Umbrella Traps: Errors That Create Trouble in the Layers

There are many reasons a business or individual might buy umbrella coverage. They may have current assets that they want to shield from the potential for loss. They may also be planning to shield future assets. They may just want the added security of knowing that in the event of a catastrophic liability claim, they are protected–and with judgments on the rise, who can blame them?

The insured may need a simple $1 million umbrella policy to make sure they are in compliance with a contract; or they may be a bigger insured with the potential of a catastrophic liability claim and they may need a complex liability tower, with multiple insurance companies and excess over excess policies. In either case, there are a few ways where their liability protection could fall apart, and they may not even realize these traps exist.

Any policy wording that is quoted here comes from the ISO CU 00 01 04 13 Commercial Liability Umbrella Coverage Form. Read your full policy for details about the specific situation that your client (or you) may be in.

Did you tell the carrier about the claim?

It feels like it should be common sense that when there’s a potential claim, the carrier needs to know about it so they can investigate, mount a defense, and reserve it properly. What if the insured thinks the claim “isn’t that bad”? If you’ve been in the insurance business for any length of time, you know that a claim can be reported and the initial assessment comes in low, but over time, it creeps up or jumps when new information surfaces.

We often look at coverages, exclusions, and definitions when we talk or write about policy language, but for our purposes here, we are focused on the policy conditions.

Duties in the Event of Occurrence, Offense, Claim, or Suit

You must see to it that we are notified as soon as practicable of an “occurrence” or an offense, regardless of the amount, which may result in a claim.

If a claim is made or “suit” is brought against any insured, you must: Immediately record the specifics of the claim or “suit” and the date received; and Notify us as soon as practicable.

You must see to it that we receive written notice of the claim or “suit” as soon as practicable.

In the first sentence, we immediately learn that there’s no such thing as a claim that “isn’t that bad” when it comes to this coverage form. It wants to know whenever something comes up that may result in a claim. The amount of the potential claim doesn’t matter. It also doesn’t seem to matter whether or not there’s an actual claim. The wording tells us that the offense or occurrence may result in a claim.

In the second sentence, we learn that when a claim is made against any insured, this policy also wants the company to be notified immediately. This may seem like a restatement of what we’ve already seen, but the difference comes from who received notice of the potential claim. In the first sentence, the claim was received by “you,” which is specific to the named insured. In the second sentence, the claim was received by any insured, which is a much broader term.

This forces us to look back at the Who Is An Insured section to discover who the policy considers an insured. We will leave that to you to read later, but everyone who qualifies as an insured according to that section could be given notice of a claim. This is also a reminder that an additional insured is an insured, and when that additional insured receives notice of a claim, this policy wants to know that, too.

The last sentence restates something that we’ve seen three times now: The policy wants to know about any claim as soon as is practicable. According to the Cambridge Dictionary Online, practicable means able to be done or put into action. That’s a good definition, but it is open to interpretation, which means that there may be disagreement about when something is practicable.

This condition could create a situation where the insured finds themselves self-insuring a liability claim because they did not give notice as soon as it was practicable, or because they thought that the claim “wasn’t a big deal.”

Did you change any of the underlying insurance policies?

Time to be honest. Sometimes insureds make decisions and forget to tell other people about them. Like that time one of your clients bought three new vehicles and didn’t tell you until one of them was involved in an at-fault accident, or when they decided to take on work in a new state and didn’t let you know because “my workers’ comp premium might have gone up.” This deserves a look at another condition.

Maintenance of/Changes to Underlying Insurance

Any “underlying insurance” must be maintained in full effect without reduction of coverage or limits except for the reduction of the aggregate limit in accordance with the provisions of such “underlying insurance” that results from payment of claims, settlement or judgments to which this insurance applies.

Such exhaustion or reduction is not a failure to maintain “underlying insurance.” Failure to maintain “underlying insurance” will not invalidate insurance provided under this Coverage Part, but insurance provided under this Coverage Part will apply as if the “underlying insurance” were in full effect.

If there is an increase in the scope of coverage of any “underlying insurance” during the term of this policy, our liability will be no more than it would have been if there had been no such increase.

You must notify us in writing, as soon as practicable, if any “underlying insurance” is cancelled, not renewed, replaced or otherwise terminated, or if the limits or scope of coverage of any “underlying insurance” is changed.

What’s most interesting about this condition isn’t that the policy allows that coverage will apply, but that it specifically tells us that the policy is not invalidated. Here’s where other coverage forms may be different because carriers might have their own forms that tell a different story. In this case, coverage still exists, but there is one major issue to deal with.

If the insured fails to maintain the underlying coverage in the way that the insurance company doesn’t expect, this policy will respond to the claim as originally intended. That is, if there should be a $1 million occurrence limit in the underlying auto policy, and that limit is lowered to $500,000, this policy won’t pay until the indemnity payment exceeds $1 million. If there’s a judgment for $750,000, the insured will self-insure through that.

Additionally, if the insured’s underlying policy is changed to reflect a broadening of coverage, this policy will not automatically provide that same broader coverage. Even if the underlying policy and this policy initially provided identical coverage, with the same exclusions and limitations, this policy will stay the same as it was, providing coverage in the same way it did before the change.

Failure to let this insurer know that underlying insurance has changed can create a coverage gap that could cost the insured significantly.

Did you see that exclusion?

When looking over an umbrella policy, it wouldn’t be advisable to assume that the umbrella covers liability claims exactly as the underlying policies would, even if the policies are issued by the same company. This is where expertise in policy review becomes important for the insured especially.

If there is a claim that is excluded from coverage on the underlying insurance, you can’t assume there is no coverage on the umbrella. It’s possible that the umbrella will provide coverage for that claim. It won’t be exactly like when the loss is covered by the underlying policy, which is a good thing for the insured. In the case where coverage is excluded on the underlying policy, and covered on the umbrella, the policy will act like there is no underlying policy, and that could activate the self-insured retention, which is better than one of the prior situations, where the policy says that there is no coverage because of changes.

On the other hand, if there’s a claim that is covered by the underlying policy, and excluded on the umbrella, it’s not covered. One of the worst-case scenarios is that the insured believes that there is coverage on the umbrella, and when the judgment comes in, finds out that this claim was excluded the whole time. Maybe that’s an unlikely outcome and maybe the insured will already be told that there’s no coverage. But maybe they don’t know that, and they find out that there’s a large check they need to write.

In the end, ensuring that the insured understands their umbrella coverage, including the terms and conditions of their own policy, is important so there aren’t any surprises when the claim comes in–especially surprises that could be easily and quickly avoided by complying with the policy requirements.