By Donald S. Malecki, CPCU

With a few exceptions, the traditional concept of the commercial umbrella policy no longer exists. Through a combination of habit and the way the documents are labeled, however, the term "umbrella" is still used even where it is inappropriate.

The rationale of insurance company product development personnel in continuing to refer to their policies as umbrellas is unclear. In fact, in many cases they may not know.

The original concept of the umbrella policy was to provide additional limits over the limits of the insured's primary policies and to serve as a substitute for the primary policy whose aggregate limit has been reduced or exhausted. The umbrella policy's distinguishing characteristic was that it provided coverage that is broader in some ways than the underlying policies or those liability policies specifically scheduled on the umbrella policy.

These latter two functions are commonly referred to as "drop-down coverage." The first drop-down feature, relating to the reduction or exhaustion of the primary policy's aggregate limits, still exists. Drop-down coverage triggered because the umbrella policy is broader than the primary, on the other hand, is rapidly disappearing. The retention the insured must assume before the second drop-down feature is activated is often waived as if it were a big deal, when in reality the insurer concedes little if anything by doing so.

Umbrella liability then and now

When Lloyd's of London first introduced the commercial umbrella policy in the mid-1940s, it was relatively simple to point to areas where the umbrella policy was broader than the underlying coverages. This same exercise was also easy with the earlier policies of domestic insurers, such as the "Big Top" umbrella of Insurance Company of North America and the "Catastrophe Liability" policy of the Travelers.

Today it is almost impossible to identify any instances where the umbrella policy is broader over, say, the commercial general liability policy. Try it. See if you can find where the umbrella coverage sold to your clients is broader than that provided by the underlying policies.

What complicates matters is that back when the umbrella policy was first being offered, the so-called "comprehensive liability policy" consisted of four pages, excluding the declarations page and underwriting schedule. Today's commercial general liability policy contains about 12 pages, exclusive of the declarations page and mandatory exclusions. To be fair, the current policy contains two additional coverage sections, personal and advertising injury, and medical payments, but that is still a lot of pages.

Coverage A and Coverage B

Some insurers--a minority--offer an umbrella liability policy referred to as the A/B format. For the most part, the "A" represents excess coverage. In general, the A part of these policies (hereinafter Part A or Coverage A) incorporates the first two functions of the umbrella policy noted above; that is, it provides additional limits above the each-occurrence limits of the underlying policies, and it drops down when an underlying policy's aggregate is reduced or exhausted.

It is important to remember, however, that if an underlying policy provides no coverage, Part A of the umbrella policy likewise does not apply. Part A therefore is said to "follow form" the underlying policy. Whether this Coverage A can be said to be a pure follow form is open to question. It usually is not considered a pure follow form.

Generally, the statement is made that Coverage A applies only to damages covered by the primary insurance and is subject to the same terms, conditions, exclusions, definitions, and limitations as the primary insurance (pure follow form), except as it relates to premium, subrogation, cancellation, other insurance, an obligation to investigate and defend, the limits of insurance, and payment of expenses (not so pure follow form).

Part B of the policy is referred to as umbrella coverage. This is where the insurer promises to pay up to the policy's limit because of an insured's legal obligation to pay damages, subject first to the insured's assumption of the self-insured retention, which often is waived.

To clarify the application of Coverage B, this section commonly states that it does not apply to any claim for which: (1) insurance is provided under Coverage A; (2) applicable primary insurance is shown to be listed in the schedule of primary policies, whether collectible or not, or for which there may be coverage by other insurance; or (3) insurance would have been provided except for the exhaustion of the primary policy limit.

Array of exclusions

It is interesting to see how many exclusions an insurance company can add to make sure that if there is any catastrophe or surprise, it does not fall on the insurer. For purposes of illustration, a randomly selected umbrella policy lists the following exclusions as being applicable to Coverage B: asbestos, expected or intended injury or damage, liability under Employees Retirement Income Security Act of 1974, workers compensation, unemployment compensation, disability law or similar law, automobile no-fault, uninsured motorists, nuclear energy liability, total pollution including all cleanup costs, occupational disease, aircraft, liquor liability, contractual liability, property in the insured's care, custody or control, and fellow employee injuries.

Also, impaired property; personal injury for libel, slander, defamation; willful violation of a penal statute; advertising, publishing, broadcasting or telecasting done by the insured; discrimination related to employment or failure to employ; property damage or loss of use of property owned or purchased on consignment or under an installment sales contract; damage to the insured's product; product withdrawal; watercraft; and recreational motor vehicles.

Some of these exclusions, of course, are necessary because specific coverage is available under other policies, such as statutory compensation, nuclear energy, and aircraft policies, or they are considered a business risk, such as damage to the named insured's product or work. Even barring those exceptions, finding some solid examples of where Coverage B applies is like "looking for a needle in a haystack."

Surprise for an insurer

In the recent case of Westview Associates, et al. v. Guaranty National Insurance Company, et al., 717 N.Y.S.2d 78 (Ct. App. 2000), the application of the A/B format umbrella policy came as a real surprise to the insurer when an apartment building owner sought defense and indemnity because of a tenant's alleged injury from the ingestion of lead paint.

The insurer denied coverage based on a lead paint exclusion in the primary liability policy, and on the fact that Coverage B contained a pollution exclusion. This state's supreme court held that, although a lead paint exclusion in the underlying policy was incorporated into Coverage A of the umbrella and precluded coverage, such was not the case with Coverage B. The court also held that the policy's pollution exclusion did not encompass lead paint.

The state appellate court, apparently misunderstanding the application of the A/B format, reversed the decision and held that the pollution exclusion applies to the entire umbrella policy. On further appeal, the decision was reversed in the insured's favor, because Coverage B did not incorporate the exclusions of the underlying policy, including the one specifically addressing lead.

The double whammy

Today more than ever before, it is the practice of insurers to require that the umbrella policy be written by the same insurer that issues the primary policy or by an affiliate company. The problem for the insured is that "all the eggs are in one basket"; further, the insurer has better control of what will be covered by its combination of policies.

In many instances where the same insurer issues both the primary and umbrella policies, the latter provides a so-called "inversion" of coverages, or what can be simply described as coverage more limited in scope than the underlying policies. The umbrella policy cannot even be said to be an excess policy, because there are instances where the primary policy applies but the umbrella policy does not. Likewise, neither the primary nor the umbrella policy may apply, resulting in a double whammy for the insured.

A change in terminology is long overdue. It is time that the term "umbrella policy" be eliminated from insurance glossaries, from insurance advertisements and texts, and from policy wording.

It also makes good risk management sense to avoid reference to umbrella policies and instead talk in terms of excess liability. This is especially important because excess coverage is what usually applies if the excess policy is not too inconsistent with the terms of the primary policy.

It is custom and practice to build a solid foundation of coverages. Once an insured is satisfied with that foundation, what the insured needs then are excess limits and drop-down protection in the event of the reduction or exhaustion of aggregate limits.

Excess liability policies, pure follow form or otherwise, are likely to produce fewer surprises for insureds than are umbrella policies. The problem is that many insurers are not keen on providing excess follow form coverage without the attachment of some additional exclusions. It is still likely to be less painful, however, to rely on an excess liability policy than on many umbrella policies today. *

The author

Donald S. Malecki, CPCU, is chairman and CEO of Donald S. Malecki & Associates. He is a committee member of the International Insurance Section of the Society of CPCU, on the examination committee of the American Institute for CPCU, and an active member of the Society of Risk Management Consultants.