising Injury definitions similar to those in the ISO CGL policy forms. An example of each definition, taken from an older umbrella policy, is shown below:

 

A. "Advertising injury" means injury arising out of one or more of the following offenses committed in the course of advertising your goods, products or services:

 

1.  Oral or written publication of material that slanders or libels a person or organization or disparages a person's or organization's goods, products or services;

 

2.  Oral or written publication of material that violates a person's right of privacy;

 

3.  Misappropriation of advertising ideas or style of doing business; or

 

4.  Infringement of copyright, title or slogan.

 

K.  "Personal injury" means injury other than "bodily injury" arising out of one or more of the following offenses:

 

1.  False arrest, detention or imprisonment;

 

2.  Malicious prosecution;

 

3.  The wrongful eviction from, wrongful entry into, or invasion of the right of private occupancy of a room, dwelling or premises that a person occupies by or on behalf of its owner, landlord or lessor;

 

4.  Oral or written publication of material that slanders or libels a person or organization or disparages a person's or organization's goods, products or services; or

 

5.  Oral or written publication of material that violates a person's right of privacy.

 

Following the example set by the ISO with its 1998 CGL form revision, many umbrella insurers combined the two separate definitions into a single Personal and Advertising Injury definition. The following is an example of this revised definition, which is typical of that found in most current umbrella forms:

 

14. "Personal and advertising injury" means injury, including consequential "bodily injury", arising out of one or more of the following offenses:

 

a.  False arrest, detention or imprisonment;

 

b.  Malicious prosecution;

 

c.   The wrongful eviction from, wrongful entry into, or invasion of the right of private occupancy of a room, dwelling or premises that a person occupies, committed by or on behalf of its owner, landlord or lessor;

 

d.  Oral or written publication of material, in any manner, that slanders or libels a person or organization or disparages a person's or organization's goods, products or services;

 

e.   Oral or written publication, in any manner, of material that violates a person's right of privacy;

 

f.   The use of another's advertising idea in your "advertisement"; or

 

g.   Infringing upon another's copyright, trade dress or slogan in your "advertisement".

 

In addition to the revised format, reference to the insured's "advertisement" was added to the definition to further clarify how the policy's personal and advertising injury coverage applies. The term advertisement is then also typically defined in the policy as a notice broadcast or published to the general public or specific market segments about the insured's goods, products or services for the purpose of attracting customers or supporters. Such notices include material placed on the Internet or other electronic means of communication, as well as parts of a website that refer to the insured's goods, products or services, that are designed to attract customers or supporters.

 

Products Hazard

 

Umbrella policies usually include a definition of products hazard. In most umbrellas, the definition of products hazard is made part of and contained within the definition of completed operations. The products hazard definition is intended to clarify that coverage applies to bodily injury and property damage resulting from, rather than to the insured's products. Coverage for damage to the insured's products is usually excluded in general liability and umbrella policies, although coverage is often extended to work performed on the insured's behalf by others.

 

As is the case under the above definition, coverage applies to the insured's liability for bodily injury and property damage arising from its products after the products have left the insured's physical possession.

 

Another reason for the products-completed operations hazard or products hazard definition is to clarify the annual aggregate amount the insurer will pay for products and completed operations losses. Most umbrella forms apply such an aggregate limit if underlying coverage is also subject to an aggregate limit.

 

If insurers would simply make the umbrella aggregate follow any limit in underlying insurance, the definitions of products hazard, completed operations hazard, or named insured's products could be eliminated from umbrella forms. Some umbrella insurers have already taken this step and are thus providing a simpler policy form.

 

Exclusions

 

Advertising Injury

 

The advertising injury exclusion in most umbrella policy forms developed after 1986 is similar to the advertising injury exclusion in the 1986 and later versions of the ISO CGL policy forms. Such exclusions typically preclude coverage for advertising injury arising out of the following offenses:

 

1.  Breach of contract, although an exception usually applies with respect to the misappropriation of advertising ideas under an implied contract;

 

2.  The insured's goods, products or services failing to meet advertised quality or performance;

 

3.  Errors in describing the insured's goods, products or services, including the price thereof; or

 

4.  Offenses committed by an insured in the business of advertising, broadcasting, publishing, etc.

 

The exception to the "breach of contract" portion of the exclusion (item 1 above) allows coverage in situations where contractual obligations and advertising injury exposures potentially overlap. For example, there could be a dispute over a contractual right to use an advertising concept, or where the insured presumed such right existed by way of an implied contract. When a claim is made in such circumstances, this particular exclusion won't impair coverage.

 

Some umbrella policies contain additional exclusions that apply to both personal and advertising injury. When this is the case, the umbrella wording is similar to that found in the ISO-CGL forms. These additional exclusions preclude coverage for personal injury or advertising injury arising out of:

 

1.  Libel or slander, if done by or at the direction of the insured without knowledge of its falsity;

 

2.  Libel or slander that takes place before the beginning of the policy period;

 

3.  Intentional violations of the law committed by the insured or with the insured's consent.

 

A few umbrella forms contain an advertising exclusion that results in coverage being either broader or more restrictive than coverage under the ISO-CGL forms. For example, some umbrellas omit the portion of the ISO-CGL exclusion that applies to insureds in the business of advertising, broadcasting, etc.

 

Elimination of the wording makes the umbrella coverage broader than that under the ISO-CGL for these insureds. A few umbrellas eliminate the exception for misappropriation of advertising ideas under an implied contract. This later omission results in narrower coverage under the umbrella than under the ISO-CGL policy.

 

A fifth advertising injury offense was added to the ISO-CGL form with the 1996 revision. This additional offense excludes coverage for advertising injury arising out of the actual or alleged release of pollutants. The wording was added in conjunction with a new pollution exclusion to Coverage B (Personal and Advertising Injury Liability). Some umbrella forms developed after 1996 may also contain this particular additional pollution exclusion wording.

 

The personal injury and advertising injury exclusions were combined to make a single set of exclusions with the 1998 ISO-CGl revision. The wording of the exclusions pertaining to advertising injury was also modified to clarify their application. The effect of the new wording was to broaden coverage. Under the new wording, the exclusions apply only to offenses committed in the insured's actual advertisement. Previously, insurers sometimes argued that the exclusions also applied to offenses committed during the process of developing the advertisement for broadcast or publication. Similar modifications may be made to umbrella policies developed in response to the 1998 ISO-CGL revision.

 

Because of variations in the wording of umbrella advertising injury exclusions, it is important to compare the wording of both the advertising injury insuring agreement and any advertising injury exclusions with the wording of the underlying general liability policy. Where the wording of the umbrella is more restrictive than underlying coverage, an attempt should be made to broaden umbrella coverage by endorsement.

 

Aircraft and Watercraft

 

Most general liability policies (other than specific aviation or marine policies) exclude coverage for liability arising out of the use and maintenance of aircraft and watercraft. Although aircraft and watercraft losses are rare, many underwriters are reluctant to insure this potentially catastrophic exposure.

 

Except for a few grammatical changes, the ISO-CGL's "aircraft, auto and watercraft" exclusion has remained unchanged since 1986. Coverage is excluded for bodily injury or property damage arising out of the ownership, maintenance, use or entrustment to others of aircraft or watercraft owned, operated by, rented or loaned to any insured. The term use includes operation and loading or unloading.

 

An exception to the ISO-CGL exclusion applies with respect to watercraft while ashore on premises owned or rented by the insured. The exclusion also does not apply to any nonowned watercraft that is less than 26 feet long, provided it is not used to carry persons or property for a charge. Liability assumed under any insured contract for the ownership, maintenance or use of aircraft or watercraft is also excepted from the exclusion.

 

Most umbrella policies contain a similar aircraft and watercraft exclusion, although in some forms the aircraft and watercraft exclusions are stated separately. The exclusion distinguishes between owned and nonowned aircraft and watercraft. A few umbrella forms contain only an aircraft exclusion. In these forms, a watercraft exclusion is sometimes added by endorsement.

 

Some older umbrella forms, particularly forms issued by the London market, excluded coverage for any aircraft or watercraft. Absolute aircraft and watercraft exclusions in umbrella policies are rare today. Modern umbrella liability policies provide at least some coverage for nonowned watercraft (and, in some cases, owned watercraft) as well as for nonowned aircraft chartered with a crew.

 

While most businesses regularly use automobiles in their operations, few by comparison use aircraft or watercraft frequently. An insured's exposure to aircraft or watercraft liability is usually either contractually-assumed or incidental. When the insured assumes liability for the operation of aircraft or watercraft in an "insured contract," the ISO-CGL's exclusion does not apply. Many umbrella forms contain a similar exception.

 

Depending on their operations, some insureds may be subject to liability arising out of an independent contractor's use of aircraft or watercraft while the contractor is performing work on behalf of the insured. Coverage for this exposure is provided by the ISO-CGL, which limits the scope of the exclusion to aircraft or watercraft owned, rented to, operated by or loaned to any insured. The use of an independent contractor's own aircraft or watercraft does not fall within the specified ownership/use requirement. As long as the independent contractor is not an insured under the policy, the insured's contingent liability will not be subject to the exclusion. However, liability arising from use of aircraft or watercraft by independent contractors working for the insured may be subject to the exclusion unless the policy contains ownership/use requirement wording similar to that contained in the ISO-CGL forms.

 

Any restrictions regarding liability coverage for aircraft or watercraft in the

 

umbrella policy should explicitly state that such restrictions do not apply to employers' liability. The following is an example of wording limiting the application of aircraft/watercraft exclusions:

 

This exclusion does not apply to bodily injury (personal injury) to any employee of the insured arising out of and in the course of his or her employment by the insured.

 

Aircraft

 

Primary liability protection for owned aircraft usually is insured by special aviation insurance. Excess coverage for these exposures can be provided by specific aviation excess programs; however, some umbrella underwriters will provide excess limits. Usually, owned aircraft exposures can be insured less expensively under separate aviation liability programs. When owned aircraft are insured under a separate aviation policy, nonowned coverage usually is provided as well. It is then reasonable for the umbrella underwriter to exclude nonowned aircraft coverage.

 

The importance of coverage for nonowned aircraft is often overlooked. Nonowned aircraft coverage should apply to employees, as well as the officers and directors of a company, all of whom may rent, borrow or charter an aircraft or fly their own aircraft on company business without the knowledge of management.

 

Not all umbrella liability policies cover all liability arising out of the use of nonowned aircraft. For example, many policies usually will not cover damage to aircraft (or other property) in the care, custody or control of the insured.

 

Some umbrella policies exclude nonowned aircraft coverage unless it also is provided by an underlying policy.

 

Restrictions on aircraft coverage also may appear in the "persons insured" definition of the umbrella policy. It is preferred that employees be insured for liability arising out of nonowned aircraft. Other restrictions on aircraft coverage included in the insured definition may be acceptable provided that they do not apply when there is underlying coverage.

 

When an insured plans to operate a hired aircraft, an operator's aviation liability policy should be purchased. In some instances, umbrella nonowned aircraft coverage is broader than the nonowned coverage provided by aviation policies. However, this is not always the case, particularly when the umbrella policy is following form over the primary policy.

 

Watercraft

 

Most umbrellas exclude coverage for owned watercraft. However, such exclusions usually apply only if there is no coverage available in scheduled underlying policies or only if liability is assumed under contract. Umbrellas that do provide coverage for owned watercraft usually limit the length of the craft they will cover. Length limitations ranging between 25 and 75 feet are not uncommon. The minimum coverage desirable is automatic coverage for owned watercraft up to 26 feet long, and unrestricted nonowned watercraft coverage.

 

Umbrella restrictions on watercraft coverage usually appear in clauses that restrict aircraft and automobile coverage as well.

 

Whenever the insured has an aircraft or watercraft exposure,

 

coverage provided by the general liability and umbrella policies should be carefully evaluated and the wording of the policies coordinated to avoid a potential gap. If the insurers are unwilling to provide any necessary modification, purchase of an additional aircraft or watercraft policy may be required.

 

Care, Custody or Control

 

General liability insurance policies usually exclude liability for damage to personal property of others in the care, custody or control of the insured. In the 1986 and later versions of the ISO-CGL insurance policy forms, the exclusion is contained within the property damage exclusion applicable to Coverage A – Bodily Injury and Property Damage Liability. Under the ISO-CGL forms, an exception to the exclusion applies to liability assumed under a sidetrack agreement. The exclusion does not apply if the property is a premises (including contents) rented to the insured for a period of seven days or less.

 

Unlike property policies, liability policies are not intended to cover damage to the insured's own property. Rather, liability policies are designed to address the issue of tort liability and to cover claims based almost entirely on negligence. However, care, custody or control exposures often can arise from bailments. The law of bailment imposes certain obligations of care upon persons entrusted with others' property for use, safekeeping, repair or maintenance. Specialty policies, such as those providing warehouse legal liability coverage, are available to cover large bailment exposures, such as inventory of others stored in an insured's warehouse.

 

An exclusion for damage to nonowned property in the care, custody or control of the insured is common to umbrella forms. Some of the more common variations in umbrella care, custody or control exclusions are:

 

1.  The exclusion applies to real and/or personal property.

 

2.  The exclusion applies only to aircraft or watercraft. This is the least onerous exclusion because its scope is limited to only aircraft or watercraft exposures.

 

3.  The exclusion does not apply to liability assumed by the insured under a contract or agreement (i.e., coverage is similar to that provided by the ISO-CGL forms).

 

4.  The exclusion applies only as respects liability assumed under a contract or agreement.

 

5   The scope and effect of the exclusion follows the underlying general liability policy.

 

Exclusions numbered 1.-4. above may be either absolute or applicable only if there is no underlying coverage.

 

Some umbrella policies contain an absolute care, custody or control exclusion that applies whether or not damage to nonowned property is covered by underlying insurance. Absolute exclusions typically preclude coverage for damage to both real and personal property, with no exceptions. The resulting exclusion is broader, and coverage is thus more restricted, than coverage provided by the ISO-CGL forms. The ISO-CGL forms make an exception for the insured's contractually-assumed liability for nonowned personal property.

 

Absolute care, custody or control exclusions are undesirable and should be avoided whenever possible. If such an exclusion cannot be removed, an attempt should be made to modify the wording to make an exception for contractually-assumed liability.

 

When the scope of umbrella coverage is narrower than the scope of coverage provided by underlying insurance, an attempt should be make to broaden the umbrella coverage by endorsement. Some umbrella policy forms do not contain a care, custody or control exclusion, but restrict coverage by endorsement. Therefore, the entire policy, including endorsements, should be reviewed when evaluating the scope of coverage provided for nonowned property in the insured's care, custody or control.

 

Discrimination

 

Both private and public entities are exposed to liability for acts of discrimination against employees and third parties. The exposure results from the enactment of such statutes as Title VII of the Civil Rights Acts of 1964 and 1971, the Age Discrimination Act of 1967, the Americans With Disabilities Act of 1990 and other state and federal laws designed to prevent discrimination.

 

Although suits alleging discrimination present a potential for the type of catastrophic loss umbrella coverage is intended to protect against, many underwriters either will not insure such claims, or will provide only limited coverage. Underwriters point to the fact that many acts of discrimination are intentional and within the control of the insured and as such should not be the subject of insurance. In addition, many acts of discrimination are considered illegal and may not be insurable under some state or federal statutes.

 

While a few umbrella policies do not contain any reference to (and, hence, no specific exclusion for) discrimination, coverage for discrimination may nonetheless be limited or excluded. For example, some umbrella forms contain personal injury definition wording that limits the coverage for discrimination. A few umbrella policies contain an "employment practices" exclusion which precludes coverage for discrimination and other employment-related actions such as wrongful termination and harassment.

 

The wording of discrimination exclusions in umbrella policies varies. A few umbrellas simply exclude "discrimination." Such an exclusion is overly restrictive because it encompasses any type of discrimination. In contrast, some umbrella policies only exclude coverage for discrimination if based on specified criteria, such as race, creed, color, sex, age, national origin or physical disability.

 

A few umbrella forms exclude coverage for discrimination only if the discrimination is committed by or at the direction of the insured or if coverage is precluded by law. An example of this wording, taken from an old Central Mutual Insurance Company policy form, is as follows:

 

     This policy does not apply:

 

     to any liability for personal injury arising out of discrimination, including fines and penalties imposed by law, if (1) committed by or at the direction of the named insured or any executive officer, director, stockholder or partner thereof, or (2) if insurance coverage therefore is prohibited by law or statute.

 

Because of the inclusion of the term "named insured" in clause (1) of the above example, coverage might be available if the alleged discrimination was committed by or at the direction of an insured other than the named insured. While the wording may be intended only to eliminate coverage for intentional acts, it is somewhat ambiguous and could lead to a coverage dispute.

 

A few umbrella policies exclude coverage for discrimination only when such coverage is prohibited by law. In most cases, illegal discrimination is based on race, religion, gender, age, physical disability or national origin. However, if coverage is excluded for any illegal discrimination, the insured may also denied coverage for the investigation and defense costs incurred to prove that no unlawful discrimination was committed. Defense of a discrimination claim, even if only a "nuisance" lawsuit, can be expensive for an insured. A discrimination exclusion which precludes any and all coverage for uninsurable acts should be avoided whenever possible.

 

Some umbrella insurers combine the exclusion for discrimination with an exclusion for other employment-related acts, such as wrongful termination, demotion, evaluation or harassment. An example of this wording from Kemper Insurance is as follows:

 

     This policy does not apply to:

 

Q. Bodily Injury or Personal Injury to:

 

1.  A person arising out of any:

 

a.  Refusal to employ that person;

 

b.  Termination of that person's employment; or

 

c.   Employment-related practices, policies, acts or omissions such as coercion, demotion, evaluation, reassignment, discipline, defamation, harassment, humiliation or discrimination directed at that person; or

 

2.  The spouse, child, parent, brother or sister of that person as a consequence of Bodily Injury or Personal Injury to that person at whom any of the employment-related practices described in paragraph a., b., or c. above is directed.

 

     This exclusion applies:

 

1.  Whether the Insured may be liable as an employer or in any other capacity; and

 

2.  To any obligation to share damages with or repay someone else who must pay damages because of the injury.

 

In a few umbrella forms, the discrimination exclusion is found within the exclusion for "employee injury" or "employment practices." It is therefore important for the wording of these exclusions to be reviewed also, especially if there is no reference to discrimination in any other exclusion or in the definition of "personal injury."

 

The issue of intentional versus unintentional discrimination was clarified in the case of Solo Cup Company v. Federal Insurance Company. Referencing the concept of "disparate impact" as established by Title VII of the Civil Rights Act of 1964, a Federal appeals court found that, although employment criteria may be neutral (i.e. non-discriminatory) in form, they can become unintentionally discriminatory in their application. An example of "disparate impact" is where an employer sets job criteria (such as a heavy lifting requirement) that results in the inability of most women to perform the job in an acceptable manner.

 

In contrast with the concept of "disparate impact" is the concept of "disparate treatment." Under the "disparate treatment" concept, an employee may treat some employees differently than other employees because of their race, color, creed, sex or national origin. When this situation occurs, there is a motive behind the discrimination. Under the "disparate impact" concept, discrimination becomes evident as a result of the consequences of the actions taken by the employer. An example of "disparate treatment" would be a case where an employer failed to promote an employee simply because the employee was female.

 

Another distinction between "disparate impact" and "disparate treatment" is that the "disparate impact" is more likely to be insurable under umbrella liability policies because it often results from an unintentional act. However, whether unintentional discrimination will be covered by an umbrella policy depends on whether the policy specifically includes discrimination within the definition of personal injury and whether the wording of the complaint contains allegations of conduct excluded by the umbrella policy.

 

It is preferred that the umbrella policy includes discrimination as covered personal injury and excludes only discrimination that is committed intentionally or for which insurance is prohibited by law. Coverage might then be allowed not only for defense and other expenses of litigation, but for unintentional acts of discrimination as well.

 

Absence of a discrimination exclusion does not always mean that coverage is granted for such acts. Coverage may be precluded by the absence of the term discrimination from the policy definition of personal injury. Even if discrimination is included within the definition, specific types of discrimination may not be covered. For example, many discrimination suits allege an unfair bias based on physical or mental handicap, sex or age. Umbrella insurers that define personal injury to include only discrimination based on race and/or religion would likely not provide either defense or liability coverage for a claim or suit alleging gender discrimination.

 

Even if an umbrella policy's personal injury definition includes discrimination, coverage may not be triggered unless the incident resulting in a claim or suit qualifies as an "occurrence." Many umbrella policies define an occurrence as an "accident." Under such wording, the insurer could disclaim coverage if the complaint contained allegations of intentional conduct on the part of the insured.

 

When evaluating the extent of discrimination coverage provided by the umbrella policy, the definition of personal injury should be reviewed to determine if discrimination is included within the definition and, if so, the types of discrimination encompassed. The definition of occurrence should also be reviewed to make sure coverage is provided for personal injury resulting from an "offense." The policy exclusions must then be reviewed to determine if discrimination coverage is limited or precluded.

 

Some umbrella policies include discrimination within the definition of personal injury and only exclude discrimination that is employment-related. When the exclusion is limited to employment-related discrimination, coverage is usually afforded for discrimination against non-employees (i.e., third parties, such as the insured's customers, vendors, suppliers, etc.). Such coverage is desirable since third parties may file discrimination claims against insureds.

 

Umbrella forms that do not contain a discrimination or employment practices exclusion and which contain a broad personal injury definition that encompasses any discrimination are preferred. Such policy forms, however, are rarely found. Insureds who desire discrimination coverage, but are unable to obtain the coverage through an umbrella policy, should consider purchase of Employment Practices Liability (EPL) insurance. Coverage for third-party discrimination is often incorporated or is available in many EPL policy forms.

 

Employer's Liability

 

Most employment-related injuries fall within the scope of state workers' compensation statutes. However, there are circumstances where an employee may, while in the course and scope of employment, sustain an injury that falls outside the scope of statutory workers' compensation. For example, the injury may result from the employee's use of the employer's products while at work, or from the employer's failure to maintain a safe work environment. Injuries that are work-related, but which fall outside the scope of workers' compensation are typically covered by employer's liability insurance.

 

Employer's liability coverage is usually provided under Part II (Employers Liability Insurance) of the standard workers' compensation/employer's liability (WC/EL) policy. For this reason, virtually all general liability and umbrella policies contain an employer's liability exclusion.

 

Under the wording of the 1986 and later versions of the ISO-CGL policy forms, the employers' liability exclusion not only applies to injuries to employees, but also extends to consequential injury sustained by an injured employee's family members. An example of consequential injury is a nervous breakdown suffered by the wife of a severely injured employee who now finds herself the sole breadwinner for the family. Coverage for such injuries is typically provided by the employer's liability section of the WC/EL policy.

 

The employer's liability exclusion applies even when the insured is liable in a capacity other than as an employer. The reference to "any other capacity" clarifies that the exclusion also applies as respects work-related injuries that fall outside the scope of workers' compensation statutes.

 

An important feature regarding the employer's liability exclusion in the ISO-CGL forms, and in virtually all umbrellas, is an exception for liability that is contractually assumed by the insured. Because there is no similar exception in the WC/EL policy, the exception in general liability and umbrella policies fills a potential coverage gap. To illustrate, assume the insured hires a contractor to perform work on the insured's premises and that the insured has contractually agreed to assume liability for any injury to the contractor's employees. If the contractor's employee is injured as a result of the insured's negligence, there would be no coverage under the insured's standard WC/EL policy because that policy excludes coverage for contractually-assumed liability. By excepting contractually-assumed liability from the employer's liability exclusion, the insured's general liability policy provides the needed coverage.

 

The employer's liability exclusion in some umbrella policies may not contain an exception for contractually-assumed liability. If coverage for contractually-assumed liability is not provided by the umbrella policy, an attempt should be made to modify the wording of the umbrella's exclusion to provide such coverage by endorsement. Also, keep in mind that for the umbrella to provide excess employer's liability coverage, the underlying EL limits must be included in the umbrella's schedule of underlying insurance.

 

Impaired Property

 

Most umbrella policies contain an "impaired property" exclusion. In older umbrella policies, this exclusion was referred to as the "design error" or "business risk" exclusion. The purpose of the impaired property exclusion is to clarify that property damage coverage does not apply to damage resulting from the inherent quality of the insured's products or work. Most insurers (and courts) feel the insured should bear the responsibility for the quality of its work product as a business risk. Such exclusions preclude "loss of use" coverage for claims arising from the insured's failure to perform contractual obligations or to perform work in a workmanlike manner.

 

The "impaired property" exclusion was introduced with the 1986 ISO-CGL policy forms (both occurrence and claims-made versions) and was subsequently adopted by most umbrella insures. Most umbrella policies now incorporate impaired-property exclusion wording similar to the wording contained in the 1986 and later versions of the ISO-CGL policy. An example from Kemper Insurance Company is shown below:

 

     This insurance does not apply to:

 

     Property Damage to Impaired Property or property that has not been physically injured, arising out of:

 

(1) A defect, deficiency, inadequacy or dangerous condition in Your Product or Your Work; or

 

(2) A delay or failure by you or anyone acting on your behalf to perform a contract or agreement in accordance with its terms.

 

     This exclusion does not apply to the loss of use of other property arising out of sudden and accidental physical injury to Your Product or Your Work after it has been put to its intended use.

 

In many umbrella policies, as well as in the 1986 and later versions of the ISO-CGL policy forms, "impaired property" is defined as:

 

     …tangible property, other than Your Product or Your Work, that cannot be used or is less useful because:

 

1.  It incorporates Your Product or Your Work that is known or thought to be defective, deficient, inadequate or dangerous; or

 

2.  You have failed to fulfill the terms of a contract or agreement;

 

     if such property can be restored to use by:

 

1.  The repair, replacement, adjustment or removal of Your Product or Your Work; or

 

2.  Your fulfilling the terms of the contract or agreement.

 

In order to qualify as "impaired," and thus to be precluded from coverage, the insured's product or work must be restorable through replacement or repair of any defective or dangerous part of the product or work, or by the insured's fulfilling the terms of a contract. If the insured's product or work causes physical injury to the property of a third person, the impaired-property exclusion does not apply and property damage liability coverage would be available to respond to a claim.

 

If repair or replacement of a defective product cannot restore the product's usefulness, coverage is available for a resulting property damage and/or loss-of-use claim. If the product can be restored to use, however, there would appear to be no coverage for the claim.

 

A coverage dispute might arise should the insured's defective product become inseparable from other property into which it is incorporated. Most insureds, risk managers and brokers take the position that such a situation does not result in "impaired property," and, thus, the impaired property exclusion does not apply. The application of the exclusion is less clear, however, if the other property must be destroyed in order to repair or replace a defective part. It may be up to the courts to determine if restoration of the impaired property must be possible for the exclusion to apply.

 

Some older umbrella policies contain an impaired-property exclusion that applies as respects both bodily injury and property damage. Some umbrellas also may omit the exception for loss-of-use claims, thereby precluding coverage for such claims. It is preferred that the wording of the impaired property exclusion in umbrella policies be similar to that in the ISO-CGL forms (i.e., the exclusion limited to property damage and an exception for loss of use claims.)

 

Owned Property, Products and Completed Operations

 

Most umbrella policies exclude coverage for damage to the insured's own property, products and work (completed operations). The exclusion of coverage for the insured's property in a liability policy seems logical as such coverage is better provided under a property policy. However, if the insured becomes liable for damage to the property of an employee, contractual indemnitee or other third party, a property policy will usually not respond. Property policies typically only cover loss to the insured's own property. The insured must then look to a liability policy for coverage.

 

Employees, indemnitees and additional insureds on underlying policies are often included as insureds under umbrella policies. But suppose their property is damaged and the named insured is liable. If the policy only excludes damage to a named insured's owned property, and if coverage for the named insured's liability is not excluded by the terms of the policy's "care, custody and control" exclusion, the umbrella might cover the loss. Such is not the case, however, with regard to real or personal property actually owned by the insured. All umbrellas exclude coverage for this exposure.

 

As with standard underlying general liability policies, the insured's products exclusion precludes coverage for property damage to the named insured's products, even if portions of the product are produced or manufactured by an entity other than the named insured. The exclusion is intended to apply only to insureds that produce "products," rather than those who provide services, such as contractors. A building constructed by a contractor, for example, is the contractor's "work," not the contractor's "product."

 

The insured's work exclusion precludes coverage for property damage to work performed by the insured. By exception wording that usually applies to the exclusion, coverage is granted for work done on behalf of the insured by a subcontractor or others.

 

While variations in wording exist, many umbrella insurers have adopted exclusionary wording very similar or identical to that found in the ISO-CGL policy forms. The wording of these typical "your product" and "your work" exclusions is shown below in the example from a Harleysville Mutual Insurance Company policy.

 

     This insurance does not apply to:

 

j.   Damage to Your Product

 

"Property damage" to "your product" arising out of it or any part of it.

 

k.  Damage to Your Work

 

     "Property damage" to "your work" arising out of it or any part of it and included in the "products-completed operations hazard."

 

     This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.

 

The above exclusion of liability coverage for damage to the insured's own products or work again seems logical, as such damage is considered to be a business risk assumed by the insured.

 

However, under the above wording, when a subcontractor performs work on behalf of the insured, the "your work" exclusion does not apply. Most umbrella forms take a similar approach.

 

Some umbrella policies contain a different exception to the insured's work exclusion. The exception to the insured's-work exclusion in these forms allows coverage for:

 

•    Property damage to the insured's work if such damage results from the work of the insured's subcontractor;

 

•    Property damage to the work of the insured's subcontractor if the damage results from the insured's work, the subcontractor's work, or from the work of another contractor or subcontractor.

 

Some umbrellas contain a different variation of the damage-to-the-insured's work exclusion. An example from Century Surety Company is shown below:

 

     This Policy shall not apply:

 

D. To "property damage" to "your work" arising out of it or any part of it and included in the "products-completed operations hazard". Insofar as coverage is available to the insured in the underlying insurance as set out in the attached Schedule of Underlying Insurance this exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.

 

In the above example, inclusion of the word "and" at the end of the second condition means that work performed for the insured by others is only covered if all three stated conditions are met. However, while the wording differs from that found in the standard ISO-CGL and some umbrella policy forms, coverage is similar.

 

Whenever umbrella coverage is not provided for work performed on the insured's behalf by a subcontractor (or others), the policy should be modified to provide such coverage by endorsement.

 

Nuclear Energy Liability

 

Most, if not all, umbrella policies contain a nuclear energy liability exclusion either as part of the policy form or as an attached endorsement. Such exclusions generally apply to nuclear facilities, including shipments of radioactive materials therefrom, that are eligible for coverage through the Nuclear Energy Liability Insurance Association (NELIA), the Mutual Atomic Energy Liability Underwriters (MAELU), or the Nuclear Insurance Association (NIA) of Canada . While a few older umbrella forms exclude nuclear energy liability even for risks not eligible for coverage through these organizations, such exclusions are rarely found in modern umbrella policies.

 

Under most nuclear exclusions, coverage is precluded for bodily injury and property damage claims arising from specified nuclear hazards. The exclusion applies as respects liability arising out of "source material," "special nuclear material," and "by-product material." While these terms are not defined in the endorsement, the Atomic Energy Act of 1954 and its various amendments define them in detail. Any organization using the defined materials must, under the law, purchase nuclear energy liability insurance. An agent or broker with special expertise in nuclear insurance is invaluable to such organizations.

 

Only bodily injury or property damage resulting from the "hazardous properties" of nuclear material is excluded. The exclusion does not apply to loss resulting from radioactive isotopes (the most common nuclear materials in commercial use) or x-rays. Also, non-nuclear hazards are not subject to the exclusion, even if they are located at a nuclear facility. However, even if the nuclear energy liability exclusion does not apply, coverage is still subject to other policy terms such as the care, custody or control or pollution exclusions.

 

Coverage is also precluded for injury or damage arising from the operation of a nuclear facility or from any nuclear material that may be disposed of from a nuclear facility if the insured is required by law to purchase coverage. The exclusion applies even if the insured fails to purchase the insurance.

 

Nuclear energy exclusions usually do not affect hospitals or other institutions using radioactive isotopes for research or patient therapy. Hospitals' nuclear medicine and radiology operations are typically insured by standard general liability and hospital malpractice liability policies.

 

For most insureds, the nuclear energy liability exclusion is of no consequence and the insurer should be asked to delete the exclusion. However, if the insured's operations involve the use of nuclear material, an opinion regarding the need for nuclear energy liability insurance should be obtained from a qualified agent or broker.

 

Pollution

 

Most umbrella policies contain one or more exclusions relating to liability for injury or damage arising out of various forms of pollution.

 

Prior to 1986, many general liability and umbrella insurers excluded coverage for injury or damage resulting from gradual pollution, but provided coverage for injury or damage resulting from the "sudden and accidental" release of pollutants. However, following several adverse court decisions holding insurers responsible for gradual pollution as well, insurers began to revise the wording of the exclusion in their policy forms to clarify their intent not to provide such coverage.

 

A new and significantly revised pollution exclusion was introduced with the 1986 ISO-CGL policy forms (both occurrence and claims-made versions). Unlike its predecessor, the new exclusion does not make an exception for sudden and accidental release of pollutions. This new wording restricts coverage by broadening the exclusion to include any pollution, whether sudden and accidental or gradual. In response, many umbrella insurers similarly revised the wording of their pollution exclusions.

 

The ISO-CGL's pollution exclusion precludes coverage for bodily injury and property damage arising from the release or escape of pollutants at or from the insured's premises, a waste disposal site, or while the pollutants are being transported. Coverage is also excluded if the pollution results from monitoring or testing for pollutants by the insured or contractors and subcontractors working on behalf of the insured. Cleanup costs are excluded, whether incurred voluntarily or in response to a claim or suit by a governmental entity.

 

There are two important exceptions to the 1986 ISO-CGL's pollution exclusion. First, the exclusion does not apply if the pollution results from a "hostile fire." A hostile fire is defined in the policy as being one that becomes uncontrollable or breaks out from its intended location. The exclusion also does not apply if the injury or damage results from pollutants brought to a premises, site or location in connection with operations conducted by the insured or a contractor or subcontractor performing work on the insured's behalf.

 

While some umbrella policies exclude all pollution, including pollution resulting from a hostile fire, many insurers use exclusion wording similar to that in the ISO-CGL forms. When the umbrella's exclusion does not contain an exception for pollution resulting from smoke or fumes from a hostile fire, the exception often may be provided by endorsement.

 

Some of the variations found in umbrella pollution exclusions include the following:

 

•    Many umbrellas exclude all pollution, even if some coverage is provided by underlying insurance. This is commonly referred to as an "absolute pollution exclusion" and is undesirable.

 

•    Many umbrellas contain an absolute pollution exclusion, but also contain an endorsement that makes an exception for pollution resulting from hostile fire.

 

     Some umbrellas exclude all pollution, but give back coverage where and to the extent coverage is available in underlying coverage.

 

•    Some umbrellas include some of the pollution coverages provided by standard auto liability policies, such as coverage for the escape of oil or gasoline associated with operation of an insured vehicle and escape of pollutants from other property if caused by a collision with an insured vehicle.

 

•    Some older umbrella forms provide coverage if the pollution results from a sudden and accidental discharge of pollutants. In some instances, a time period is specified in which the pollution must be discovered, remediation undertaken, and/or reported to the insurer.

 

•    In a few older policies, coverage is provided for pollution resulting from certain perils specified in the policy. This "named perils" approach is now uncommon. Endorsements are usually attached that make the exclusion absolute, or limit coverage to pollution resulting from hostile fire.

 

•    Some policies contain an exception for pollution that results in injury to employees. This exception is desirable as it results in continuity between the underlying employer's liability and umbrella coverages. Because there is no pollution exclusion in the standard workers' compensation/employer's liability (WC/EL) policy, the exception allows umbrella coverage to apply excess of the underlying employer's liability coverage, thus eliminating a potential coverage gap.

 

•    Some umbrella forms do not exclude coverage for losses arising out of alleged or threatened pollution. If the insured incurs expenses to prevent a pollution incident, those expenses may be covered by these forms.

 

•    Some umbrella policies exclude coverage for any cleanup costs, whether such costs are ordered by the government or demanded by any other party. This type of provision is more restrictive than the ISO-CGL exclusion which is limited to government-ordered cleanup costs.

 

New wording was added to the ISO-CGL's pollution exclusion with the 1996 form revision. The new wording provides an exception for the escape of pollutants necessary to the operation of mobile equipment. For coverage to apply, the pollutants must escape from a part of the equipment designed to hold, store or receive such pollutants, such as a gas tank or oil reservoir. This exception is typically found in auto liability policies. The exclusion still applies, however, if the pollutants are intentionally discharged from the mobile equipment.

 

Also added with the 1996 ISO-CGL revision was a pollution exclusion applicable to Coverage B (Personal and Advertising Injury Liability). The additional exclusion was prompted by adverse court decisions which resulted in the CGL policy being held to cover pollution-related personal injury claims. Such a claim could result, for example, if the property of a business owner (Company A) was allegedly damaged by discharge of pollutants into an underground aquifer by a neighboring company (Company B). If the court ruled that the polluted aquifer constituted a "wrongful entry" into Company A's premises, it could also rule that a personal injury (as defined in the CGL policy) had occurred and hold Company B's CGL policy liable for coverage. The new language was included to prevent such an interpretation from triggering coverage under the 1996 ISO-CGL.

 

However, the 1996 ISO-CGL's Coverage B exclusion also creates the potential for a coverage dispute. Assume in the above example that Company A's property becomes less valuable because of the polluted aquifer and the president of Company A writes an open letter stating the pollution was caused by illegal dumping of pollutants by Company B. Company B then loses business and sues Company A for libel. If Company B's suit is successful, it is unclear if Company A's 1996 ISO-CGL coverage would be triggered, or if the exclusion would apply.

 

A personal injury and advertising injury pollution exclusion may be present in umbrella forms developed in response to the 1996 ISO-CGL. It is therefore important to review the underlying general liability and umbrella policies carefully to determine the scope of the pollution exclusion in both policies and to identify any potential coverage gaps.

 

The ISO-CGL's Coverage A pollution exclusion was again modified with the 1998 form revision. A new exception to the exclusion applies if the insured is a contractor performing services at a customer's premises and if the customer is added as an additional insured to the policy. However, this new exception applies only if the premises was never owned or occupied by any insured other than the additional insured. A second new exception applies to bodily injury arising out of smoke, fumes, soot or vapors from building heating equipment. In addition, a third new exception applies to bodily injury or property damage caused by fumes from materials brought into a building in connection with the insured's or a contractor's operations. Further, the definition of hostile fire has been moved from within the pollution exclusion to the "Definitions" section of the 1998 ISO-CGL.

 

The scope of the exclusion for costs related to government-ordered testing or cleanup of pollutants has been narrowed and clarified under the 1998 ISO-CGL form. Under the 1996 and prior versions of the ISO-CGL policy form, coverage for costs related to the testing or cleanup of pollutants is excluded even if the insured is requested to take such action by or on behalf of a governmental authority. Under the revised 1998 ISO-CGL wording, an exception to the exclusion applies if the insured has a legal liability for property damage resulting from such activities.

 

Despite the frequent use of an absolute pollution exclusion, many umbrella insurers will provide coverage for pollution resulting from a hostile fire when specifically asked to do so. Given the catastrophic nature of pollution losses, the courts may continue to look to insurers to share in the burden of pollution damage and cleanup costs by holding insurers at least partially responsible for such costs.

 

Important pollution coverage issues that have been addressed by the courts over the years are discussed below. These issues were primarily addressed with regard to general liability coverage, but also may be applicable to umbrella policies containing similar language.

 

An issue in determining if coverage exists for pollution liability is whether the insured had knowledge of the potential for a pollution loss and when such knowledge was acquired. If prior knowledge is found to have existed, the insurer could deny coverage since the policy may not have been triggered by an "occurrence."

 

The 1986 and subsequent ISO-CGL policy forms, and many umbrella policies, define occurrence to mean "an accident, including continuous or repeated exposure to harmful conditions." The term accident has often been relied upon by insurers to deny coverage for known gradual pollution. However, some courts have ruled that coverage for "continuous and repeated exposure" mitigates the meaning of the term accident and implies that insurers intended to cover pollution that took place over a period of time.

 

Even if the insured's conduct was intentional, the courts may still find that an "occurrence" took place. Under the 1986 and later ISO-CGL forms, as well as most umbrella forms, coverage is precluded for bodily injury or property damage that is expected or intended by the insured. If the subsequent injury or damage is determined to be unexpected or unintentional, the pollution exclusion may be held not to apply.

 

A major issue that has confronted the courts is whether the insured is entitled to coverage for cleanup costs given the wording of pollution exclusions and other policy provisions. The issues are often whether cleanup costs are "damages" under the policy and whether cleanup efforts are a liability imposed by law.

 

There are several theories courts may consider in determining whether coverage for cleanup costs should apply. For example, as a matter of public policy, the pollution should be removed from the damaged property. It can be argued that it is the insurers (who are in the business of spreading the cost of risk), not the general public, who should bear the cost of this burden. In addition, it could be argued that cleanup costs are incurred in the process of mitigating future damages. Such mitigation is an obligation of the insured that can be arguably imposed by law to avoid future liability to third parties. Hazardous waste cleanup is important to the public health and safety and as such may override the plain meaning of insurance policies seeking to exclude such coverage.

 

Most general liability and umbrella policies contain wording that excludes pollution cleanup costs. However, many of these forms exclude only costs related to government-ordered cleanup. The insurers' logic behind this limited wording is that there is no coverage for voluntary cleanup costs because there is no legal obligation of the insured to pay.

 

There is, however, a split of authority by the courts on whether voluntary cleanup costs are covered by a general liability policy and, if so, under which policy provisions. Some courts have held that insurers have a duty to indemnify insureds for voluntary cleanup costs undertaken to avoid further damage. From the perspective of these courts, it is senseless to argue an insurer's obligation to pay if the insured allows the damage to continue but not if the insured takes steps to reduce the loss. This position is in line with the general legal obligation imposed by most states that there is a duty to mitigate future damages if the party responsible for the loss has the ability to do so. Other courts have viewed the duty to mitigate damages as a liability imposed by law. In many states, mitigation of damages is a well-established principle requiring an injured party to take all reasonable measures to mitigate his or her own loss and thereby minimize the liability.

 

Most general liability and umbrella policies exclude coverage for damage to property in the insured's care, custody or control and to property owned or occupied by or rented to the insured. Courts in states that recognize public ownership of underground water have ruled that the pollution exclusion does not apply to contamination to ground water. In these states, damage to ground water is considered damage to a third party and is not excluded from coverage. Courts in other states may view the situation differently.

 

Over the past several years, general liability and umbrella insurers have restricted and clarified coverage for injury and damage resulting from the release or escape of pollutants. While most pollution exclusions found today allow some coverage for pollution resulting from hostile fire, many umbrella policies contain an absolute pollution exclusion. In some general liability and umbrella forms, the pollution exclusion applies not only to bodily injury and property damage, but may extend also to personal injury and advertising injury.

 

Whether coverage for pollution and subsequent cleanup costs is covered under a general liability or umbrella policy may depend on many factors. Those factors include federal statutes, state statutes, actual policy wording, the specific facts of a given case, the insured's expectation as to coverage, new theories of recovery and whether the pollution occurred on, from or away from the insured's premises.

 

While many general liability policy forms now contain pollution exclusions that are similar to ISO-CGL exclusions, the wording of umbrella pollution exclusions varies greatly. Both primary and excess liability policies should therefore be reviewed carefully in light of the insured's operations to attempt to identify coverage differences and potential coverage gaps.

 

At a minimum, all insureds should seek coverage for pollution arising out of smoke and fumes from a hostile fire. Umbrella insurers are usually willing to provide this coverage by endorsement, often at no cost. However, even umbrella coverage that is as broad as underlying coverage may not be enough for many insureds. When an uninsured pollution exposure exists, specialty pollution coverages may be required. Today's pollution liability market is vibrant with options to meet most coverage needs.

 

Pollutant

 

Coverage for liability arising from pollution is governed by many factors including but not limited to actual policy wording, the specific facts of a given case, existing or new theories of liability, case law, and where such pollution occurred. But just what is a "pollutant"?

 

The following are common examples of the definition of pollutant.

 

"Pollutants" means any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. "Waste" includes materials to be recycled, reconditioned or reclaimed.

 

United National Group, CU1 (3/96)

 

"Pollutants" mean any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. As used in this definition, waste includes materials to be recycled, reconditioned or reclaimed.

 

ACE, XS-20835 (08/06)

 

 

"Pollutants" mean any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. Waste includes materials to be recycled, reconditioned or reclaimed.

 

Penn National Insurance, 71 1184 0405

 

The above use nearly identical wording and punctuation and are rather sweeping definitions, the precise meaning of which have sometimes led to broad interpretation of the scope of applicable pollution exclusions.

 

The following is another example of a definition of pollutant, which includes the above language but expands the scope of the definition to also include substances which are "generally recognized" in industry or government to be harmful or toxic to persons.

 

"Pollutants" mean any solid, liquid, gaseous, or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals, petroleum, petroleum products and petroleum by-products, and waste. Waste includes materials to be recycled, reconditioned or reclaimed. "Pollutants" include, but are not limited to, substances which are generally recognized in industry or government to be harmful or toxic to persons, property or the environment regardless of whether the injury or damage is caused directly or indirectly by the "pollutants" and whether:

 

a.        The insured is regularly or otherwise engaged in activities which taint or degrade the environment; or

 

b.        The insured uses, generates or produces the "pollutant".

 

The Cincinnati Insurance Company, US 101 12 04 (12/04)

 

The following is another example of a Pollutant definition that has been drafted to specifically address the meaning of what constitutes a "liquid" and to clarify that a pollutant is not an "electromagnetic field."

 

Pollutants means any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapors, soot, fumes, acids, alkalis, chemicals and waste material. Waste material includes materials which are intended to be or have been recycled, reconditioned or reclaimed.

 

The term liquid as used herein shall not mean potable water or agricultural water, or water furnished to commercial users.

 

The terms thermal irritant and contaminant as used herein shall not mean to include an electromagnetic field.

 

AIG Specialty Excess, 70110 (3/98)

 

Sometimes the word pollutant is used within the definition but not defined in the policy, as illustrated in the following example.

 

(p) "Bodily injury", "personal injury" or "property damage" arising out of the discharge, dispersal, release or escape of smoke, vapors, soot, fumes, acids, alkalis, toxic chemicals, liquids or gases, waste material or other irritants, contaminants or pollutants.

 

Philadelphia, Commercial Excess Liability Policy PI-CXL-001 (6/92)

 

In addition to the above example, insurers often include related exclusionary endorsements regarding specific pollutants, such as but not limited to variations of the following:

 

•          Silica Exclusion

 

•          Polychlorinated Biphenyl (PCB) Exclusion

 

•          Lead Exclusion

 

•          MTBE and Fuel Oxygenates Exclusion

 

•          Sound Exclusion

 

•          Elexcromagnetic Fields Exclusion

 

•          Nuclear Exclusion

 

•          Fungus Exclusion

 

•          Mold Exclusion

 

These types of exclusions are used to reinforce and clarify that the insurer does not cover such specific pollutant exposures. Always read any pollution exclusion in the context of and in conjunction with any definition of pollutant or pollution condition, as well as other endorsements to the policy that may restrict or expand pollution coverage. Where words such as pollution or pollutant are not defined, ask the broker or insurer to provide a written explanation of what such key words mean. Where specific pollution exposures exist, it may be necessary to investigate—through one or more insurance brokers or direct-writing insurance companies—specialty pollution markets and coverage forms that often provide more suitable protection.

 

Product Recall (Sistership)

 

General and umbrella liability insurance policies nearly always contain exclusions that apply to the cost of recalling an insured's defective work or product. Insurers generally consider such cost to be a business risk for which the insured should be solely responsible.

 

Product recall (or so-called "sistership") exclusions began to appear in liability insurance policies in the mid-1960s. It was during that time that McDonnell Douglas grounded one of its DC-7 passenger planes to inspect it for a possible mechanical defect. Following that initial inspection, all of that plane's "sister" aircraft were similarly grounded, checked and repaired (if necessary) before being returned to service. The cost of the grounding, repair and subsequent claims was staggering and led to insurers adding an exclusion for such costs in general liability and umbrella policy forms.

 

Over the years since 1982 when Johnson & Johnson voluntarily recalled 31 million bottles of Extra-Strength Tylenol, public awareness of product recalls has increased dramatically. The Food and Drug Administration and the Consumer Product Safety Commission issue many highly-publicized recalls each year, ranging from food products, automobiles and televisions to baby products and toys. In addition to recalls mandated by government agencies, product manufacturers sometimes voluntarily recall their products.

 

Product-recall exclusions typically apply to the costs related to the withdrawal, inspection, repair, and replacement of the insured's products or work, as well as to the loss of use resulting from such activities, providing the recall is necessary because of a known or suspected defect or deficiency. If the insured's product or work has an unknown defect or deficiency, the exclusion usually does not apply and the policy will respond to bodily injury or property damage claims resulting from the defect or deficiency.

 

In many general liability and umbrella policy forms in use before 1986, it was not clear whether the product recall exclusion applied only to the cost of voluntary recalls, or applied to the cost of recalls initiated by third parties as well. (An example of a third-party-initiated recall is when the Consumer Product Safety Commission orders a recall of vehicles found to contain possibly defective seat belts.) This ambiguity resulted in several courts finding that the product recall exclusion did not apply to claims initiated by third parties. As a consequence, and to limit their exposure, the ISO and many insurers developed general liability policy wording to clarify that the exclusion was intended to apply regardless of who initiates the recall.

 

The product-recall exclusion in most umbrella forms contains wording similar or identical to that found in the 1986 and later versions of the ISO-CGL policy forms. An example of that wording, taken from a modern umbrella policy from Kemper Insurance Company, is shown below:

 

     This insurance does not apply to:

 

a.  Damages claimed for any loss, cost or expense incurred by you or others for the loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal or disposal of:

 

1.  Your Product;

 

2.  Your Work; or

 

3.  Impaired Property;

 

     if such product, work, or property is withdrawn or recalled from the market or from use by any person or organization because of a known or suspected defect, deficiency, inadequacy or dangerous condition in it.

 

Under the above wording, the exclusion also applies to recalls of impaired property. Impaired property as defined in the ISO-CGL and many umbrella forms, means property other than the named insured's products or work that cannot be used or is less useful because it incorporates the named insured's product or work thought to be defective, inadequate or dangerous. An example of impaired property is the known presence of a harmful contaminant in gasoline that could cause damage to a vehicle's engine.

 

Some older umbrella policies may contain a product recall exclusion that also applies to the cost of recalling the goods or products of others if those goods or products are sold, handled or distributed by the named insured or others on the insured's behalf. An example of this broader, and undesirable, exclusion wording is shown below:

 

     This policy does not apply:

 

     to such part of any damages or expense which represents the cost of inspecting, repairing, replacing, removing, recovering, withdrawing from use, or loss of use of, because of any known or suspected defect or deficiency therein, any goods or products or any part thereof (including any container) manufactured, sold, handled or distributed by the named insured, or by others trading under his name; or work completed by or for the named insured; or other property of which such goods, products or work completed are a component part or ingredient.

 

Fortunately for insureds, product recall exclusions containing the above wording are no longer common.

 

The cost of product recalls typically includes, but is not limited to, the expense of notifying the public of the recall; analyzing, testing and remanufacturing the product; repairing the defect; re-distributing the product and compensating vendors for any loss of business resulting from the recall. Obviously, such costs can be substantial. For this reason, any company with a significant products recall exposure should seriously consider purchase of special product recall insurance. Such coverage is currently available from several domestic insurers, including Chubb, CNA, American International Group, Underwriters at Lloyd's, and others.

 

Punitive Damages

 

As a general rule, compensatory damages are awarded to plaintiffs for their actual and indirect monetary loss, as well as for mental and physical injury. Punitive, or exemplary, damages are usually imposed only when the action causing the injury is judged to be intentional or malicious, or if the insured consciously disregards the safety of others. Most personal injury suits that allege intentional torts (libel, wrongful entry, malicious prosecution, discrimination, etc.) include a prayer for punitive damages. Whether a liability policy will respond to punitive damage liability depends on (1) the policy language, (2) public policy in the particular jurisdiction, and (3) case law.

 

The law allowing insurance coverage for punitive damages varies from state to state. In some states, punitive damages are not insurable as a matter of public policy. In other states, punitive damages are uninsurable if they are assessed directly against a policyholder for his or her own conduct. However, if punitive damages are assessed against the insured vicariously for the actions of another (for example, an employee), these states may allow coverage for this exposure.

 

Insurers exclude coverage for punitive damages in a variety of ways:

 

     Absolute exclusion: Coverage for punitive damages is excluded, regardless of underlying coverage. This type of exclusion is the most restrictive.

 

     Conditional policy exclusion: The exclusion of coverage for "fines, penalties, punitive or exemplary damages" may apply only if there is no coverage for such damages in underlying insurance policies. If the underlying policy doesn't cover punitive damage, such wording has the same effect as an unconditional (absolute) punitive damages exclusion.

 

     Definition of "Ultimate Net Loss": There is no separate punitive damages exclusion, but the exclusionary wording is contained within the definition of ultimate net loss. The insurer lists various covered expenses and damages within the definition, but at the end of the definition may include wording such as "ultimate net loss shall not include… any fines and penalties imposed by law." The effect of this added wording is the same as an absolute punitive damages exclusion.

 

     Definition of Loss or Damages: An exclusion for punitive damages, fines, penalties, etc. is appended to the definition of loss or damages. A few insurers specifically include punitive damages within the definition of loss or damages.

 

     Definition of Personal Injury: Some umbrella forms contain an exclusion for punitive damages (and/or fines and penalties) within the definition of Personal Injury. When such wording is present, coverage is usually excluded only for assessed punitive damages, fines or penalties which result from specified acts committed by the insured, such as discrimination.

 

     Within the policy insuring agreement: A few umbrella insurers exclude punitive damages by limiting coverage to "compensatory damages," or by making an exception for punitive damages.

 

Even in the absence of punitive damages exclusion wording, the umbrella still may not provide coverage. Most umbrella coverage is triggered by an "occurrence." Occurrence is sometimes defined to mean an accident, including continuous or repeated exposure to conditions, which results in bodily injury or property damage neither expected nor intended by the insured. If a court determines that the third party's injury was expected or intended by the insured, there may be no occurrence as defined in the policy. Without an occurrence, there may be no coverage available to the insured for damages, although the insured may still have the benefit of defense coverage under the terms of the policy.

 

In some states, if punitive damages are alleged in a complaint which includes other allegations that are within the scope of policy coverage, the insurer is required to defend the entire action. However, when only punitive damages are sought, the law regarding the insurer's obligation to defend may vary by jurisdiction. In a few states, however, even if the only demand made is for punitive damages, the insured may be entitled to defense under the "reasonable expectation" theory.

 

If an umbrella policy is silent regarding coverage for punitive damages, it does not necessarily mean that such damages are not covered. Some courts take the position that where a liability policy agrees to pay damages without defining that term, a coverage ambiguity is created. In such cases, the insured is given the benefit of the doubt and the policy is interpreted as providing the insured with protection against all damages, whether compensatory or punitive. However, not all courts agree that punitive damages should be covered when the policy is silent on that issue.

 

Some umbrella insurers will agree to pay punitive damages if the law in any potentially applicable jurisdiction allows for the insurability of such damages. This type of provision is commonly referred to as a "most-favorable-venue" clause. A typical most-favorable-venue clause will state that the insurer will pay a punitive damage award if the jurisdiction where (1) the insured is located or incorporated, (2) the insurer is located or incorporated, (3) the occurrence or offense giving rise to the punitive damages award happened, or (4) the lawsuit is pending. Such clauses result in a greater likelihood of coverage for punitive damages. However, insureds should be aware that both most-favorable-venue clauses and clauses covering punitive damages regardless of insurability may potentially raise regulatory issues for insurers and tax issues for insureds.

 

Umbrella policies may not contain punitive damage exclusionary wording for several reasons. Possibly, failure to include such wording was merely an oversight on the part of the persons who draft policy wording. Another reason may be that the insurer prefers to rely on underlying coverage to set punitive damages coverage guidelines, or to have such guidelines established by public policy or state law in jurisdictions where the policies are to be sold. Also, complications in determining the existence of punitive damages coverage may arise from both the way a lawsuit is worded and the resulting settlement provisions. It is sometimes difficult to establish which part of a judgment is actual damages and which part is punitive or exemplary damages.

 

Because many states allow insurance coverage for punitive damages, it is preferred that the umbrella policy specifically include coverage for punitive damages where insurable under state law. Since questioning the intent of an insurer when ambiguous language is found may result in a clarification (or endorsement) which clearly precludes such coverage, it is recommended that insureds accept any ambiguous wording.

 

 

Uninsured/Underinsured Motorists (UM/UIM)

 

Under most umbrella policies, coverage does not apply unless the insured has a legal obligation to pay damages. Uninsured/underinsured motorists (UM/UIM) insurance is a voluntary coverage provided under automobile liability insurance which pays for medical bills incurred by an insured and his or her passengers when the responsible party is either uninsured or is underinsured.

 

Most umbrella policies contain an uninsured/underinsured motorists exclusion. Presence of the exclusion may be to reinforce the insurer's position that there is no intent to provide excess uninsured or underinsured motorists coverage. Because the primary source of protection for employees (whether drivers or passengers) injured in the course and scope of employment while driving is usually workers' compensation insurance, insureds also may view UM/UIM coverage as unnecessary.

 

However, consider a situation where an employee's passenger is severely injured in an accident caused by a negligent and uninsured adverse driver. In some states, "guest" statutes allow passengers to bring claims against otherwise inculpable drivers for UM/UIM payments. A few courts have ruled that umbrella policies must respond to uninsured motorists claims, notwithstanding any policy provision that specifically precludes such coverage. For this reason, some umbrella insurers now require the insured to sign a "rejection of UM coverage" endorsement in hopes of avoiding this obligation.

 

When first-party UM/UIM coverage is considered a contingent third-party liability, the umbrella policy should provide excess coverage. Although umbrella insurers may try to claim that the underlying auto liability coverage limits apply to UM/UIM claims, the courts may not agree.

 

A significant coverage gap can result when underlying UM/UIM coverage is held to apply to a loss. This is because insureds often purchase only minimum statutory auto UM/UIM limits, rather than limits equal to the auto liability limits. Insureds should therefore consider purchase of UM/UIM coverage in the same limits as purchased for auto liability. Since no-fault injury awards are relatively small, increasing the primary auto UM/UIM limits would nearly eliminate the umbrella insurer's exposure.

War

 

A war exclusion limits the insurer's liability for losses that could result from such acts as civil unrest, terrorism or actual warfare. When such activity occurs, the resulting bodily injury and property damage is often substantial. The war exclusion also serves to limit the insurer's liability for losses that are not necessarily catastrophic, but which are beyond the scope of reasonable general liability coverage.

 

Most umbrella policies contain one of two types of war exclusions. The first type uses wording similar to that found in the 1986 and later ISO-CGL policy forms. That wording is shown below from a Harleysville Mutual coverage form:

 

     This policy does not apply to:

 

d.  War

 

     "Bodily injury" or "property damage" due to war, whether or not declared, or any act or condition incident to war. War includes civil war, insurrection, rebellion or revolution. This exclusion applies only to liability assumed under a contract or agreement.

 

Under the above wording, the war exclusion only applies to contractually-assumed liability. This is reasonable, since no party should accept a contract that requires assumption of liability for damage caused by war or related acts. Some umbrella policies are more restrictive, however, and do not limit the war exclusion to contractually-assumed liability. Some umbrellas limit the scope of the exclusion to injury or damage occurring outside the U.S., its territories and possessions and Canada . Such territorial provisions may allow coverage for domestic civil unrest, rebellion, etc. In a few umbrella policies, acts of terrorism are specifically made a part of the war exclusion by the insurer.

 

The second type of war exclusion, sometimes found in policies issued to insureds with overseas operations, has no contractual liability exception and may incorporate several so-called "political risk" exclusions. These additional exclusions include but may not be limited to:

 

•    Acts of foreign enemies

 

•    Terrorism

 

•    Invasion

 

•    Military or usurped power

 

•    Confiscation or nationalization or requisition or destruction of tangible property by or under the order of any government or public or local authority

 

The following example illustrates why insurers normally include a war exclusion in umbrella policies. Assume that an insured defense contractor manufactures military equipment and supplies, such as tanks and ammunition. Further assume that the insured's products are used by revolutionaries in a foreign country in an attempt to overthrow the government. The insurrection results in substantial damage to government property and hundreds of injuries to both military and civilian personnel. It is possible that the insured could be named in a lawsuit for contributing to the bodily injuries and/or property damage sustained by the foreign government.

 

It is preferred that umbrella policies either do not contain a war exclusion, or limit applicability of the exclusion to contractually-assumed liability. Although for most insureds the war exclusion is of little consequence, wording of the exclusion could be a significant issue for insureds with overseas operations or who, for example, manufacture products that could be used to conduct war, terrorist acts or similar activities. These insureds should attempt to supplement coverage provided by the umbrella policy through use of specialty or manuscript coverage forms or endorsements.

 

Workers Compensation

 

Virtually all umbrella policies exclude coverage for the insured's obligation under workers compensation, disability, unemployment compensation or similar laws. These exposures are typically insured elsewhere, such as by a workers compensation/employer's liability (WC/EL) policy. In umbrella policies, the exclusion is usually called a "Workers Compensation" exclusion, although some insurers refer to them as "Employment Laws" or "Employee Injury" exclusions. The intent of the WC exclusion in umbrellas is to prevent any duplication of coverage for workers' compensation claims.

 

There are two basic types of workers compensation exclusion typically found in umbrella policies. The first type is an "absolute" exclusion, which is similar to the wording of the "Workers Compensation and Similar Laws" exclusion in the 1986 and later ISO-CGL policy forms. An example of such wording from Kemper Insurance is shown below:

 

     This insurance does not apply to:

 

     Any obligation of the Insured under a Workers Compensation, Unemployment Compensation or Disability Benefits Law or under any similar law.

 

The following is another form of absolute workers compensation exclusion from Transamerica Insurance Company:

 

     This insurance does not apply:

 

     to any obligation for which the insured or any carrier as his insurer may be held liable under any workmen's compensation, unemployment compensation or disability benefits law, or under any similar law.

 

In the example immediately above, the addition of the wording "or any carrier as his insurer" clarifies that the exclusion applies not only to the direct liability of the insured (whether or not self-insured for workers compensation), but to any liability imposed on the insured's workers compensation insurer as well.

 

Umbrellas may also preclude coverage for any obligation the insured has under federal statutes such as the U.S. Longshore and Harborworkers Act (USL&H) and the Jones Act. USL&H and Jones Act exclusions may be part of the basic policy form or may be added by endorsement, especially where the insured has operations subject to those Acts.

 

The second and less common basic type of workers compensation exclusion makes an exception for liability that is assumed under a contract or agreement. An example of this wording, taken from an old ITT Hartford umbrella policy, is shown below:

 

     This policy does not apply:

 

     to any obligation of the insured under a workers' compensation, disability benefits or unemployment compensation law, or any similar law, except for liability of others assumed by the 'insured' under any contract or agreement.

 

The specimen wording immediately above is preferable for insureds who must contractually assume liability for injuries to persons working for someone else. In some umbrella WC exclusions, an exception for the insured's contractually assumed liability applies only when similar coverage is provided by underlying policies.

 

There may be instances where an umbrella that excludes the contractually-assumed risk of workers compensation claims is overly restrictive.

 

For example, some insureds may contractually assume liability for injury to employees of a contractor doing work on behalf of the insured. When an organization contractually accepts liability for a work-related injury, coverage for the injury might not be available through the organization's WC/EL policy. Workers compensation coverage is statutory, and such statutes only apply as respects actual employees of the organization. In addition, employer's liability coverage under the WC/EL policy specifically excludes liability assumed in a contract. In the absence of the umbrella's exception for liability that is contractually assumed, the organization might find itself without the benefit of either WC/EL or liability coverage.

 

Some umbrella policies contain two workers compensation exclusions. In these policies, the exclusion applicable to Coverage A (excess coverage) may be worded similarly to the following example from Ranger Insurance Company:

 

     The exclusions applicable to the "underlying insurance" also apply to this insurance. Additionally, this insurance does not apply to:

 

     any obligation imposed by law under any automobile no-fault, uninsured motorist, underinsured motorist, workers compensation, disability benefits or unemployment compensation law or any similar law.

 

The exclusion applicable to Coverage B (umbrella coverage) may then be worded similar to the following, also from Ranger:

 

     This insurance does not apply to:

 

     any obligation of the insured under a workers' compensation, disability benefits or unemployment compensation law or any similar law.

 

If it is necessary for the insured to contractually assume workers compensation liability for employees of another entity, an attempt should be made to add the other entity to the insured's WC policy as an "additional insured." Unfortunately, most WC insurers are reluctant to increase their exposure by complying with such a request.

 

Insuring Agreements

 

Advertising Injury

 

Most umbrella policies provide coverage for claims alleging injury that arises out of the insured's advertising activities. The coverage grant is usually found in the policy insuring agreements, and is usually referred to as "advertising injury" or "advertising liability."

 

For coverage to apply, most umbrellas require that the occurrence or offense causing the injury take place during the policy period and within the coverage territory. There is generally no limitation as to when the injury itself actually occurs. An example of an advertising injury insuring agreement from a Harleysville Insurance Company policy is shown below:

 

     We will pay on behalf of the insured the "ultimate net loss" in excess of the "applicable underlying limit" which the insured becomes legally obligated to pay as damages because of:

 

A  ."Personal Injury" or "advertising injury" covered by this policy and caused by an "offense" committed during the policy period.

 

Some umbrella policies, however, require both the occurrence or offense causing the injury and the resulting injury to take place during the policy period. The following from Kemper Insurance is an example of this form of insuring agreement:

 

     We will pay on behalf of the Insured, those sums in excess of the Retained Limit that the Insured becomes legally obligated to pay as damages by reason of liability imposed by law or assumed by the Insured under an Insured Contract because of Bodily Injury, Property Damage, Personal Injury or Advertising Injury covered by the terms of this policy, that takes place during the Policy Period and is caused by an Occurrence…

 

The term advertising injury is usually defined in the "Definitions" section of the policy. Some umbrellas, however, include a description of covered injuries or offenses in the insuring agreement, rather than in a separate policy definition.

 

Although there are variations in the wording of advertising injury definitions in umbrella policies, most policy forms contain wording similar to that in the 1996 ISO-CGL. Under the ISO-CGL forms, advertising injury is defined as including the following offenses:

 

•    Libel or slander;

 

•    Oral or written violation of a person's right of privacy;

 

•    Misappropriation of another's advertising ideas or business style; or

 

•    Copyright, trademark or slogan Infringement.

 

A few umbrella insurers restrict coverage by omitting one or more of the above stated offenses from the definition. For example, a few umbrella forms do not include infringement of copyright, trademark or slogan. Conversely, coverage is broadened in some umbrellas by the inclusion of piracy and unfair competition (or other offenses) in the definition.

 

Like the ISO-CGL policy forms, most umbrella forms also contain an advertising injury exclusion. The advertising injury exclusion may appear as a stand-alone exclusion, or it may be combined with the policy's personal injury exclusion. Regardless of the format, the wording of the exclusion is usually similar to that shown below from a Kemper Insurance policy:

 

     This insurance does not apply to:

 

K. Personal Injury or Advertising Injury:

 

1.  arising out of oral or written publication of material if done by or at the direction of the Insured with knowledge of its falsity;

 

2.  Arising out of oral or written publication of material whose first publication took place before the beginning of the policy period;

 

3.  Arising out of the willful violation of a penal statute or ordinance committed by or with the consent of the Insured; or

 

4.  For which the Insured has assumed liability in a contract or agreement. This exclusion does not apply to liability for damages that the Insured would have in the absence of the contract or agreement.

 

L. Advertising Injury arising out of:

 

1.  Breach of contract, other than misappropriation of advertising ideas under an implied contract;

 

2.  The failure of goods, products or services to conform with advertised quality or performance;

 

3.  The wrong description of the price of goods, products or services, or

 

4.  An offense committed by an insured whose business is advertising, broadcasting, publishing or telecasting.

 

In the 1996 ISO-CGL form, the above exclusion was expanded to include personal and advertising injury resulting from pollution, including the cost of remediation. The new wording may have been prompted by several court decisions that held a general liability policy to cover pollution-related personal injury claims. Some umbrellas developed after 1996 may also incorporate such pollution language.

 

A few umbrella insurers have chosen a hybrid method of providing advertising injury coverage. For example, in some umbrellas, offenses such as invasion of privacy, libel, slander and defamation are included within the definition of "personal injury." However, there may be no distinction as to whether the injuries arise in the normal course of business or from the insured's advertising activities. These policies also contain an "advertising injury" definition that includes infringement, unfair competition and idea misappropriation which arise from advertising or publicity activities.

 

Under the 1996 and prior versions of the ISO-CGL, coverage disputes sometimes resulted from the wording of the advertising injury insuring agreement that refers to offenses occurring "in the course of advertising" the named insured's products or services. The disputes involved application of the exclusions in situations where the excluded offense occurred prior to actual broadcast or publication of the insured's advertisement. Absent wording that restricted the exclusions to offenses arising out of the advertisement itself, insurers could argue that the exclusions applied to the entire process of planning, developing, writing and broadcasting or publishing the advertisement.

 

The 1998 ISO-CGL forms contain new wording that clarifies the scope of the exclusions by limiting their applicability to the insured's advertisement, as that term is defined in the "Definitions" section of the 1998 CGL policy. Applicability of the exclusions was further expanded with the 2001 ISO-CGL revision, which clarifies that the exclusions also apply to the insured's Internet and other electronic communications activities. However, the exclusions only apply as respects that portion of a Web site that includes the insured's advertisement.

 

Umbrella policy forms that have not been revised in response to the 1998 or 2001 ISO-CGL revisions may not include wording that limits the advertising injury exclusion to the insured's advertisement. As a consequence, the scope of the advertising injury exclusions in these older umbrella forms may sometimes be ambiguous and lead to a coverage dispute. Together, the advertising injury definition and exclusions establish the scope of coverage provided by the umbrella policy. When assessing the adequacy of coverage provided, it is therefore necessary to compare the wording of the umbrella's definition and exclusion to the wording of each in the underlying general liability policy.

 

Advertising injury liability coverage in umbrella policies usually applies only for insureds that are not in the business of advertising, broadcasting, etc. Specialty policies have been designed to provide advertising liability for insureds in the business of advertising, broadcasting, telecasting, etc., whether such advertising activities are conducted over the Internet or by more traditional means.

 

Declarations

 

Every umbrella policy contains a declarations page that states important factual information about the insured and the insurance contract. Such information normally includes but may not be limited to the following:

 

1.  Named Insured—Referred to numerous times in the policy, and specifically defined in the policy. The name of the first insured listed is often designated as the agent for policy cancellation and premium payment. It should be clear if the named insured is an individual, partnership, corporation, limited liability company or joint venture.

 

2.  Address—The location where premium and cancellation notices will be sent.

 

3.  Insurer—The insurance company that provides (underwrites) the policy. In some cases, this may be one of a group of related insurers.

 

4.  Policy number.

 

5.  Policy Term/Period—The stated inception and expiration dates, inclusive of which occurrences and offenses are covered. Also affects the application of the aggregate limit of liability.

 

6.  Limits of Liability—The "per occurrence" and "aggregate" amounts payable under the policy, as more fully described in the policy form.

 

7.  Retroactive Date—Primarily for "claims-made" coverage. Coverage is typically excluded for claims arising from occurrences that take place before the designated retroactive date, regardless of when the claim is presented.

 

8.  Premium, Adjustable Rate (if applicable) and Minimum Premium.

 

9.  Schedule of Underlying Insurance—Underlying insurance that must be maintained during the term of the umbrella policy. The umbrella pays claims excess of the underlying limit specified for each type of underlying coverage. This schedule may be contained in a separate endorsement, but it is referred to in the declarations and policy form.

 

10. Self-Insured Retention (S.I.R.)—The amount each claim the insured must pay if no underlying insurance applies. In some umbrella policies, both the SIR and the underlying coverage limits are referred to as the "retained limit."

 

11. Designation of Policy Form Numbers—Sometimes includes the form numbers for all endorsements which are part of the policy at inception.

 

12. Countersignature—The signature of an authorized representative of the insurer, if applicable.

 

13. Forms and Endorsements Attached to the Policy at the Inception Date—When not shown in number 11. above.

 

It is important that insurance policy declarations be correct and complete. In the event of a loss, incorrect or incomplete information reflected in the declarations can result in a coverage dispute with the insurer, or even a rescission of coverage. Such disputes can arise because of policy introductory wording or a "Representations" condition found in many umbrella policies. While the wording varies among policy forms, "Representations" conditions typically contain the following provisions:

 

•    By accepting the policy, the insured agrees that the statements in the application and/or policy declarations are the insured's agreements and representations at that they are accurate and complete;

 

•    The policy was issued in reliance upon those agreements and representations;

 

•    The policy embodies all agreements existing between the insured and the insurer relating to the insurance provided.

 

Even if there is no reference to the application, the information contained in the application is material to the underwriting process and is the source of statements appearing in the declarations. Umbrella insurance applications often contain a closing statement worded similar to the following:

 

     The applicant represents that the above statements and facts are true and that no material facts have been suppressed or misstated.

 

Statements made by the insured in the application and that appear on the policy declarations are as important a part of the contract between the insurer and the insured as is the policy form itself because the application is the basis of the underwriter's decision to provide coverage.

 

Insureds and their representatives should carefully examine the application and declarations to be sure that no material misstatements or errors are present which could later result in a coverage dispute.

 

Some umbrella policies use a policy format which contains two insuring agreements, Coverage A and Coverage B. In these forms, the Coverage A insuring agreement normally provides liability coverage that generally is no broader in scope than the underlying insurance scheduled on the umbrella policy—similar to the coverage provided by an excess-only liability policy. The Coverage B insuring agreement provides liability coverage that is usually broader than the coverage provided by underlying policies, and which is subject to a self-insured retention (SIR) that applies as respects losses not covered by underlying insurance.

 

An example of an umbrella policy Coverage A insuring agreement from a Fireman's Fund policy is shown below:

 

1.  We will pay on behalf of any Insured those sums in excess of Primary Insurance that any Insured becomes legally obligated to pay as damages or a Covered Pollution Cost or Expense. Provided that such damages and Covered Pollution Cost or Expense:

 

a. Are covered by Primary Insurance;

 

b. Arise from injury or damage during our Policy Period; and

 

c. Take place anywhere in the world.

 

2.  The terms and conditions of Primary Policies apply to Coverage A, unless they are inconsistent with any provisions of this policy.

 

3.  The amount we will pay is limited as described in Limits of Insurance.

 

Like excess-only liability policies, Coverage A is designed to follow the form of, and apply on the same basis as, the underlying primary policies. However, while such coverage is often referred to as "following form," it is dangerous to assume that it follows the terms and conditions of the underlying policies in every way. In most instances, coverage only follows the form of underlying coverage where the terms and conditions of the primary and umbrella policies do not conflict. Where there is a conflict of terms and conditions, the umbrella policy will usually govern.

 

Another type of following-form coverage is included in most other umbrella policies that do not utilize the A/B coverage format. This coverage, usually referred to as "drop-down" coverage, is provided by wording such as the following from Century Surety Company:

 

II. LIMIT OF LIABILITY

 

     In the event of reduction or exhaustion of the aggregate limits of liability under said underlying insurance by reason of the payment of damages for "personal injuries," "property damage" or "advertising liability", . . . this policy shall:

 

(1) In the event of reduction, pay in excess of the reduced underlying limits, or

 

(2)  In the event of exhaustion continue in force as underlying insurance subject to all terms and conditions of such underlying insurance, but not for broader coverage than is available under this policy. [EMPHASIS ADDED]

 

Even umbrella policies with such wording do not unequivocally follow the form of underlying coverage. For example, when the umbrella is required to replace exhausted aggregate limits in the underlying insurance, it is often unclear whether the umbrella follows the terms and conditions of the primary policy or the umbrella. Some umbrella forms, however, specifically state that the umbrella's terms and conditions will apply regardless of the scope of underlying coverage.

 

Whatever the umbrella policy's format, tailoring coverage to completely conform with the terms and conditions of underlying coverage can be a difficult task, often requiring many endorsements. The preferred way to assure continuity between primary and umbrella policies is with one broad endorsement designed to eliminate any inconsistencies between the umbrella and primary policy. Such "liberalization clause" or "broad as primary" endorsements in umbrella policies may contain wording similar to that shown below.

 

     In the event that the insured suffers a loss which is covered by the underlying insurance set out in the schedule attached to this policy, the excess of which would be payable under this policy except for terms and conditions of this policy which are not consistent with the underlying insurance, then notwithstanding anything in this policy to the contrary, this policy is amended to follow and be subject to the terms and conditions of such underlying insurance in respect of such loss.

 

The intent of the above wording is to provide coverage that is excess of underlying insurance, no matter how broad the underlying coverage. A request for a "follow-form" endorsement may result in more careful underwriting of the umbrella and perhaps even a request for copies of underlying policies.

 

Besides issuance of a "follow-form" endorsement, umbrella underwriters can use other measures to make the umbrella coverage as broad as the underlying insurance. Umbrella exclusions can be amended to follow form, and restrictions in various policy definitions can be made conditional upon the scope of underlying insurance. However, if underlying coverage is less broad than coverage provided by the umbrella, the overall effect of such measures may be to restrict, rather than expand the umbrella's coverage. A "broad-as-primary" endorsement thus remains the best way to avoid coverage gaps when follow-form coverage is desired. Note, however, that underwriters may not always be willing to issue this broad coverage extension.

 

Since an important reason for purchasing an umbrella policy is to obtain the broadest possible coverage, an umbrella policy that is more restrictive or only as broad as primary insurance fails to perform one of its principal objectives.

 

As usually specified in the insuring agreement(s), the umbrella policy will either "indemnify" or "pay on behalf" of the insured. An example of each type of wording is shown below with the first item from Cincinnati Insurance and the second from Crum & Forster Insurance.

 

     We will indemnify the Insured for ultimate net loss in excess of the retained limit which the Insured becomes legally obligated to pay as damages…

 

     We will pay on behalf of the "Insured" those sums in the excess of the "Retained Limit" which the "Insured" by reason of liability imposed by law, or tort liability assumed by the "Insured" under contract or agreement rior to the "Occurrence", shall become legally obligated to pay as damages for…

 

Policies that indemnify the insured do not require the insurer to make payment to the insured until the insured has first made payment for covered damages or expenses. Thus, a potential disadvantage of indemnity forms is that insureds may have to use their own funds to pay for defense or damages and then seek reimbursement from the insurer. Fortunately, most indemnity policies require only that the insured is "legally obligated to pay" before the insurer is required to make payment. The presentation of bills for legal and investigative costs to the insurer and/or the declaration of a court judgment establish the insured's (and, consequently, the insurer's) obligation to make payment.

 

Under "pay-on-behalf" policy forms, the insurer promises to pay damages on behalf of the insured. The insured does not have to first make payment and then seek reimbursement. Expenses for investigation and defense are normally paid by the insurer as they are incurred.

 

A few umbrella policies do not contain an "indemnify" or "pay on behalf" provision. Instead, these forms provide that the insurer will "pay the loss" or use similar wording. Two examples of this hybrid wording are shown below, the first from Cincinnati Insurance and the second from St. Paul Fire & Marine.

 

We will pay those sums the "insured" is legally obligated to pay as damages…

 

We'll pay amounts any protected person is legally required to pay as damages…

 

Even when wording shown in the two examples immediately above is used, the insurer usually will pay loss on behalf of the insured. However, such ambiguous wording could result in a dispute regarding the timing of the insurer's payment. Endorsements that require the insurer to pay loss on behalf of the insured should be requested whenever the policy's insuring agreement contains ambiguous wording.

 

The insurer's agreement to pay claims and costs on behalf of the insured is generally preferable to a promise to indemnify, reimburse or pay the loss of the insured. Obviously, any insured would prefer that the insurer directly pay all settlements, judgments and costs as they are incurred.

 

In practice, there may be little difference between indemnity, pay-on-behalf and pay-the-loss policy forms. "Loss payable" conditions in most umbrella policies make indemnity policies similar to pay-on-behalf policies.

Property Damage

 

The grant of property damage liability coverage in umbrella policies is usually found in the policy insuring agreements. For coverage to be triggered, the property damage must be caused by an occurrence that takes place during the policy period and in the policy territory, regardless of when the damage occurs. In a few umbrella forms, the occurrence causing the damage and the resulting damage must both take place during the policy period. An example of both types of insuring agreement are shown below, the first from Bituminous Casualty and the second from Fireman's Fund.

 

     We will pay on behalf of the insured the "ultimate net loss" in excess of the "retained limit" because of "bodily injury" or "property damage" caused by an "occurrence" which takes place during the policy period and in the "coverage territory"…

 

1.  We will pay on behalf of any Insured those sums that any Insured:

 

a.  Becomes legally obligated to pay as damages because of:

 

i.   Bodily Injury or Property Damage that takes place during our Policy Period and is caused by an Occurrence;…

 

The property damage insuring agreement may be combined with the bodily injury insuring agreement (as shown in the above examples), or the two insuring agreements may be separate. While there are many minor variations in wording, most current umbrella policies contain property damage insuring agreement wording similar to that used in the ISO-CGL policy forms.

 

In some cases, bodily injury or property damage that manifests itself during the policy period results from an occurrence that took place (or may have taken place) prior to policy inception. Coverage disputes have sometimes developed over which policy should provide coverage—the policy in effect at the time of the original occurrence, or the policy in effect when the injury or damage becomes evident. A similar question can arise over injury or damage that initially occurred prior to policy inception, but which reoccurs during the policy period.

 

The ISO attempted to clarify coverage in such situations by incorporating a "known loss" provision into the 2001 edition of the ISO-CGL forms. Under the provision wording, coverage for bodily injury or property damage that results from an occurrence that took place prior to policy inception is covered, but only if the insured was unaware of the actual or potential injury or damage at the time of policy inception. This is the case even if the claim involves a continuation, change or resumption of bodily injury or property damage that occurs during or after the policy period. Some umbrella insurers have already modified their forms to also incorporate a "known loss" provision, while other insurers may include the provision in an attached endorsement.

 

The scope of property damage liability coverage is governed by the policy's definition of property damage and any applicable exclusions.

 

     To provide coverage at least as broad as the coverage provided by the ISO-CGL policy forms, the umbrella's definition of "property damage" must include three types of property damage:

 

1.  Physical injury to or destruction of tangible property

 

2.  Loss of use of damaged or destroyed tangible property.

 

3.  Loss of use of tangible property that has not been physically injured or destroyed.

 

Unless the umbrella's definition of "property damage" includes all of the above three elements, coverage may not be as broad as underlying ISO-CGL coverage. For example, assume that loss of use of tangible property that has not been injured or destroyed is not included in the umbrella's "property damage" definition. If an occurrence renders tangible property less valuable without causing physical injury or loss of use, the property has only suffered a diminution in value. Since the diminished value was not the result of any physical injury or loss of use, the courts in some states may hold that the loss is not covered by the policy. Most "property damage" definitions in umbrella policies include all three of the elements shown above.

 

Some older umbrella policies contain a different property damage definition as illustrated below:

 

     Injury to or destruction of tangible property, including the loss of use of tangible property.

 

While this definition may appear to be too short to convey broad coverage, note that the word "injury" is not preceded by the word "physical." As a result, this language could be construed to mean that tangible property does not have to be physically injured in order for coverage to apply.

 

Tangible property that has suffered only a diminution in value conceivably could be covered, using the diminished value as a measure of the damages or loss of use caused by an occurrence. However, it is by no means a certainty that the term "injury" will always be construed to cover loss of use of property which has not been damaged or destroyed.

 

Some older umbrella policies may instead contain the following property damage definition:

 

     The term property damage means loss of or direct damage to or destruction of tangible property.

 

Because there is no requirement for physical injury in the above definition, coverage may be found to apply in situations where there is a diminution in the value of tangible property without physical injury or loss of use. In addition, the phrase "loss of" is unclear regarding coverage for the loss of use, whether the property is damaged or not. It is conceivable that this definition could be found to provide coverage for diminished value where there is no physical injury or loss of use, but not for claims involving only the loss of use of property.

 

Personal Injury

 

Nearly all umbrella insurers provide personal injury liability coverage for specified injuries or offenses. In most cases, "personal injury" is listed as one of the insured hazards included in the policy insuring agreements.

 

For coverage to apply, most umbrella forms require the occurrence or offense causing the injury to take place during the policy period and within the coverage territory. It does not matter when the injury actually occurs. An example from Bituminous Casualty of a typical umbrella personal injury insuring agreement is shown below:

 

4. INSURING AGREEMENT

 

a.  This insurance applies to "personal and advertising injury" only if caused by an "offense":

 

(1) Committed in the "coverage territory" during the policy period; and

 

(2) Arising out of your business.

 

Some umbrella policies, however, require the occurrence or offense causing the injury and the resulting injury to take place during the policy period. The requirement that both the occurrence or offense and the resulting injury take place within a specified time (the policy period) results in coverage that is more restricted than coverage provided by the insuring agreement wording shown above. The following is an example from Kemper Insurance of this second form of insuring agreement:

 

     We will pay on behalf of the Insured those sums in excess of the Retained Limit that the Insured becomes legally obligated to pay as damages by reason of liability imposed by law or assumed by the Insured under an Insured Contract because of Bodily Injury, Property Damage, Personal Injury or Advertising Injury covered by the terms of this policy, that takes place during the Policy Period and is caused by an Occurrence…

 

The term personal injury is usually defined in the "Definitions" section of the policy. A few older umbrella forms do not contain a personal injury definition, but instead include a description of covered injuries or offenses in the insuring agreement.

 

Some umbrella policy forms include the term bodily injury in the personal injury definition. However, most umbrellas, particularly those developed following introduction of the 1986 ISO-CGL forms, contain separate bodily injury and personal injury definitions. The purpose of separate bodily injury and personal injury definitions is usually to distinguish between those types of injury that result in physical harm to a person (bodily injury) from those offenses which cause non-physical injury. In some umbrellas, the bodily injury definition may include non-physical injuries such as emotional distress, humiliation and shock. By separately defining the terms bodily injury and personal injury, the insurer may restrict the application of certain exclusions to either type of injury.

 

To understand the scope of personal injury coverage, it is necessary to compare the wording of the umbrella's bodily injury and personal injury definitions to those in the underlying general liability policy.

 

In the 1998 ISO-CGL forms, bodily injury is defined as meaning bodily injury, sickness or disease, including resulting death.

 

Personal injury is then defined in the ISO-CGL policy forms as meaning injury, other than bodily injury, which includes but is not limited to one or more of the following offenses:

 

•    False arrest, detention or imprisonment and malicious prosecution;

 

•    Wrongful eviction and invasion of privacy. Coverage extends to the insured's liability arising out of the conduct of others acting on behalf of the insured;

 

•    The oral or written publication of material that slanders or libels a person's or organization's products or services;

 

•    The oral or written publication of material that violates a person's right of privacy;

 

Consequential bodily injuries, such as emotional distress and mental anguish, are included within the scope of the 1998 ISO-CGL's personal injury definition.

 

The scope of coverage for personal injury in the 1998 ISO-CGL policy is limited by the wording of the "personal and advertising injury" exclusions. The exclusions preclude coverage for personal injury arising out of the following offenses:

 

•    Acts caused or directed by the insured with knowledge that the act would violate another's rights and would inflict personal and advertising injury.

 

•    Oral or written publication of material done with the insured's knowledge of its falsity.

 

•    Oral or written publication of material first published prior to inception of the policy.

 

•    Criminal acts committed or directed by the insured.

 

•    Offenses for which the insured has assumed liability in a contract or agreement. The exclusion does not apply, however, to liability the insured would have in the absence of the contract or agreement.

 

In the 1996 ISO-CGL form, the personal and advertising injury exclusion was expanded to include personal injury resulting from pollution, including the cost of remediation. According to the ISO, this exclusion was added to clarify the original underwriting intent and was prompted by several court decisions that held the policy to cover pollution-related personal injury claims. Some umbrella forms developed after 1996 may also incorporate the additional pollution language.

 

Most umbrellas contain personal injury definitions and exclusions that are similar to the ISO-CGL definition and exclusion . However, the scope of personal injury coverage provided by umbrella policies is almost always broader than the coverage provided under the ISO-CGL policy. Included within the definition of "personal injury" (or, in some cases, within the definition of "bodily injury") in many umbrella policies are one or more of the following injuries or offenses:

 

•    Assault and battery (if to protect persons and property)

 

•    Discrimination (unless coverage is prohibited by law)

 

•    Emotional distress

 

•    Fright

 

•    Humiliation

 

•    Mental anguish

 

•    Mental injury

 

•    Shock

 

Coverage for offenses or injuries such as assault and battery, discrimination, fright, humiliation and shock is usually unique to umbrella policies.

 

A broad definition of personal injury includes the words "personal injury includes but is not limited to," preceding any listing of specified offenses. However, few insurers provide such broad coverage. The alternatives would be to list as many offenses as possible in the definition or to leave the term personal injury undefined.

 

Whenever an umbrella policy does not specifically provide coverage for assault and battery, the definition of personal injury should be amended to specifically include coverage for "assault and battery committed for the purpose of protecting persons and property."

 

When discrimination is included within the definition of "personal injury," coverage may appear quite broad, particularly if the different kinds of discrimination (e.g., racial, sexual, religious) are not listed. However, many umbrellas contain an exclusion that lists the specific types of discrimination the insurer does not intend to cover. Employment-related discrimination is often specifically excluded under the umbrella. Coverage for employment discrimination claims may sometimes be obtained by endorsement to the umbrella policy, or through purchase of a separate employment practices liability (EPL) policy.

 

Territory

Most umbrella policies state the territory over which coverage applies. The policy territory may be specified in the insuring agreement, in a separate section near the beginning of the policy (often found following the defense or limits of liability provisions), in the declarations, or as a policy condition. The location of the wording is not important. A few umbrella forms do not contain a policy territory statement, in which case coverage is presumed to be worldwide.

 

The two most common policy territory provisions are:

 

1.   The policy applies "anywhere in the world" or "worldwide."

 

     Coverage is provided for injury or damage resulting from the insured's covered operations, products, etc., regardless of where the occurrence or offense originates. Worldwide coverage is broader than coverage provided by the ISO-CGL policy forms, which limit coverage to injury or damage originating in the United States, Puerto Rico and Canada .

 

2.  The policy applies anywhere in the world or worldwide, providing a suit for damages is filed within specified jurisdictions.

 

     The policy provides worldwide coverage, but will only respond to suits filed within the specified coverage territory.

 

Limitations of policy territory are sometimes found in the limits of liability section of the policy. For example, some umbrellas may specify that when umbrella coverage drops down to replace exhausted underlying liability coverage, losses arising out of hazards such as products or completed operations will only be covered if the original suit for damages is brought in the United States. Similar restrictions are sometimes found in the umbrella policy defense agreement.

 

Any policy territory limitation means that the umbrella policy does not provide true worldwide coverage. For the insured to have the broadest umbrella coverage, the policy should provide both liability and defense coverage on a worldwide basis, regardless of the nature of the covered loss.

 

Umbrella coverage may sometimes be affected by limitations imposed by local insurance regulations or laws in foreign countries. For example, some countries may prohibit direct payment of loss or defense costs by non-admitted insurers. In such case, the insured must then make payment and seek reimbursement from its insurer. If the insured has an exposure in such jurisdictions, policy territory wording similar to that shown below should be added, if necessary, by endorsement:

 

     In any jurisdiction(s) where the company may be prevented by law or otherwise from carrying out the terms of this insurance, the Company shall reimburse the insured for ultimate net loss and defense expenses incurred with its written consent and in accordance with all other terms and conditions of this insurance.

 

Limits of Liability

 

"Drop-Down" Coverage

 

An important function of umbrella liability insurance is to provide replacement coverage for exhausted underlying insurance. If underlying coverage limits are reduced or exhausted, umbrella coverage should be activated.

 

Many umbrella policy forms contain a provision stating that coverage will drop down to replace reduced or exhausted underlying coverage limits. The provision is often found in the "Limits of Liability" section of the policy, but is sometimes contained in "Other Insurance" or "Maintenance of Underlying Insurance" provisions. Drop-down coverage is one of the characteristics that distinguish excess liability coverage (which does not provide this protection) from umbrella coverage (which usually provides this feature). Some umbrella policies, however, do not contain a drop-down provision.

 

Even when an umbrella policy provides drop-down coverage, it may not be clear whether such coverage applies on the same terms and conditions as the underlying policy, or whether the umbrella's terms and conditions apply. An example of an ambiguous drop-down provision from a Crum & Forster policy is shown below:

 

     If the applicable limits of "Underlying Insurance" or "Other Insurance" are reduced or exhausted by payments from one or more "Occurrences," the Limits of Insurance of this policy will apply in excess of such reduced or exhausted limits.

 

The words "will apply in excess of such reduced or exhausted limits" in the above example do not make the terms and conditions of coverage clear. The following phrase, if added to the above, would eliminate this ambiguity:

 

     …and except for the limits of liability of this policy, shall be subject to all the other terms and conditions of the exhausted underlying policy.

 

Some umbrellas, however, clearly state that drop-down coverage will be governed by the terms of the umbrella, not those of the underlying or primary policy. Consider the following wording taken from an old policy form:

 

     In the event of reduction or exhaustion of an aggregate limit of liability under underlying policies of insurance by reason of losses paid thereunder, this policy subject to its Insuring Agreements, Definitions, Exclusions, Conditions and other terms, shall:

 

(1) in the event of a reduction pay the "ultimate net loss" in excess of the reduced underlying limit of liability; or

 

(2) in the event of exhaustion continue in force as underlying insurance.

 

When the umbrella does not clearly state how coverage applies when the drop-down feature is activated, a coverage dispute may result. Many umbrella underwriters take the position that unless otherwise stated in the policy, the umbrella's provisions take precedence. The courts, who often tend to interpret coverage broadly in favor of the insured, may disagree, particularly if the underlying coverage is broader than the umbrella coverage.

 

The value of any "drop-down" provision is always limited if the umbrella coverage is not at least as broad as the underlying policy. When the coverage afforded by the umbrella is broader than underlying coverage, having the umbrella "drop down" on its own terms is desirable.

 

The drop-down feature of most umbrella forms is triggered by the exhaustion of underlying coverage limits by payment of losses that occur during the policy period. When the policy effective and expiration dates of underlying liability and umbrella policies are not concurrent (i.e., the same), a potential coverage gap can exist.

 

To illustrate, assume that a primary general liability policy is written for the term January 1, 2001 to January 1, 2002. Assume also than an umbrella policy is written for an annual term beginning June 1, 2001 and that it applies excess of the underlying policy's $1,000,000 policy aggregate limit. If the underlying coverage aggregate was reduced by $250,000 following payment of claims occurring prior to June 1, 2001, the required $1 million underlying aggregate limit would no longer exist. Rather, the underlying aggregate would be only $750,000. Depending on how the umbrella's drop-down provision and "underlying insurance" condition are worded, there could be a $250,000 uninsured gap in coverage.

 

Whenever possible, primary and umbrella liability policies should be written for the same policy periods. When such concurrency of policy periods is not possible, insureds should consider purchase of additional underlying aggregate limits. This is especially true if the underlying aggregate limits are likely to be significantly reduced by claims occurring prior to inception of the umbrella's coverage. Umbrella insurers usually make such practice mandatory by specifying minimum underlying aggregate limits that must be in place as of the umbrella's inception date.

 

In the past two decades, more than 36 insurance companies have declared bankruptcy or been ruled insolvent by insurance regulators. An insurer's financial solvency should therefore be an important concern for insureds.

 

Because umbrella policy forms may not always clearly state how coverage is intended to apply in the event of an underlying insurer's insolvency, the courts have become increasingly involved in resolving such disputes. Since court rulings often vary from state to state, the confusion continues. The following discussion addresses the issue of insolvency as respects umbrella and excess policies and how they respond to the insolvency of underlying insurers.

 

Many umbrella policies limit their payment to loss that is in excess of the limits of underlying insurance scheduled in the umbrella's declarations. In addition, many umbrella policies drop down to provide coverage in excess of exhausted underlying limits. But what if underlying coverage is not payable for reasons other than exhaustion of policy or aggregate limits?

 

Most umbrella policies state that they will drop down and replace aggregate limits reduced or exhausted "by reason of losses paid" thereunder. Since the payment of losses is not the reason underlying aggregates are no longer available in an insolvency situation, some courts have ruled there is no obligation for the umbrella to drop down.

 

Umbrella insurers also sometimes rely on the policy's "maintenance of underlying insurance" condition, which typically reads as follows, using a Harleysville Insurance Company policy:

 

     You shall maintain in force the insurance afforded by each policy listed in the Schedule of Underlying Insurance in the Declarations for the full term of this insurance. The terms, conditions and endorsements of "underlying insurance" will not materially change and renewals or replacements of "underlying insurance" will not be more restrictive in coverage. Limits of "underlying insurance" will not be reduced except for any reduction or exhaustion of the aggregate limit(s) of insurance due to the payment of claims or defense.

 

     If you fail to comply with the above, this insurance is not invalidated. However, in the event of a loss, we will pay only to the extent that we would have paid had you so complied.

 

The above wording requires that the insured maintain the scheduled underlying coverage limits except for any reduction in aggregate limits "…due to the payment of claims or defense." In the event of a failure on the part of the insured to do so, coverage is intended to apply as if such coverage had been maintained.

 

However, a court looking for an ambiguity might consider that an underlying insurer's insolvency is not a failure by the insured to maintain underlying limits. As a result, the underlying insurance condition may not act to preclude a finding that the umbrella must provide coverage in place of an insolvent underlying insurer.

 

Umbrella clauses which might be considered ambiguous by the courts with respect to providing coverage above an insolvent underlying insurer include the following:

 

1.  The language used in the "other insurance" condition in some umbrella forms states that the umbrella coverage applies excess of other "collectible" insurance. A court could interpret this to mean that the umbrella applies excess of scheduled underlying insurance, even if that underlying insurance is partially or fully uncollectable due to insolvency of the insurer.

 

2.  A few older umbrella forms state that coverage applies excess of the "amount recoverable" under the scheduled underlying insurance. In the absence of any other reference to insolvency of the underlying insurer in the policy, this wording could make it easier for a court to require the umbrella to drop down and replace the insolvent underlying policy whose limits cannot be recovered.

 

The effect of ambiguous drop-down policy wording is illustrated by a case decided by the Massachusetts State Supreme Court. In applying the doctrine of reasonable expectations, the court ruled that when an umbrella policy is ambiguous as respects insolvency situations, it must drop down and pay claims within the insolvent primary insurer's layer of coverage. The umbrella policy in the Massachusetts case stated that the insurer would indemnify the insured for loss in excess of the total limits of liability of underlying insurance. In addition, the policy stated that, if the underlying limit of liability were reduced, the umbrella policy would pay excess of the reduced limit.

 

It was the "excess of reduced limits" wording that the court found to be ambiguous. The court held that, from this wording, a reasonable insured probably would expect the umbrella to respond if the primary insurer were insolvent. In reaching it's decision, the court sidestepped wording in the maintenance-of-underlying-insurance condition of the policy which required the policyholder to maintain underlying limits except for reductions because of injury or destruction.

 

Some older umbrella forms contain a "financial impairment" condition that specifically addresses the issue and states the policy will not drop down to replace underlying coverage lost due to insolvency. An example from RLI is shown below:

 

H. Financial Impairment

 

     …In the event there is diminished recovery or no recovery available to the insured as a result of such financial impairment of any insurer providing scheduled underlying insurance or unscheduled underlying insurance, the coverage under this policy shall apply only in excess of the limits of liability stated in the scheduled underlying insurance or unscheduled underlying insurance. Under no circumstances shall we be required to drop down and replace the limits of liability of a financially impaired insurer. Nor shall we assume any other obligations of a financially impaired insurer.

 

Even in the absence of policy wording such as the above, umbrella insurers usually have no intention of dropping down to cover losses not paid by an insolvent underlying insurer. Most courts seem to agree and have found traditional umbrella wording sufficient to defeat any such expectation by insureds.

 

Unlike umbrella policies designed to provide higher limits and often broader coverage than the underlying policies, excess policies are generally designed to provide coverage excess of a specified coverage amount. As such, most excess policy forms do not contain a drop-down provision. If the underlying insurer becomes insolvent, it may be unclear in some instances whether the excess policy will drop down to assume the underlying insurer's liability for loss payment. For example:

 

1.  Some excess forms state that the policy applies excess of and after all scheduled underlying insurance has been exhausted. However, the word "exhausted" may not always be defined in the policy. A court may or may not construe the underlying insurer's insolvency to mean its limits have been "exhausted."

 

2.  Some excess forms state that liability attaches only after the underlying umbrella insurer(s) have paid or "have been held liable to pay" the full amount of their ultimate net loss liability. An insolvent underlying insurer may be held liable to pay while being unable to do so.

 

3.  Other excess liability forms pay excess of the loss "recoverable" under the underlying insurance. It could be argued that, in the event the underlying insurer becomes insolvent, the excess insurer must pay, since the underlying limits are unrecoverable.

 

However, absent any ambiguous wording, the courts generally hold that an excess policy is designed to be excess over a specific dollar amount and is not intended to provide drop-down coverage, regardless of the amount paid by the underlying insurer.

 

When an underlying insurer becomes insolvent, the umbrella could be required to defend claims tendered by the insured to that underlying insurer. However, whether the umbrella insurer is obligated to assume defense on behalf of an insolvent insurer depends on a number of factors, including policy wording, the facts of the case and previous court decisions in the state deciding the issue. Some state courts have ruled that, under certain circumstances, it would be unfair to make an excess insurer a guarantor of the primary insurer's financial condition. Courts in other states may view the situation differently.

 

In the past, insureds forced to deal with an insolvent primary insurer had little recourse. They had to submit their claims to state guarantee associations which may have had little or no funds available to pay the claims. Insureds that were unable to have their claims paid by the guarantee associations sometimes turned to their agent or broker for financial relief.

 

In many states, if the insurer was licensed and solvent at the time coverage was placed, it was difficult for the insured to allege negligence on the part of an agent or broker placing coverage with an insurer who later became insolvent. Some judicial decisions, however, indicate that a much higher standard of care for agents and brokers has emerged.

 

Though it was overturned on appeal, a 1988 Texas case is an example of this higher standard of care. In that case, a jury found an agent liable for $772,000 in damages suffered by the insured when its insurer became insolvent and unable to pay. The insured experienced an actual loss of $490,000 due to a fire. The state guaranty fund reimbursed only $50,000. The trial court awarded the balance of $440,000 due under the policy plus damages for lost profits ($212,000), lost equity ($100,000) and attorney fees ($20,000).

 

The jury had determined that the agent was negligent in placing and maintaining coverage. This finding came despite the fact that the insolvent insurer had a B+ Rating in Best's Insurance Reports when the coverage was placed and was not declared insolvent until six months after the claim was filed.

 

While the verdict in this case eventually was overturned on appeal, the case illustrates the importance of insurer solvency and financial stability. Had this precedent been upheld on appeal, it may have been harder for agents/brokers to do business with anything but the most financially sound insurers. As a result, only the very large insurers would have benefited at the expense of the hundreds of smaller insurers which may have been unfairly deprived of business. This reduction in business could actually have increased insolvencies among these smaller insurance companies.

 

For insureds, it is best to avoid the cost and hazards of potential litigation by purchasing coverage from financially strong insurers. Agents and brokers can provide valuable service in this area. To protect themselves, agents and brokers should undertake and document a thorough investigation of a proposed insurer's financial status before placing or renewing coverage.

 

Ultimate Net Loss

 

Many umbrellas contain a definition of ultimate net loss. Such definitions are important because they normally describe the types of payments that the policy covers or excludes.

 

There is wide variation in the wording of ultimate net loss definitions, as illustrated by the examples below from Cincinnati Insurance, Harleysville Insurance, and Bituminous Casualty, respectively:

 

     "Ultimate net loss" means the sum actually paid or payable in the settlement or satisfaction of the insured's legal obligation for damages, covered by this insurance, either by adjudication or compromise. "Ultimate net loss" does not include Defense and Supplementary Payments as described in SECTION I.C. of this policy.

 

     "Ultimate net loss" means the sum actually paid or payable due to a claim for which the insured is liable either by a settlement to which we agreed or a final judgment. Such sum will include proper adjustments for recoveries and salvage.

 

     "Ultimate net loss" means the total amount of damages for which the insured is legally liable in payment of "bodily injury," "property damage," "personal injury" or "advertising injury." "Ultimate net loss" may be established by adjudication, arbitration, or a compromise settlement to which we have previously agreed in writing. "Ultimate net loss" shall be reduced by any recoveries or salvages which have been paid or will be collected, but the amount of "ultimate net loss" shall not include any expenses incurred by any insured, by us, or by any "underlying insurer."

 

Some definitions of ultimate net loss include only damage or settlement awards paid or payable by the insured. Expenses, such as the cost of defense, investigation and attachment bonds, may be specifically excluded or they may not be mentioned at all. Even if the definition excludes or is silent regarding defense expenses, it cannot be assumed that such costs will be paid in addition to the policy's limit of liability. Often, payment of such expenses is addressed under separate policy defense provisions.

Some definitions of ultimate net loss include defense costs and expenses. When defense costs and expenses are considered to be loss, such expenses normally reduce the amount available under the policy for payment of bodily injury, property damage, personal injury and advertising injury claims.

 

Some definitions of ultimate net loss state that the policy will pay sums in excess of the insured's self-insured retention (SIR). The costs encompassed by the definition are then subject to the required retention.

 

Nearly all definitions of ultimate net loss exclude amounts recoverable as subrogation and salvage, and/or any amounts payable by other (including underlying) insurance.

 

Because ultimate net loss usually reduces the policy's per-occurrence and aggregate limit of liability, the definition should be carefully reviewed. However, the definition often does not present the entire picture as respects amounts payable under the policy. Other policy provisions, such as limits of liability and defense, also must be reviewed to determine the full scope of coverage provided.

 

Also, whenever defense costs are included in the definition of ultimate net loss, consideration should be given to purchasing higher policy limits in order to provide sufficient coverage for both losses and defense expenses.

 

Persons Insured

 

Generally

 

General and umbrella liability policies always specify those individuals and entities to which coverage applies. Many umbrella forms include a "Who Is An Insured" section in which the covered persons and entities are identified. Most umbrellas also define terms such as "Insured" and "Named Insured" to further clarify how coverage applies to the various persons or entities insured under the policy.

The wording of the "Who Is An Insured" section of many umbrella forms is similar, though usually not identical, to the wording contained in the 1986 and later versions of the ISO-CGL forms.

The following is an example "Who Is An Insured" section wording taken from an umbrella policy from Cincinnati Insurance:

 

     SECTION II – WHO IS AN INSURED

 

f.   If you are designated in the Declarations as:

 

a.  An individual, you and your spouse are insureds, but only with respect to the conduct of a business of which you are the sole owner.

 

b.  A partnership or joint venture, you are an insured. Your members, partners, and their spouses are also insureds, but only with respect to the conduct of your business.

 

c.    A limited liability company, you are an insured. Your members are also insureds, but only with respect to the conduct of your business. Your managers are insureds, but only with respect to their duties as your managers.

 

d.  An organization other than a partnership, joint venture, or limited liability company, you are an insured. Each of the following is also an insured:

 

(1) Any subsidiary company of such organization, including any subsidiary company thereof:

 

     (a)       Existing at the effective date of this policy; or

 

     (b)       Acquired during the policy period.

 

(2) Any other company controlled and actively managed by such organization or any such subsidiary:

     (a)       At the effective date of this policy; or

 

     (b)       If the control and active management thereof was acquired during the policy period.

 

g.   Each of the following is also an insured:

 

a.  Any "executive officer", director, "employee" or stockholder of yours while acting within the scope of their duties as such.

 

b.  Any person, organization, trustee or estate with respect to which you are obligated to written contract to provide insurance such as is afforded by this policy, but only with respect to operations by or on behalf of you or property owned or used by you.

 

c.   Any person or organization while acting as your real estate manager.

 

d.  Any person or organization having proper temporary custody of your property if you die, but only:

 

(1) With respect to liability arising out of the maintenance or use of that property; and

 

(2) Until your legal representative has been appointed.

 

e.   Your legal representative if you die, but only with respect to duties as such;

 

f.   At your option, and subject to the terms of the coverage of this insurance, any additional insureds covered in the "underlying insurance" listed in the Schedule of Underlying Policies, but only to the extent that insurance is provided for such additional insureds thereunder.

 

     No person or organization is an insured with respect to the conduct of any current or past partnership, joint venture, or limited liability company that is not shown as a Named Insured in the Declarations.

 

With respect to the permissive use of autos, the "Who Is An Insured" section of some older umbrella policies also includes wording similar to that contained in the standard ISO Business Auto Policy (BAP) form. An example of this additional wording from Markel American Insurance is shown below.

 

C.  With respect to:

 

1.  An "auto"; or

 

2.  "Mobile equipment" registered in your name under a motor vehicle registration law;

 

     Any person is an insured while driving such "auto" or "mobile equipment" along a public highway with your permission.

 

     Other persons or organizations responsible for the conduct of such person(s) are also insureds, but only for their liability due to the operation of the "auto" or registered "mobile equipment."

 

     However, the owner or anyone else from whom you hire or borrow an "auto" is an insured only if that "auto" is a trailer connected to an "auto" owned by you.

 

     But no person or organization is an insured under this paragraph C. for:

 

1.  "Bodily injury" to a co-employee of the person driving the "auto" or "mobile equipment"; or

 

2.  "Property damage" or property owned by you or the employer of a person who is an insured under this provision; or

 

3.  An "auto" you hire or borrow from one of your partners, or "employees," or members of their households, if they are the owner of such "auto"; or

 

4.  An "auto" being used by a person employed in the business of selling, servicing, repairing, or parking "autos" unless they are your "employees"; or

 

5.  The movement of property to or from an "auto" except you. [sic] your "employees," partners, lessees, or borrowers of such auto and employees of the lessees or borrowers.

 

D. Any organization you newly acquire or form, other than a partnership, joint venture, or "limited liability company," and over which you maintain ownership or majority interest, will be deemed to be a Named Insured. However:

 

1.  Coverage under this provision is afforded only until the 90th day after you acquire or orm the organization or the end of the policy period, whichever is earlier;

 

2.  Coverage is applicable only in excess of the limits of the "underlying insurance" as shown in the Schedule of Underlying Insurance. You must add such organization to your "underlying insurance" as soon as possible, advising us of such additions. We may then make adjustment of premium charges.

 

3.  Coverage A does not apply to "bodily injury" or "property damage" that occurred before you acquired or formed the organization; and

 

4.  Coverage B does not apply to "personal injury" or "advertising injury" due to an "offense" committed before you acquired or formed the organization.

 

E. No person or organization is an insured with respect to the conduct of a current or past partnership, joint venture, or "limited liability company" that is not shown as a Named Insured in the Declarations.

 

Some umbrella policies do not include a separate "Who Is An Insured" section. In these forms, the "Insured" and "Named Insured" definitions specify the persons and organizations granted coverage under the policy.

 

In umbrella policies that utilize the A/B coverage format, the definition of "Insured" under Coverage A (excess coverage) may state that coverage applies to the same persons and entities covered by underlying insurance. The Coverage B (umbrella coverage) section may then contain an abbreviated version of the ISO-CGL's "Who Is An Insured" section.

 

A feature common to many umbrella forms is the automatic extension of coverage to other parties to which coverage is extended (i.e., additional insureds) in underlying policies (part B.5. in the above example), or when such extension is required by contract. The contractual extension can be added to the standard ISO-CGL policy by endorsement, on either a per-entity or blanket basis. Some umbrella forms limit their liability for such contractual agreements to the amount specified in the contract. Such limitation is usually by endorsement.

 

The protection afforded by the umbrella policy to the "named insured" is often different, and broader, than that provided to an "insured" (which includes additional insureds). For example, as respects auto or aircraft coverage, some umbrellas state coverage applies to "named insureds." Use of the word "named" limits coverage to those insureds specifically listed on the policy. Coverage may then not apply to other additional insureds that are not specifically listed. The first named insured is usually the entity designated to be responsible for premium payment and to give or receive notices of cancellation. Other policy provisions, such as exclusions, severability of interests (cross liability) clauses and policy assignment conditions also may affect an "insured" differently than a "named insured."

 

As a general rule, most current umbrella policies extend coverage to the following persons and entities:

 

•    The Named Insured organization (as shown on the Declarations)

 

•    Individuals (if a sole proprietorship)

 

•    Partnerships and Joint Ventures, but only if specifically listed on the Declarations page

 

•    Limited Liability Companies, although a special endorsement is sometimes needed to achieve this extension

 

•    Officers, Directors and Stockholders (and, in some policies, trustees with respect to their duties as such)

 

•    Employees (and, in some policies, volunteers)

 

•    New Acquisitions and Subsidiaries

 

•    Additional insureds that are covered by underlying insurance

 

Additional Insureds

 

Coverage provided by most umbrella policies can be extended to persons or organizations that do not otherwise qualify as "insureds" under the policy. These "additional insured" entities, such as property or equipment lessors, are typically added to underlying general liability and some umbrella policies by endorsement. Additional insureds can be added on either an individual or blanket basis. Unlike the terms "named insured" and "insured," "additional insured" is a rarely defined term in umbrella policies.

 

When the umbrella policy provides blanket coverage for entities that are additional insureds on underlying policies, the wording of this coverage extension is usually found in the "Persons Insured" or "Who Is An Insured" section of the policy. In umbrellas that do not contain a "Persons Insured" or "Who Is An Insured" section, the provision may be contained in the definition of "Insured." The following from Cincinnati Insurance is representative of this additional insured coverage wording:

 

     SECTION II — WHO IS AN INSURED

 

f.   At your option and subject to the terms of the coverage of this insurance, any additional insureds covered in the "underlying insurance" listed in the Schedule of Underlying Policies, but only to the extent that insurance is provided for such additional insureds thereunder.

 

While most umbrellas grant coverage to additional insureds on underlying policies, the scope of coverage is normally no greater than that provided by the underlying insurance.

 

Some older umbrella forms provide blanket liability coverage for additional insureds only if such liability is assumed by the insured under a written contract. An example of this wording from Crum & Forster is shown below:

 

     III. NAMED INSURED AND INSURED

 

2.  any person or organization, trustee or estate that has obligated you by written contract to provide the insurance that is afforded by this policy, but only with respect to liability arising out of "Your Work", "Your Product" and to property owned or used by you;

 

As stated in the above example, the coverage extension is limited to liability arising from the insured's work, the insured's products, and property owned or used by the insured.

 

Some umbrella forms restrict the amount of contractually-assumed liability to the coverage limits required by the contract. An example of this wording from RLI is shown below.

 

     SECTION IV. INSURED

 

     Each of the following is an insured under this policy to the extent set forth below:

 

     Any person or organization, as to which an insured is required, by virtue of a written contract entered into prior to an occurrence, to provide the kind of insurance that is afforded by this policy, but only with respect to operations by or on an insured's behalf, or to facilities an insured owns or uses, and only to the extent of the limits of liability required by such contract, but not to exceed the applicable limits of liability set forth in this policy and only if such occurrence is also covered by scheduled underlying insurance.

 

A few older umbrella policy forms subject coverage for additional insureds to a condition captioned "Additional Insureds in Underlying insurance". In these forms, the condition typically requires that the umbrella insurer be notified when additional insureds are added to underlying policies, presumably so that an appropriate premium charge may be made. Such conditions sometimes state that automatic coverage for additional insureds ceases after a specified period unless the underwriter is not notified of their existence.

 

Many current umbrella policies that utilize the A/B coverage format automatically extend Coverage A (excess coverage) to any persons or entities insured by underlying coverage, but do not provide the same extension under Coverage B (umbrella coverage). In such cases, umbrella coverage for additional insureds must be specifically added by endorsement.

 

The protection afforded by most umbrella policies to the "named insured" is usually different than that provided to other "insureds," including additional insureds. For example, as respects permissive use of autos or aircraft coverage, coverage is often broader for the named insured than for other insureds. Other policy provisions may also affect insureds differently than named insureds.

 

Cross Liability

 

Many umbrella policies contain a "severability-of-interests" or "cross-liability" provision. Usually contained in a condition captioned "Severability of Interests" or "Separation of Insureds," such provisions state that the policy's coverage applies to each insured separately but that only the one policy limit applies.

 

Although the caption may differ, the wording of the severability-of-interests provision in many umbrella policies is similar to the wording used in the 1986 and later ISO-CGL forms. An example from Kemper Insurance is shown below:

 

     Separation of Insureds

 

     Except with respect to our Limits of Insurance and any rights or duties specifically assigned in this Coverage Part to the first Named Insured designated in Item 1. in the Declarations, this insurance applies:

 

     As if each Named Insured were the only Named Insured; and

 

     Separately to each Insured against whom claim is made or "suit" is brought.

 

     Umbrella underwriters sometimes attach a "cross-suits" exclusion endorsement to policies covering more than one insured. Such endorsements may apply as respects cross suits between named insureds (only), or between any insureds. A typically-worded cross-suits exclusion is shown below:

 

     This policy does not apply as respects any suits brought against any insured under this policy by or on behalf of any other insured under this policy.

 

Cross-suit exclusions are undesirable because they usually not only preclude coverage for loss, but for defense as well.

 

A cross-liability exclusion is especially undesirable when an insured organization consists of multiple entities, each having different ownership . An example is a real estate development firm which serves as the general partner and creates limited partnerships or joint ventures to finance new property acquisitions or development. Each entity may thus include different limited partners or stockholders. Circumstances may arise that result in the general partner having to file suit against one of the partnerships/joint ventures, or vice versa.

 

To illustrate a cross-suit situation, consider the following scenario. A parent firm owns 51 percent of Corporation A (49 percent is publicly held) and 51 percent of Limited Partnership B (49 percent is owned by unrelated limited partners). Limited Partnership B is damaged as a result of an auto accident caused by employees of Corporation A. The directors and officers of the parent company, which controls 51 percent of the injured Limited Partnership B, may have a fiduciary duty to their minority limited partners to file suit against Corporation A to recover damages caused by Company A's employee.

 

As a result of the suit, the officers and directors of the parent firm are faced with a dilemma. If they do not initiate a suit against Corporation A, they may face a liability suit from the minority owners of Limited Partnership B. Conversely, if the parent firm files suit and the umbrella policy covering all of the entities contains a cross-liability exclusion, there would be no coverage (including that for defense) for Corporation A.

 

Whenever the named insured organization consists of multiple entities, an attempt should be made to remove any cross-suits exclusion from the umbrella policy. If the exclusion cannot be removed, consideration should be given to purchasing separate insurance for each named insured entity.

 

Employees

 

Employers typically have a liability exposure resulting from acts of their employees, particularly those employees that interact with the public as part of their job duties. The extension of liability coverage to employees themselves is often considered by employers to be a worthwhile benefit to the employer. Employees that have the benefit of the employer's general liability coverage are probably less likely to cooperate with a third-party claimant than would be the case if they were uninsured.

 

Most general liability and umbrella policies extend coverage to an organization's employees with respect to their duties in conduct of the named insured's business. In the 2001 ISO-CGL, coverage for employees is described in the policy's "Who Is An Insured" section. Under wording of that section, employees (defined in the policy as including leased workers but not temporary workers) other than executive officers, volunteers and managers of limited liability companies are insureds as respects acts within the scope of their employment or while performing duties related to conduct of the insured's business. A volunteer worker is defined in the 2001 ISO-CGL as being a person who is not the insured's "employee," who donates his or her time, who works at the direction of and for the insured, and who receives no compensation from the insured or anyone else. Some umbrella policies developed in response to the 2001 ISO-CGL may contain a similar extension of coverage.

 

Employees are not insured for bodily injury or property damage to a co-employees while the co-employee is the course of employment or while performing duties related to conduct of the insured's business. They are also not insured for bodily injury or property damage to partners or members of joint ventures, partnerships or limited liability companies. Employees are not considered insureds as respects bodily injury or personal injury arising from the provision or failure to provide professional health care services. Unlike employees, however, volunteers can still seek coverage under the policy if they are injured by a co-employee who is driving the insured's mobile equipment. Also, the injury-to-employees exclusion under Coverage C (Medical Payments) also does not apply to volunteer workers under the 2001 ISO-CGL.

 

The ISO-CGL wording also precludes coverage for employees who damage property that is owned, occupied or used by the named insured, that is rented to, in the care, custody or control of the insured, or over which the insured, its employees partners or members (if the insured is a partnership, joint venture or limited liability company) is exercising physical control.

 

By adding a definition of employee to the 1993 ISO-CGL revision, and by including leased workers within the definition, the ISO resolved a previous coverage ambiguity. Before introduction of the definition, it was sometimes unclear if the policy extended the same coverage to leased workers as to regular employees. Now, it is clear that leased workers are considered the same as regular employees for purposes of ISO-CGL coverage.

 

However, addition of the "employee" definition also eliminated coverage for the named insured as respects bodily injury or personal injury to leased workers. The ISO-CGL policy's fellow-employee exclusion now applies as respects leased workers as well as to regular employees.

 

Like the ISO-CGL forms, most umbrella forms provide coverage for employees while performing duties on behalf of the named insured's business. However, because of the additional exposures covered by umbrella contracts, such as automobiles, nonowned aircraft and nonowned watercraft, employee coverage is broader in umbrella policies than under standard CGL policies. For example, most umbrellas extend coverage to employees while permissively using automobiles owned, leased or rented to the insured and which are covered under the insured's business auto policy. However, umbrella coverage is typically excluded as respects employees who use their own vehicles, even if they do so in the conduct of the insured's business. Coverage for employees using their own vehicles in conduct of the insured's business can be obtained by endorsement to the standard business auto policy.

 

A few older umbrellas cover employees only with respect to their permissive operation of mobile equipment on public highways. Such a provision is excessively restrictive, and fortunately no longer common. In addition, some umbrella forms extend coverage to employees of additional insured organizations, but only if similar coverage is granted in underlying policies.

 

Umbrella coverage for employees should always be at least as broad as the coverage provide by underlying insurance. However, it should not be assumed that employees (including leased workers) are fully covered under standard general liability and umbrella forms as respects all exposures. As is the case with executive officers, various policy provisions, exclusions and definitions in the umbrella policy can restrict or broaden coverage for employees. Where coverage is found to be insufficiently broad, an attempt should be made to add the desired coverage by endorsement.

 

Limited Liability Companies

 

Prior to 1996, coverage under the ISO-CGL and most umbrella policy forms was afforded to only three principal categories of business entity as named insureds. The entities were: (1) sole owners of the business, (2) partnerships or joint ventures (if named on the declarations), and (3) organizations other than a partnership or joint venture. As respects entities other than partnerships or joint ventures, coverage extended to the organization's officers, directors and shareholders.

 

In the early 1990s, a relatively new corporate structure, the Limited Liability Company (LLC), began to emerge. The LLC is not a corporation, nor is it a partnership or joint venture. Having no "directors" or "shareholders," LLCs are designed to provide certain tax and liability advantages as compared to ordinary corporations. Like corporations, however, LLCs shield the personal assets of their owners in the event the company is faced with economic loss. LLCs provide their owners with statutory immunity from any debt obligation of the company. The LLC has no tax liability itself, because income is distributed to the owners, who are then taxed individually.

 

It was somewhat unclear if coverage under the 1993 and prior ISO-CGL policy forms, as well as other general liability forms and endorsements, extended to limited liability companies. In 1996, however, new language was introduced to the "Who Is An Insured" section of the ISO-CGL forms to clarify the insurer's coverage intent. The new wording specifically recognizes limited liability companies and their members and managers as insureds.

 

The new wording falls short of affording an LLC the same status as a corporation. There is no automatic coverage for newly formed or acquired LLCs. Also, no person or organization is an insured with respect to the conduct of any current or past LLC unless that person or organization is specifically listed as an insured in the policy declarations. As respects acquisitions or past conduct, the LLC is given the same status as that of a partnership or joint venture. Many umbrellas developed in response to the 1996 ISO-CGL forms treat limited liability companies in the same manner.

 

Besides the added reference to limited liability companies, a definition of executive officer was added to the 1996 ISO-CGL forms. Under the new definition, executive officer means a person holding any of the officer positions created by the organization's charter, constitution, by-laws or "…similar governing document."

 

The executive officer definition wording may make coverage unclear as respects members of LLCs, since many LLCs are governed by articles of organization that do not recognize the typical executive officer titles. However, the courts may find that the phrase "or…similar governing document" indicates the insurer's intent to cover LLC members to the same extent as a corporation's executive officers.

 

In practice, many umbrella insurers treat LLCs the same as corporations and their members and managers are afforded the same coverage as a corporation's executive officers. However, this may not always be the case. When coverage for LLCs is required, the wording of the "Who Is An Insured" sections of both the underlying and umbrella liability policies should be reviewed carefully. If coverage as respects LLCs is unclear, the insurer's intent to provide such coverage should be clarified by endorsement.

 

New Acquisitions/Subsidiaries

 

Standard general liability policies typically extend coverage to newly formed subsidiaries and other entities that come under the control or active management of the named insured. Umbrella policies usually provide a similar coverage extension, as illustrated by the following wording from a Bituminous Casualty policy:

 

     Any organization, you newly acquire or form, other than a partnership, joint venture, or limited liability company, and over which you maintain ownership or majority interest, will qualify as a Named Insured if there is no other similar insurance available to that organization. However:

 

(a) Coverage under this provision is afforded only until the 90th day after you acquire or form the organization or the end of the policy period, whichever is earlier;

 

(b) Coverage is applicable only in excess of the limits of "underlying insurance" as shown in the Declarations Page, and you must add such organization to your "underlying insurance" as soon as practicable, advising us of such additions. We may then make adjustment of premium charges as called for in Condition 9. Maintenance of Underlying Insurance.

 

(c)  Coverage does not apply to "bodily injury" or "property damage" that occurred before you acquired or formed the organization; and

 

(d) Coverage does not apply to "personal injury" or "advertising injury" arising out of an "offense" committed before you acquired or formed the organization.

 

Under the above wording, the automatic coverage extension does not apply as respects partnerships, joint ventures or limited liability companies. These types of entities usually must be specifically added to the policy for coverage to apply.

 

In the ISO-CGL forms, the automatic coverage is only valid for 90 days, or until the end of the policy period (whichever is less). Many umbrella forms contain a similar provision, although the time period may vary from 30 days to 120 days or more. Both primary liability and umbrella insurers include the time limitation so that insureds will notify them of the change in operations. Upon notification, the insurer may then continue coverage, usually for an additional premium, or limit coverage for the new entity by endorsement. A few umbrellas do not specify a time limitation for automatic coverage.

 

Automatic coverage is limited, as such coverage does not normally apply as respects occurrences or offenses that took place prior to the acquisition or formation of the new entity. Obviously, insurers do not wish to assume unknown past liabilities. Coverage also only applies to the extent there is no other similar insurance available to the new organization.

 

Unlike the ISO-CGL forms, some umbrellas specifically state the insurer is to be notified of any newly acquired or formed entities. Notification must be made within a specified time period, or the policy may require "prompt" notice of the new operations. Wording that requires "prompt" notice is undesirable, since the term "prompt" is ambiguous and could lead to a potential coverage dispute. An "as soon as practicable" notification requirement is preferred.

 

Some umbrellas automatically extend coverage to all subsidiaries or organizations under the control or active management of the named insured stated in the Declarations. Such policies may not require the formal addition of the newly formed/acquired entity to the policy. However, the wording of the policy's automatic coverage extension should be closely reviewed before assuming that no reporting is required.

 

A few umbrella policies do not provide automatic coverage extension for newly formed or acquired organizations. When the policy does not provide automatic coverage for new entities, each new entity for which coverage is desired must be specifically listed on the policy for coverage to apply.

 

Because the duration of automatic coverage for newly formed/acquired entities varies among insurers, the wording of the umbrella's coverage extension provision should be compared to the wording of the underlying general liability policy. Where the provisions differ between policies, they should be made similar by endorsement. Also, in order to avoid potential misunderstandings and coverage disputes, it is recommended that great care be taken to list all of the insured's subsidiaries and newly-formed organizations on all liability policies.

 

Officers, Directors and Stockholders

 

Standard general liability and umbrella policies typically extend coverage to officers, directors and stockholders of the named insured organizations, unless the insured is a partnership, joint venture or limited liability company. However, in the 2001 ISO-CGL forms, the extension of coverage is limited to executive officers, directors and trustees while performing their duties as officers, directors or trustees, and to the organization's stockholders with respect to their liability as stockholders.

 

Reference to limited liability companies in the ISO-CGL's form was added with the 1993 form revision. Previously, it was unclear if coverage extended to such organizations, as they are typically controlled and operated by "partners" and "members" rather than by directors and officers. The new wording specifically recognizes limited liability companies and their members and managers as insureds. Many umbrella forms developed in response to the 1993 ISO-CGL revision contain a similar provision.

 

The meaning of the term executive officer is significant, as these persons are exempt from the ISO-CGL policy's fellow-employee injury exclusion. In the 1986 and 1989/90 ISO-CGL forms, it was unclear whether the executive officer exception to the exclusion extended to other key management persons. Because the term "executive officer" was undefined, insureds were sometimes able to argue that company managers and supervisors were "officers," and therefore entitled to coverage for alleged bodily injury or personal injury to employees.

 

To prevent a broad interpretation of the executive officer exemption from the policy's fellow-employee exclusion, the ISO added a definition of executive officer with the 1993 ISO-CGL revision. Under the new definition, an executive officer is a person holding any of the officer positions created by the insured's charter, constitution, by-laws or similar governing document.

 

Managers and supervisors are not covered as executive officers unless their titles are listed in the insured organization's governing documents. The 1993 ISO-CGL revision thus resulted in a potentially significant reduction in coverage for managers, supervisors and other middle and top management personnel who now are specifically not encompassed by the executive officer definition.

 

Some umbrella policies issued in response to the 1993 ISO-CGL revision include a similar definition of executive officer. However, some umbrellas do not contain the definition, thereby potentially providing middle and top management personnel with coverage for claimed injury to fellow employees.

 

Officers and directors are covered only with respect to bodily injury, property damage, personal injury and advertising injury coverages provided by the policy. The standard ISO-CGL, and most umbrella policy forms, are not intended to encompass exposures resulting from wrongful acts such as breach of duty or poor decision-making. These wrongful acts are more properly covered by directors and officers liability policies.

 

A few umbrella forms contain a broad exclusion that precludes coverage for liability arising out of wrongful acts, such as breach of duty of directors and officers. An example of this exclusion wording from an American States Insurance Company policy is shown below:

 

     SECTION III. – EXCLUSIONS

 

P.  Any wrongful act, error, omission or breach of duty by any insured in the performance of the office of director or officer of any organization.

 

In the absence of a definition of "wrongful act" or "breach of duty," the above wording could be interpreted by the courts as removing some or all of the protection potentially afforded these persons under the umbrella policy. It therefore could eliminate the coverage insureds need and expect when they purchase an umbrella policy. If a suit alleging personal injury, property damage or advertising injury is filed against a company's officers or directors, the umbrella policy should respond. For these reasons, an exclusion such as the above should be deleted whenever if possible.

 

Partnerships and Joint Ventures

 

The ISO-CGL policy forms and nearly all umbrella policies cover partnerships and joint ventures, as well as the individual members of such entities. Spouses of the members are also covered, but only as respects to conduct of business operations.

 

For coverage to apply, the ISO-CGL forms, and most umbrella policies, require both past and current partnerships and joint ventures to specifically be listed on the Declarations. Some umbrella policies may not include such a requirement.

 

Having to specify all past partnerships and joint ventures for which coverage is desired can be a burdensome task for an insured. For example, the operations of some insureds, particularly large property developers, include numerous partnerships or joint ventures that were or may be created and terminated at various times in the past or during the policy period.

 

Because of the sometimes large number of entities that must be reported to the insurer, there is the potential that an entity will be inadvertently omitted as a named insured. The omission could result from a typographical or reporting error and may not be discovered until coverage is needed. To avoid a potential coverage gap, great care should be taken to include all past and current partnerships and joint ventures on the policy. If the exposure as respects entities that are no longer in existence is felt to be small, underwriters may include coverage for these entities at no additional premium.

 

There is a good reason why insurers hesitate to extend coverage to unnamed partnerships and joint ventures. The courts in some states have in the past found a joint venture to exist based on the conduct of the parties involved, even though there was never an intent to create such an entity. Coverage could therefore be found for an unnamed joint venture even though its existence was implied by law as opposed to being created by an agreement.

 

An important issue to be considered when dealing with numerous named insured partnerships and joint ventures is that of severability of interests, or "cross liability." Whenever possible, the umbrella policy should provide coverage in the event one insured entity files a cross-suit against another insured entity. Such actions are not uncommon, especially where financial interests of the various parties may overlap.

 

Proprietorships

 

Most standard general liability and umbrella policies grant coverage to individuals who are the sole owner of an insured business entity.

 

Individuals, as sole proprietors, are usually insured only if they are named in the declarations and only with respect to businesses of which they are the sole owner. Thus, it is important to specifically name these individuals on the declarations.

 

Like the ISO-CGL forms, most umbrella policies extend coverage to the spouse of a covered individual, although this is not always the case. Because a sole proprietorship is often a family-run business, any family members who participate in the operation of the business should be added to the policy as additional named insureds by endorsement.