New Trends in primary insurance terms may leave the company with NO insurance for major items, like defense costs, and excess carriers “following form” will be off the hook too
It used to be a safe and sensible way to go. Secure your primary (or “lead”) insurance with a deductible or self-insured retention (SIR) that matched your risk appetite, then attend to large losses with an umbrella policy above it, further burnished by a series of excess general liability policies atop the umbrella. The primary policy was necessarily complex because it also addressed the routine and frequent problems associated with auto liability and workers compensation. The excess policies were there to address the big general liability issues that might come along. It made a tidy package.
You could sleep secure in the knowledge that the umbrella and excess policies “followed form” to the underlying insurance, including the primary lead. So long as you did truly understand your primary policy, and so long as that primary policy actually spelled out favorable terms, your peaceful sleep was justified.
But recent trends in the terms of primary liability insurance have called this premise into serious question. Insomnia may now be the more appropriate state than happy dreams. Here’s why.
EXCESS POLICIES ARE ONLY AS GOOD AS THE PRIMARY TERMS THEY FOLLOW
We often find in our portfolio reviews that policyholders tend to focus on the importance of “follow form” protection from the top down. By that we mean that they view the feature of following form to be a safeguard working to their benefit, because it serves to prevent an excess carrier from issuing coverage that varies from the terms of the insurance beneath it. This is of course true. But it is also true that a policy that is following the form of policies beneath it will be only as favorable to the policyholder as those underlying policies are. And excess carriers will jealously guard their ability to rely on the restrictive terms of underlying policies—and without exception will specifically state that in no event or circumstance will they ever provide insurance that is broader than that provided below.
We believe companies should look at the “follow form” principle from the bottom up. In our view, nothing is more vital than the terms of the primary lead policy. Get that policy right first. Then lock in the identical terms above it.
ONE KEY EXAMPLE OF HOW SERIOUS POTHOLES IN THE PRIMARY POLICY, COMBINED WITH FOLLOW FORM EXCESS POLICIES, CAN DEVASTATE COVERAGE
Terms for defense costs
Primary liability carriers, for good reason, have become seriously concerned with skyrocketing legal fees and other litigation costs. They have pounded on law firms for lower and lower rates, but there is only so low you can go. So some primary liability insurers are now creatively transferring the responsibility for very large legal fees to the policyholder. They are doing this by getting companies to agree, normally in a lengthy endorsement to the policy, that even though the base policy provides a “duty to defend” the policyholder, the policyholder will pay ALL legal defense costs—even when those costs exceed the deductible or SIR—in any case in which no liability is actually paid. In other words, if you win, the whole legal bill is on your head, and none of it will be paid by the insurer.
Any general counsel will tell you that the expense of defeating a meritless claim can be huge. And most risk managers believe (and until recently have been usually correct) that the legal fee “bleeding” at least ends once the deductible or SIR is reached by the legal expenses.
This limitation on what was once accepted coverage also benefits the following form insurers who sit above.
And this divergence from the conventional notion of coverage for defense costs also results in a deadly minefield of conflict of interest in expensive, but flimsy, claims. If the merits of the claim look weak, but the depositions and extensive discovery needed to defeat it on summary judgment or at trial will run into the millions, the insurer, often controlling settlement, has an incentive to take it all the way, knowing that if the policyholder wins the case, it (the insurer) will pay nothing and the policyholder will pay the millions needed to achieve the good result.
Many companies would be better off moving away from the conventional format of broad form primary coverage (for autos, workers compensation and the first portion of general and products liability), sitting beneath separately purchased umbrella / excess policies that follow form. By buying coverage for auto and workers compensation alone (for a reasonable premium driven by just those exposures), it can address all other operating and products liability with carefully worded policies. For example, if it is comfortable with an SIR of, say, $1 million, it can buy a lead general liability policy with a per occurrence limit of $15 million or more, and build into that lead policy optimal terms. It can then secure successive layers above it, to the total level it desires, and make certain that each follows the favorable terms of the first. Importantly, by breaking the general liability policies away from the complexities of the auto and workers compensation components, the GL program can usually be purchased at lower cost—sometimes very substantially lower cost. It is worth your while to take a fresh, independent look at the possibilities.