Even with so-called “following form” excess insurance, when multiple layers of umbrella coverage are needed to attain the desired level of catastrophe protection, there is a heightened potential for coverage gaps. Some of the problems that may be encountered with structuring high excess limits of protection include, but are not limited to, the following:

Following-form excess policies do not always clearly state which underlying form(s) they are following. While these excess forms may provide the same coverage as an underlying policy, it may not be clear which underlying policy they follow in a multi-layered program. Some excess underwriters include their own definitions and exclusions in these so-called “following form” policies. When present, the wording of these definitions and exclusions should be reviewed carefully and, if necessary, modified by endorsement. Even though the underwriter may think the wording of a definition or exclusion is identical to the wording of a definition or exclusion in an underlying policy, differences often exist. As discussed previously, most excess forms that purport to follow the terms of underlying coverage do so only to the extent that there is no conflict between the two forms.

The forms may include different prior insurance and/or non accumulation of liability provisions. Such differences can reduce the amount of coverage available to the insured under any other applicable insurance in effect prior to the subject policy's inception date.

The follow-form excess wording may state that coverage follows the form of a coverage layer other than the first or immediately underlying excess policy. This provision can magnify problems if other coverage layers are inconsistent.

So called ”Self-destruct provisions.” Some excess umbrellas can destruct (i.e., automatically cancel) in at least two ways (and should be avoided if possible):

”Maintenance of underlying insurance” conditions may state that if scheduled underlying insurance is not maintained, the excess policy will cease to apply. Thus, if the insured should switch underlying carriers or if an underlying insurer cancels its policy, the excess insurer may attempt to deny coverage.

The excess form may contain an “automatic cancellation” provision. Such a provision typically states that if the underlying insurance is cancelled, the excess policy is simultaneously cancelled without notice to the insured.

Some excess policies may exclude defense coverage. These policies state that defense expenses will not be included in the definition of “ultimate net loss” and further exclude coverage in the insuring agreements. Because defense costs have the potential to penetrate any excess layer, this language should be avoided. If the excess policy excludes defense costs, and underlying insurers tender their policy limits, the insured could be responsible for all subsequent defense costs.

Some excess policies may prorate defense costs between the insured and the insurer based on each party's proportion of loss payments. This provision is also undesirable. If defense costs are not paid by an underlying insurer, the insured may have to pay a large portion of such costs.

Some excess policies do not obligate the insurer to provide a defense (i.e., they have the right to associate in the defense of a claim, not the duty to control the defense). This is acceptable only if the insurer is required under the policy to pay defense costs as “ultimate net loss” or under some similar policy term.

Some excess forms state that the underlying policy limits can only be exhausted by the payment of claims. Defense costs will not be credited toward exhausting underlying limits.

One method of minimizing coverage inconsistencies when structuring a layered excess program is to make sure that no endorsements are permitted on the excess policies that would result in more restrictive coverage terms than are in the first underlying policy.

Another method of minimizing the difficulties is to have a single “fronting” insurer provide all excess coverage limits. In this case, the insurer may simply issue one policy and arrange for other insurers to share or reinsure the risk, either by providing coverage for one or more layers or by percentage of participation.

Because any deviation from complete following form coverage can result in a potential coverage dispute or gap, each umbrella or excess policy should be endorsed with wording that supersedes and negates all preprinted policy terms and conditions (except the policy term, limits and premium) which are not consistent with the first umbrella or excess policy.

 Umbrella Coverage Depends on the Provisions of the Policy, Not the Label on the Policy

The name or title of the policy is not a determining factor in the scope of coverage provided by an umbrella policy. This can be confusing, and a policy called an “umbrella” may provide coverage that is only as broad or even less broad as the underlying primary insurance. For this reason, it is necessary to look at the substance of the policy to determine the type of coverage provided.

Certain policy provisions are indicative of umbrella coverage, irrespective of the name or title of the policy. Such provisions include coverage that is over and above that provided by underlying policies, the requirement that the insured maintains underlying insurance, the existence of “other insurance” clauses that trigger the insurer's obligation to pay loss upon exhaustion of underlying insurance, or that require the proration of loss with other excess coverages. In one case the court determined that the policy in question was an umbrella policy, even though it was clearly labeled an excess indemnification policy since it was not triggered until the primary policy exhausted its primary and excess limits.

Nearly all the umbrella policies analyzed in FC&S Umbrella Channel provide some features indicative of umbrella coverage; however, as discussed elsewhere, true umbrella coverage is not widely available. The variations and nuances of coverage, though, can be numerous. Despite the importance of reviewing variations in the scope of coverage provided by umbrella policies, price rather than breadth of coverage is often the principal criteria used by insureds to determine which policy to purchase. This is particularly so during periods when coverage is expensive and not readily available.

FC&S Umbrella Channel identifies many of the important differences between umbrella policies and may help readers to better understand the implications of wording used in the basic policy form. Such an understanding is necessary to determine how the umbrella interacts with underlying coverage and to make sure the umbrella is broad enough to adequately cover the insured's exposures.

Many states require endorsements that amend the basic coverage, such as those limiting the insurer's ability to cancel a policy. Although state-mandated endorsements are not reflected in our analysis, readers should always consider such requirements, if any, established by state insurance departments.

There is no ideal umbrella form since no single policy can meet the precise needs of every insured. Proper coverage can be selected only after careful risk analysis. FC&S Umbrella helps readers determine whether a given policy form meets the insured's needs, but it is not a substitute for that essential first step in risk management, risk identification. If an umbrella form is inadequate to cover a particular organization's risks, modifications may be possible, subject to the flexibility of the underwriter and the price the insured is willing to pay.

Many insurers are sensitive to the needs of their insureds and are flexible in modifying their basic umbrella policies. However, such potential flexibility cannot be reflected in an analysis of the basic policy form, even when mandatory endorsements are considered. There is no way to know in advance the extent to which a particular insurance policy will meet the special needs of a given insured.

We realize that it is impractical for insurers to revise their printed forms for every change in circumstance that may arise, so the use of a variety of endorsements at the underwriter's option must be expected.

The function of an umbrella policy includes raising the primary limits to cover losses that if uninsured would be catastrophic to the organization, as well as providing broader coverage than primary insurance. There is also a third important function of umbrella policies: an umbrella also should drop down to replace primary aggregate limits when such underlying limits have been exhausted. Structurally, such protection is represented in the above diagram labeled Structuring Excess Umbrella Coverage.

Not all umbrella policies fulfill all three functions. A straight excess liability policy may only raise limits and replace primary coverage. However, it can substitute for an umbrella if the primary policy provides coverage as broad as typical umbrellas. This arrangement may not be desirable to an insured if broader primary protection is not needed or if it is more expensive. However, some primary programs—particularly those that are loss rated—provide coverage so broad that following form excess is all that is needed.

When excess umbrella protection is needed to provide higher umbrella limits, the structure changes. The excess umbrella policies should be following form over the underlying umbrella coverage. If two, three, or more additional excess policies are necessary to provide the required total limits of liability, it can become cumbersome to attempt to describe the coverage and policy limits excess of the first umbrella. Separate descriptions would be required for each underlying policy limit, each subdivision of limits (such as bodily injury, property damage, and personal injury), each subdivision of coverage (such as products, malpractice, and operations), and to distinguish per-occurrence limits from policy aggregates.

Excess underwriters providing coverage above the first umbrella often find it easier to write limits “up to” the policy limit stated, but excess of all underlying policies. Sometimes this technique is referred to as providing limits that are the “difference between” underlying insurance and the excess policy limit. This has the effect of smoothing out the jagged coverage provided by a fixed-limit policy which is placed above varying underlying limits.

In the diagram, such a policy would stop at $5 million for all coverages, although it would be providing only $3 million excess of the primary aircraft coverage, $4.9 million excess of employers' liability, and so forth.

Underwriters consider such limit variations when pricing excess layers of umbrella coverage according to how far they are removed from likely losses. The layer of coverage with the highest probability of experiencing one or more large losses is sometimes referred to as the “working” or “burning” layer.

The working loss layer is a function of a particular organization's loss history and risk profile and can vary accordingly. Knowing where an insurer prefers to participate relative to the working or burning layer is an important role of the insurance broker. Failure to consider an insurer's preference can result in inferior protection or higher prices. A broker who is experienced and knowledgeable of the umbrella and excess liability marketplace will take care to evaluate alternative ways to structure the umbrella program so that it provides the most comprehensive protection at the best price.

The graph shows some of the ways in which a $20 million limit program could be structured. Many other possibilities exist. Any one or more of the plans shown could be correct for an insured, depending on the aptness of coverage, price, and the specific needs of the insured, if other factors are equal.

 Factors that vary in umbrella program structures are as follows:

Underlying limits: These vary, depending on the underwriter's requirements. In some instances, it may be advantageous to increase the primary coverage limit since this may reduce the price of the first umbrella. It may also have a domino effect on the excess layers where the excess premium is based on the price of the preceding layer. (A lower underlying limit may also lead to a better total cost, as shown in the next diagram.)

Excess (gap) layers: In some instances, it may be difficult to obtain primary coverage with limits high enough to meet the umbrella underwriter's minimum underlying requirements. A layer of excess coverage between the first dollar primary policy and the first umbrella may be required to fill this gap in limits. This layer usually will be following form (straight excess) of the primary policy.

Limit of first umbrella: Where it is necessary to have multiple layers of umbrella coverage to achieve the desired coverage limits, the first umbrella is usually considered a “burning” or “working” layer. Since the risk of loss is greater, the price is higher for this layer of coverage than subsequent layers. This is one reason a high limit excess program ($30 million or more in limits) probably would not be written by a single insurer.

Several excess umbrellas required to complete the program: Many excess liability markets want at least $5 million or more in underlying limits before their coverage attaches. Thus, it is common to see at least one umbrella and one or more excess (following form) policies in a well-marketed program.

 Vertical layering: In a high-limits program, several insurers may share a layer of the coverage. This is called “quota sharing” or “participation.”

A simple example of the pricing on primary and first umbrella policies illustrates the variations that can result when different structures are used. The example assumes the same primary and umbrella insurers are quoting on the account in both instances.

The example illustrates that the strategy used to obtain quotes and structure coverage limits can make a great difference in the insured's cost.

In practice, the possible variations in program arrangement are often numerous. Insurance market conditions change frequently, and good results often depend heavily on the marketing skills of the broker.