Too often, the only focus is on the umbrella limit. And, even then, the limit may simply be expressed as "$25 million excess of primary," which overlooks how the aggregate limits within the umbrella may apply—an important consideration.

Nonstandard Forms

While the Insurance Services Office, Inc. (ISO), has promulgated for a number of years a commercial umbrella policy form (CU 00 01 April, 2013, edition) (as well as a commercial excess policy form—CX 00 01 April, 2013, edition), most insurers offering commercial umbrella coverage still write their own policy forms—or at least draft their own endorsements to their forms. Therefore, unlike many of the insurance policies that underlie it, the commercial umbrella is not a "standard form." To understand what you have purchased, it is necessary to read the policy.

Umbrella and Excess Liability

While commercial umbrella policies and excess liability policies¹ typically sit above more than one type of underlying liability insurance (e.g., commercial general liability (CGL), business auto liability, employers liability, etc.), umbrella policies have traditionally been distinguished from excess liability coverage in that an umbrella may be somewhat broader than the underlying coverage. For example, an umbrella policy may include a worldwide coverage territory, which is often a broader coverage territory than found in the underlying liability policies. Excess liability policies are traditionally different from an umbrella policy in that excess liability policies do not provide broader coverage than the policies over which they are excess, and they generally follow only the terms of the underlying policies.

However, this distinction between umbrella and excess liability policies is fading and may even be misleading. Umbrella insurers do not generally "drop down" and provide coverage over known uninsured liability exposures.² In addition, some insurers use an umbrella policy form that may include the characteristics of both an umbrella and excess liability policy—usually by using a bifurcated (divided) insuring agreement. The first insuring agreement is the excess and follows the terms of the underlying policy; the second insuring agreement is the umbrella and covers liability exposures not covered by the underlying insurance.

Be aware that in many instances, both insuring agreements are subject to numerous exclusions. And don’t be overly influenced by the policy title—some insurers will call their umbrella policies "excess commercial liability," while other insurers will title their excess policies as "commercial umbrella liability." The takeaway is that there is no substitute for reviewing the actual terms and conditions of the policy itself, including all endorsements.

Point One—All Umbrella Policies Do Not Follow Form

If I had a nickel for every time someone insisted, as a general matter, that the umbrella was "follow form" and provided the exact same coverage as the underlying insurance, I would have quite a few nickels. This point is simply not true. Umbrella policies may well be "stand alone," which means such umbrella policies are subject to their own insuring agreements, definitions, conditions, and exclusions, independent of the underlying policies.

Even if an excess liability policy is purchased and does expressly state it will follow the terms, conditions, exclusion, limitations, and definitions of the underlying insurance, invariably, that promise is qualified and usually includes important disclaimer wording.

For example, one excess liability insurer, after promising to "… follow form the terms, conditions, definitions, and exclusions of the underlying insurance," further states, "… except to the extent that the terms, conditions, definitions and exclusions of this policy differ…. In the event of any conflict, the terms conditions, definitions, and exclusions of this policy shall control." In other words, we follow form unless we don’t follow form—necessitating a complete reading of the excess liability policy to identify where is does not "follow form."

This is not trickery on the part of the insurer—instead, it is a usual and customary practice of excess liability insurers. Buyers should be on notice of this practice and, therefore, should never conclude, without reviewing the complete excess liability policy, that even a policy that begins by promising to "follow form" actually does so in all circumstances.

A Word on Primary and Noncontributory

The "every umbrella is follow form" notion leads too many to believe that the umbrella follows the other insurance clause of the underlying policies. For example, if the other insurance condition of the CGL policy has been amended to include coverage on a primary and contributory basis (e.g., CG 20 01 04 13), the assumption is that the umbrella is also written on a primary and noncontributory basis for an additional insured. I find this view particularly puzzling—if the umbrella followed the CGL other insurance condition, it might well be primary coverage, not excess coverage.

A typical umbrella other insurance condition is quite different from the other insurance condition found in underlying policies and may state the following (in pertinent part).

If other insurance applies to a "loss" that is also covered by this policy, this policy will apply excess of such other insurance. However, this provision will not apply if the other insurance is specifically written to be excess of this policy.

The last sentence is referring to a second (or higher) layer excess liability policy—not the CGL policy of an additional insured. Some umbrella insurers are willing to amend the other insurance condition to provide primary and noncontributory coverage in some circumstances, but it should not be assumed that the umbrella provides the desired order of coverage simply because the underlying CGL policy may provide it.

For example, here is wording that an excess liability insurer may use that would be necessary to amend the other insurance condition to provide the agreed upon "primary and noncontributory" coverage in the umbrella or excess liability policy to follow the primary CGL policy (in pertinent part).

If the written contract in which you have agreed to provide insurance for that person or organization [as an insured] specifically requires that this insurance apply on a primary and noncontributory basis, this insurance will apply as if other insurance available to that person or organization under which that person or organization qualifies as a named insured does not exist, and we will not share with that other insurance.

Of course, there are numerous approaches to this matter, and other wording that changes the other insurance condition may be just as effective. The larger point is that the other insurance condition of an umbrella or excess liability policy usually must be amended to provide primary and noncontributory coverage to an additional insured.

Sublimits

Liability policies often have sublimits. For example, the CGL policy typically includes a sublimit for "damage to premises rented to you." It is highly unlikely that the umbrella or excess liability insurer intends to drop down and pay losses in excess of a $50,000 or $100,000 damage to premises rented to you limit.

Some insurers exclude the exposure entirely by adding to the umbrella or excess policy a "real and personal property care, custody and control" exclusionary endorsement that excludes property damage to any real property rented to or occupied by any insured. Other insurers exclude any exposure that is subject to a sublimit—usually defined as a limit that is less than the limits shown in the schedule of underlying insurance—but should recognize payment of a claim within the sublimit is a reduction in the underlying policy aggregate limit. In either case, a buyer should not usually expect the umbrella or excess liability policy to drop down and pay for damage excess of the underlying policies’ sublimits.

Point Two—Umbrella Policy’s Defense Obligation

While usually the underlying insurers have a duty to defend an insured with the cost of defense paid by the underlying insurance in addition to the policy limit, there are numerous instances in which it may be critical for the umbrella or excess liability insurer to defend an insured. In other words, whether an umbrella insurer has a duty to defend, and when that duty is imposed on the insurer, is often overlooked, but it is a very important umbrella coverage matter.

For example, suppose the insured’s CGL policy has just paid in settlements the full amount of its product liability aggregate limit due to a series of product claims involving bodily injury that took place during the policy year. A similar products claim—also involving bodily injury during the same CGL policy year—arrives in the form of a complaint against the insured. The CGL insurer has no duty to defend or pay damages on this new products claim. When the umbrella insurer drops down over the exhausted CGL policy's product liability aggregate limit, will the umbrella insurer be obligated to defend this new products claim? That depends on the defense provision of the umbrella policy that will drop down.

No Duty To Defend

A few umbrella insurers unequivocally state that they have no duty to be involved in any defense of any claim, suit, or proceeding. In the example above, the insured, and not the umbrella insurer, will be required to defend the new products liability claim, with all defense costs paid by the insured.

No Duty To Defend but the Right To Associate in the Defense

Some umbrella insurers will not have any duty to defend but will have a right—but not the duty—to associate in the defense of any claim or suit that may involve their insurance. While it might make strategic sense for the insurer to become involved in and defend the new product claim noted above, the insurer is not obligated by the umbrella defense wording to do so. Stated differently, the insurer’s right to associate in the defense of a claim is for the protection of the insurer and not the insured, and it is not the equivalent of the insurer’s duty to defend the insured for the new claim.

This is a very meaningful difference—the duty to defend is a very broad obligation and is usually triggered if any of the allegations in the complaint are potentially covered by the liability policy (in this case, the umbrella policy). The wording of the right to associate in the defense reduces the insured’s protection to be available only at the insurer’s option—even if the allegations are potentially covered by the umbrella policy, the insurer owes the insured no duty to defend. It has merely reserved its right to protect its own interests. While the insurer may decide to defend the new product claim, the policy does not obligate the insurer to provide a defense to any insured.

This situation may be particularly exacerbated if the umbrella insurer sees no exposure to its policy because the insurer believes that the new products claim is not covered and, thus, perceives no interest it wants to protect. In any event, the insured might very well end up providing and paying for the defense of the new product claim.

No Duty To Defend but the Right To Assume Charge of the Defense

The right of an umbrella insurer to assume charge of the defense is not mutually exclusive with the right to associate in a defense—both rights of the insurer may be within the same policy. But for the same reasons, the right to assume charge of the defense without the duty to defend is problematic. Again, this provision is intended to protect the insurer’s interest, but in a different way—if the insurer believes the underlying claim may reach the umbrella but is not being handled properly, the right to assume charge of the defense usually gives the umbrella insurer the right to take over the defense of the claim, including "… the right to select or dismiss defense counsel for the purpose of continuing the defense…." It is worth repeating that the right to assume charge of a defense is not the same as the duty to defend its insured.

Duty To Defend—Limited Circumstances

From the insured’s viewpoint, the most favorable defense provision in an umbrella is the insurer’s express duty to defend, albeit in limited circumstances, such as (a) when the underlying insurance has been exhausted or (b) when the underlying insurance does not provide coverage. In most instances, even if the duty to defend does not arise, the umbrella insurer will also maintain its right to associate in any defense and may even assert its right to assume charge of a defense of a claim or suit that may reach their umbrella policy.

The example above of the new product claim would be defended by the umbrella with a duty to defend provision, as this claim clearly falls within (a) above—the underlying insurance has been exhausted. And, despite the belief the umbrella insurer may have that the new product claim may not be covered by the umbrella, if the allegations are potentially covered by the umbrella, the insurer is still obligated to defend that claim—the benefit of the "duty to defend" obligation.

While the umbrella insurer is obligated to defend when the underlying insurance does not provide coverage, as stated in (b) above, this duty is restricted. The umbrella insurer has no obligation to defend an insured against a suit for which there is no potential coverage under the umbrella policy, even if the underlying insurer does not provide coverage. Rather, this second qualification is often (but not in all situations) interpreted to provide the insured a "backup" for its defense when the underlying insurer has improperly denied its obligation to defend. While the caselaw is mixed on the purpose of this provision, the general intent is to protect the insured from being left without any defense. Umbrella insurers who undertake to provide the insured this "backup" defense of a claim that was wrongly denied by the underlying insurer may have a right of contribution to recover its defense expenses from the underlying insurer that erroneously denied the insured its right to be defended.

Of course, it may be obvious that what exactly is meant by "an underlying insurer not providing coverage" is the subject of some dispute. A few courts have found that wrongfully denying the insured a defense does not mean that the underlying insurance does not provide coverage, holding that whether the policy provides coverage is based on the policy wording and not based on the underlying insurer’s actions regarding the discharging of its duties under its policies. In other words, if the policy obligates the underlying insurer to defend, then the underlying insurance provides coverage. If the underlying insurer wrongfully denies a defense that does not mean, in the context of the umbrella’s defense obligation, the "underlying insurance does not provide coverage" and therefore trigger the umbrella insurer’s duty to defend.

Point Three—Claims May Not Reduce the Underlying Aggregate Limits

Whether found within the insuring agreement, the limits section, or the maintenance of underlying insurance section, some umbrella insurers recognize the exhaustion of an underlying aggregate limit only if the claim paid by the underlying insurance is also covered by the umbrella policy. Here is wording that typically includes such restrictions (Maintenance of Schedule of Underlying Insurance in pertinent part).

You agreed that during the Policy Period:

 

3. The total applicable limits of Scheduled Underlying Insurance shall not decrease, except for any reduction or exhaustion of aggregate limits by payment of Loss to which this policy applies; [emphasis added]

As noted above in the "Sublimits" section, if the umbrella insurer totally excludes any property damage to property occupied or rented to the insured, any claim paid by the CGL policy within the damage to premises rented to you limit would not be recognized as reducing the CGL policy general aggregate limit. For example, if the CGL insurer paid its limit of $100,000 for fire damage to a warehouse rented to an insured, this reduction in the CGL policy general aggregate limit of the CGL would leave a gap of $100,000 between the actual CGL general aggregate limit and the general aggregate limit as required by the umbrella insurer.

While this is just one example of this issue, it is far preferable for the umbrella insurer to recognize the reduction or exhaustion of the underlying insurance by payment of claims that are covered by the underlying insurance, regardless of whether or not the umbrella covers that claim. Here is wording that is more favorable (Maintenance of Underlying Insurance in pertinent part).

During the "policy period", you agree:

 

2. That the Limits of Liability of the policies listed in the Schedule of Underlying Insurance as shown in Item 5. of the Declarations will be maintained except for any reduction or exhaustion of aggregate limits by payment of loss in claims or suits covered by the Underlying Insurance. [emphasis added]

Point Four—Loss Payable

When the umbrella insurer is obligated to "attach" and pay some or the entire limit in damages is of vital importance, yet umbrella policies are often silent or vague on this point, other than to generally state the loss must exceed the underlying insurance limits.

A fairly common loss payable clause (CU 00 01 04 13) states the following.

Liability under this Coverage Part does not apply to a given claim unless and until:

 

a. The insured or insured's "underlying insurer" has become obligated to pay the "retained limit"; and

b. The obligation of the insured to pay the "ultimate net loss" in excess of the "retained limit" has been determined by a final settlement or judgment or written agreement among the insured, claimant and us.

"Retained limit" means the available limits of "underlying insurance" scheduled in the Declarations or the "self-insured retention", whichever applies.

Provided either the insured or the underlying insurer has become obligated to pay the "retained limit" listed in the schedule in the declarations, the umbrella insurer must pay in excess of the "retained limit."³ Of course, that obligation must be by final settlement or judgment, as described above. However, consider the following actual example.

Per-Claim Deductible

A policyholder had a $10,000 per claim deductible as part of the CGL policy that included a $1 million each-occurrence limit. An explosion occurred that resulted in numerous claims for bodily injury and property damage. The claim settled for $1,785,986. However, because most of the claims were within the deductible, the CGL insurer paid only $497,999 in damages, with the insured paying $1,287,987 as deductible payments.

The policyholder made claim under the umbrella policy, which included loss payable wording similar to the above. ⁴ The umbrella insurer took the position that as the CGL insurer had not paid $1 million, the umbrella insurer owed no payment of damages. Of course, the insured took a different position. Because the insured is obligated to pay $1,785,986, the insured has satisfied the umbrella insurer’s loss payable condition, and any amounts paid by the insured policyholder in excess of $1 million should be paid by the umbrella insurer.

The tenth circuit court (applying Oklahoma law) decided that the wording was ambiguous⁵ and that the loss payable provision of the umbrella could mean either the insured is obligated to pay in excess of $1 million or the CGL insurer was obligated to pay in excess of $1 million. The court remanded the matter to a lower court to determine how the loss payable condition should be interpreted.⁶

Noncash Settlement

In another actual example⁷ based on similar loss payable wording in the umbrella policy,⁸ the loss involved bodily injury because of the death of a young woman who fell from a portable rock climbing wall. Due to an exclusion for amusement devices⁹ included on each policy, both the underlying CGL insurer and umbrella insurer denied defense and indemnity to the insured. The insured entered an agreement limiting the collection of any judgment to amounts payable by the insurance policies. The owner was found liable, with an entry of judgment that included damages awarded to the parents of the deceased woman of over $4.5 million.

The parents then pursued the insurers, and, in exchange for a settlement payment of $700,000, the parents released the CGL insurer to the full extent of the policy limit of $1 million. The umbrella insurer denied coverage for any additional payments, contending that as the CGL insurer did not pay its full $1 million, the loss payable condition was not triggered.

Upon appeal, the Missouri Supreme Court disagreed with the umbrella insurer, concluding that the underlying CGL limit requirement of $1 million was met. The court went on to explain that the loss payable condition was not dependent on the underlying limit being "fully exhausted by cash payment" before the umbrella insurer was obligated to pay, and "the policy recognized that the underlying limits of insurance may be fulfilled by something other than insurance. Here, the underlying limits of insurance were met by a settlement that consisted of a settlement of a $700,000 payment and a $300,000 release, totaling $1 million."

In sum, the wording in the loss payable condition needs to be carefully reviewed and understood by the buyer, particularly when viewed through the lens of claims in which the underlying insurer may not have paid its full limits, but which the insured is obligated to pay damages in amounts that exceed the underlying limits.

Point Five—What about Those Aggies?

Of course, this reference is to the aggregate limit or limits shown on the umbrella declarations page and also found within the limits section of the policy.

For example, an umbrella policy that lists on its declarations page that the policy limit is $25 million each occurrence and $25 million annual aggregate should raise questions. Is the insurer providing aggregate limits that are different from the underlying policies? Is the intent to impose an aggregate limit for policies that do not include an aggregate in the underlying insurance, such as the business auto liability coverage? Does one annual aggregate limit actually mean it is the most the umbrella insurer will pay in total for the policy year, despite the fact that an underlying policy includes multiple aggregate limits, such as the CGL (a general aggregate limit and a separate products-completed operations aggregate limit)? Or does it mean that separate aggregate limits may apply to each underlying policy, such as the employers liability policy limit for disease, the liquor liability aggregate, or the garage liability coverage aggregate limits?

Most Favorable

The following wording is offered and may be the most favorable to an insured.

SECTION III—LIMITS OF INSURANCE
1. The Limit of Insurance shown in the Declarations as EACH OCCURRENCE is the most we will pay for damages arising out of any one occurrence or offense.
2. The Limit of Insurance shown in the Declarations as AGGREGATE WHERE APPLICABLE shall apply in the same manner as the aggregate limits shown in the SCHEDULE OF UNDERLYING INSURANCE.

In the above wording, the umbrella declarations will list the aggregate limit as applying "where applicable" in lieu of "annual aggregate," and, thus, the umbrella will apply its aggregate limits in the same manner as the aggregate limits are shown in the schedule of underlying insurance.¹⁰ No aggregate would apply to the business auto liability coverage; the aggregate limit in the umbrella would apply in the same manner as the CGL (separately to general aggregate limit and to the products-completed operations limit). If liquor liability is listed with an aggregate limit, then the umbrella will apply its aggregate limit separately for liquor claims, and so on.

A less desirable but common umbrella aggregate limit arrangement is to include one general aggregate limit that does not apply to business auto claims or products-completed operations claims, for which the policy lists a separate aggregate limit. Such an arrangement would be provided by the following wording (in pertinent part).

B. The General Aggregate limit stated in Item 3 of the Declarations is the most we will pay for all damages under this policy, except for:

 

1) Damages included within the Products-Completed Operations Hazard; and
2) Damages because of Bodily Injury or Property Damage to which this policy applies, caused by an Occurrence and resulting from the ownership, maintenance or use of an Auto covered under the Schedule of Underlying Insurance.

C. The Products-Completed Operations Aggregate limit stated in 3C of the Declarations is the most we will pay for damages included in the Products-Completed Operations Hazard.

Least Favorable

The least desirable arrangement of the umbrella limit arrangements is to apply one annual aggregate limit to all umbrella claims, regardless of whether the underlying policy included an aggregate limit, if the underlying policies included multiple aggregate limits or more than one underlying policies included an aggregate limit.

A more common "middle ground," which is less favorable than applying the aggregate limits of the umbrella in the same manner as the underlying policies, is to apply one annual aggregate limit to all but auto claims, meaning that a separate aggregate limit does not apply to the products-completed operations hazard. Wording that is typical of this approach is as follows (in pertinent part).

The Aggregate Limit is the most we will pay for the sum of all "ultimate net loss" under:
a. Coverage A, except "ultimate net loss" because of "bodily injury" or "property damage" arising out of the ownership, maintenance or use of a "covered auto"; and
b. Coverage B.¹¹

In sum, there exists a wide variation in how umbrella insurance arranges aggregate limits—the implication being that a buyer should not be content with only "$25 million excess of primary," as there may be substantial differences between umbrella policies that have not been considered.

Conclusion

There is a certain irony to giving short shrift to a liability policy that is only important when damages from a liability claim may be in the range of tens of millions of dollars. In other words, it is not advisable to review your umbrella policy or policies for the first time only after being faced with a complaint that alleges liability for damages in the millions of dollars.

The purpose of this article is to point out some critical issues to look for in your commercial umbrella policy. In other words, while this article is not intended as an exhaustive review of all of the issues that you may need to understand a commercial umbrella policy, this may be regarded as a starting point. Looking for something specific often makes the task a little less daunting and maybe even a little less tedious.

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¹ An excess liability policy can also be purchased to be excess of only one liability policy, with such an excess policy sometimes referred to as a "buffer layer."

² If underlying insurance is not provided, insurers may elect to use a retained limit endorsement, which states the insurer will not be liable until the listed retained limit is exhausted by payment. The amount of the retention is usually equal to an amount required for the underlying insurance limit.

³ "Self-insured retention," as used here, applies only when no underlying insurance applies.

⁴ The court noted the loss payable wording was as follows. "Coverage under this policy will not apply until [Yaffe] or [Yaffe’s] underlying insurer is obligated to pay the [R]etained [L]imit."

⁵ While an ambiguity is usually resolved against the drafter, the court noted, "Great American had no opportunity to respond to Yaffe’s summary-judgment motion and entry of judgment against it would therefore be improper."

⁶ Yaffe Cos. Inc. v. Great Am. Ins. Co. 499 F.3d 1182 (10th Cir. Okla. 2007).

⁷ Schmitz v. Great Am. Assur. Co., 337 S.W.3d 700 (Mo. 2011).

⁸ The actual loss payable clause stated, "coverage under this policy will not apply unless and until the insured or the insured’s ‘underlying insurance’ is obligated to pay the full amount of the ‘Underlying Limits of Insurance.’"

⁹ It was later agreed the amusement device exclusion applied only to rides, and the rock wall was not a ride and, thus, not excluded.

¹⁰ Although not addressed here, making certain the Schedule of Underlying Insurance accurately reflects the policies and the correct limit structure for each of the underling policies is obviously critical.

¹¹ CU 00 01 04 13 at page 12 of 18.

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Craig F. Stanovich, CPCU, CIC, CRM, AU, is cofounder and principal of Austin & Stanovich Risk Managers LLC, a risk management and insurance advisory consulting firm specializing in all aspects of commercial insurance and risk management, providing risk management and insurance solutions, not insurance sales. Services include fee-based "rent-a-risk manager" outsourcing; expert witness and litigation support; and technical/educational support to insurance companies, agents, and brokers. Email him at .