Media attention given to litigation costs involving pharmaceuticals, asbestos and similar products makes it important to be aware of the amount of defense coverage provided in multi-layered umbrella liability insurance programs.
Some excess umbrella insurance policies state that they exactly follow the terms of the "governing" underlying policy, and do not contain any exceptions to this statement. This is the ideal form for an excess umbrella policy. Unfortunately, not all insurance-company-developed forms take this approach. Instead, most state that they follow the terms of the governing underlying policy, but then go on to recite a list of exceptions.
One common exception involves defense. Many excess umbrella policies state that the insurer cannot be called upon to actually provide a defense. However, they include the cost of defense as a reimbursable item, along with indemnity costs. Thus, the policy limit can be applied toward any combination of indemnity and defense.
Some excess umbrella policies state that they cannot be called upon either to provide a defense or to reimburse the insured for defense costs. This arrangement is undesirable, as the underlying aggregate limit may be exhausted, leaving no available limit for the defense of additional claims. This problem can be solved, at least in theory, by a recalculation of the loss totals for each layer as additional defense costs accrue. In effect, the insured would be presenting to the excess umbrella insurer a claim for the indemnity portion of a loss already paid by the first layer umbrella, but which is "pushed up" to the excess layer by additional defense expenses chargeable to the first layer.
Not all excess umbrella policies allow underlying limits to be used for defense. Some policies define loss to exclude defense costs. For example:
Loss does not include investigation, adjustment, defense or appeal costs and expenses not costs and expenses incident to any of the same, notwithstanding that the underlying insurance may provide insurance for such costs and expenses.
The insuring agreement might then use the word loss as follows:
To indemnify the insured for the amount of loss which is in excess of the applicable limits of liability of the underlying insurance…
Taken literally, this policy form recognizes only the indemnity portion of a loss (but not the defense costs), both in application of its coverage and in exhaustion of the underlying limit. As an example, consider how this language would apply to a loss involving a $6 million judgment plus $1 million of defense costs. In this example, the first layer umbrella, with a $5 million limit, defines ultimate net loss to include indemnity and defense costs, as most do. The excess umbrella contains the language quoted above. If the insured submits the $1 million bill for defense to the first layer umbrella, only $4 million is left to apply to the indemnity portion of the claim.
Thus, a gap is created between the two policies equivalent to the amount of defense costs paid by the first-layer umbrella insurer. If the first-layer umbrella is reserved for the indemnity portion of the claim, the insured is no further ahead, as the second-layer policy will not pay defense costs either. Thus, the effect of this language in the second-layer policy is to deny the insured any recovery of defense costs both from the excess umbrella, and from the first-layer policy, for losses that use up the first layer's limit.
This arrangement would affect both defense costs for one catastrophic loss and defense costs for a series of liability claims that exhaust the products liability aggregate limit or other aggregate limits.
One solution to this problem is to request attachment of an endorsement providing true following-form language, which would override all other terms of the excess umbrella policy. If the insurer is unwilling to provide such an endorsement, then this deficiency must be corrected by (1) redefining loss or ultimate net loss (whichever term is used) to match the definition used in the first umbrella layer, or by (2) finding an insurer which has a better policy form.