With verdicts, judgments and defense costs rising steadily in the United States, the limits of insurance on standard business liability insurance policies may not be high enough to provide sufficient financial protection for a mid-sized or small company.
Excess and umbrella insurance policies are designed to address this potential insufficiency by providing additional limits of insurance above the primary policy. For example, a commercial general liability policy may provide a business with a $1 million limit of insurance, but a company may wish to supplement those limits with an excess or umbrella policy with a limit of $5 million, $10 million or more.
Buyers should be wary. With both an excess and an umbrella policy, terms, conditions and limits that appear appropriate when a policy is purchased can fall unexpectedly short when needed most – as a claim is resolved. For excess policies, the average time from when a loss occurs to when a claim is adjudicated is about five years, meaning a limit that seems suitable when the policy is purchased in 2014 may not provide the expected protection down the road.
Understanding the Differences
While excess and umbrella policies are similar, there are differences to consider. Excess insurance will generally provide insurance for the same exposures as those in the underlying, or primary, liability policy. The scope of the excess insurance will follow the terms and conditions of the primary insurance policy, but at a higher limit. Some umbrella policies will offer higher limits than a primary liability policy while also addressing gaps in the insured’s liability program by providing insurance for exposures not addressed by the primary policy.
Excess and umbrella insurance can play an important role in guarding a company’s balance sheet by offering higher limits and, in some cases, broader insurance protection than is available in underlying policies.
A variety of factors are combining to inspire small and mid-sized companies purchasing excess and umbrella insurance to consider higher limits.
One important factor is more stringent contractual requirements. For example, a growing number of commercial lenders are requiring higher liability limits that are more appropriate and cost-effective to insure through an excess or umbrella policy.
Similarly, more companies are requiring higher limits from those with whom they do business. For example, before launching specific projects or products, a growing number of companies are asking vendors or subcontractors to demonstrate the financial ability to defend themselves against liability claims – increasing the potential importance of excess and umbrella insurance in protecting a company’s balance sheet.
Determining the value of these higher limits can be challenging. Inflation can affect insurance limits and, although inflation trends have been low in the United States in recent years, that trend can shift in an unfavorable direction during the life-span of an insurance claim.
In addition to broad inflationary factors, insurance severity trends can also influence the future value of a policy limit. Higher verdicts, defense costs and settlements can increase loss trend factors. In turn, those trends may mean that the future value of an excess policy limit is decreasing more rapidly than general inflation rates. For instance, a 3 percent inflation rate and higher litigation costs may combine to create an effective 7 percent annual reduction in the future value of a policy limit. Therefore, a $5 million limit in 2014 dollars may provide only $3 million or less in protection in 2020.
In addition to guarding against the potential devaluation of policy limits, it’s important to understand the less-tangible considerations that can play an important role in the insurance purchase decision.
While financial strength and industry experience of the insurance carrier are always key factors to consider when buying insurance protection, the high-severity (and often long-tail) nature of excess claims makes choosing the proper carrier especially important. An insurer that’s only provided liability insurance for a few years, for example, may not have experience defending complex liability claims.
It’s also important to understand the relationship between the company’s primary insurance program and its excess umbrella insurance and the roles their respective carriers are likely to play in the event of a large loss.
Agents, brokers and companies need to evaluate whether an excess and umbrella insurance carrier will have the industry experience, international capabilities and financial resources to adjust the client’s insurance portfolio as the company grows and its needs change.
All of these factors can provide reasons
for companies to consider adding or enhancing excess and umbrella insurance. As trusted risk management advisors, agents and brokers can also play an important role in helping companies determine the most appropriate policy limit and the terms and conditions best suited for each company’s unique needs.