RISK MANAGEMENT
By Donald S. Malecki, CPCU
Understand the interaction between
contractual liability and additional insured status
Seek out those insurers that are willing to underwrite on an individual, rather than a class basis, and to provide reasonably broad coverage as required by written contract.
For whatever reason, some people occasionally wear both a belt and suspenders. It probably boils down to being a matter of one's tastes. If applied properly, however, only one of the two is necessary. The same protocol applies when dealing with the insurance equivalent of belt or suspenders, which is the interaction between contractual liability and additional insured status. Both complement one another, but only one is necessary.
Thus, if an indemnity agreement is considered to be void and unenforceable for some reason, so, too, is the contractual liability coverage (the belt). When this happens, the indemnitee (the one who seeks to transfer the financial consequences of risk to the indemnitor) can then fall back on its status as an additional insured (the suspenders).
If, on the other hand, the indemnity agreement is not considered to be void and unenforceable, neither is status as an additional insured. The question then is: Which of the two should apply? The answer is: the broader of the two.
Many people in the insurance and risk management industry are familiar with how this concept works. Others are not. Unfortunately, some within this latter category are the product development personnel of insurance companies, or those, some of whom may be attorneys, who are responsible for drafting forms. The result can be utter confusion, despair, argument, and litigation.
It really is not certain whether those responsible for drafting policy provisions are ignorant of how the belt or suspenders concept is supposed to apply, or are well aware of how the concept should work, but have no intention of seeing that the concept works properly. Sometimes it's a combination of both.
If one were to trace the evolution of contractual liability coverage, one would note an eventual broadening over the decades since it became available. Insurers at first provided very limited coverage. Referred to as "limited contractual," it was nothing more than a reaffirmation of the indemnitor's common law responsibility. Coverage, therefore, was limited solely to protecting the indemnitee because of what the indemnitor did. This coverage, in other words, did not involve any assumption of the indemnitee's negligence. Today, this is known in CGL policy parlance as liability for damages that the insured would have in the absence of a contract or agreement.
A bold move occurred in 1941 when coverage was extended to five types of agreements--the same five that currently exist when a contractual limitation endorsement is attached (discussed in the June 2003 edition of this column). While these agreements, such as leases and easements, are limited in number, they do cover the sole fault of the indemnitee. They also apply to liability assumed by the "insured" as opposed to the "named insured."
Degrees of fault transfer
With the increasing demand for broader coverage and competition, however, two additional forms of indemnity agreements were added to contractual liability coverage. The second one is referred to as the "intermediate form" and the third one as the "broad form" contractual.
The intermediate form requires the indemnitor to be responsible not only for its own negligence, but also for the joint or comparative fault of the indemnitee, whether the indemnitee's degree of fault is 1% or 99%. This form does not apply to liability of the indemnitee resulting from its sole fault.
The broad form contractual requires the indemnitor to be responsible for all liability, including the sole fault of the indemnitee. While this assumption may appear to be unreasonable, it's permitted by some states so long as the intent is clear, conspicuous, and agreed to by the parties. Other states flatly hold these agreements, dealing with construction contracts, to be void and unenforceable, whereas some states will make an exception if these agreements are covered by insurance, such as additional insured status.
It's common for commentators on contractual liability insurance to explain the three degrees of contractual risk transfer. It was necessary to do so prior to 1976, because underwriters could set a price on contractual liability coverage only by reading the contract and categorizing it as limited, intermediate, or broad. This exercise was largely eliminated in 1976, when broad form contractual liability coverage was automatically included in the broad form CGL endorsement of the Insurance Services Office (ISO).
It's no longer necessary for underwriters to read and categorize indemnity agreements. The reason, which apparently isn't understood by some people in the insurance business, is that the standard CGL policy, since 1986, automatically includes broad form contractual liability coverage; that is, the sole fault tort liability of the indemnitee! This broad coverage is built into the rate. This broad contractual coverage also is built into the Commercial Liability Policy, GL-200, of American Association Insurance Services (AAIS).
The fact that a liability policy automatically includes broad form contractual liability coverage doesn't mean that this broad coverage will be provided. It's first necessary to read the contract to confirm that broad form contractual is required, and that the contract isn't otherwise unenforceable. It may turn out that the contract requires only an intermediate transfer. If so, that's the coverage provided, even though the named insured is paying for the broader coverage.
Examining additional insured status
It stands to reason that, if the CGL policy of ISO or the GL-200 policy of AAIS automatically includes broad form contractual liability coverage (belt), then the additional insured endorsement (suspenders) that is issued should also reflect the sole fault of the indemnitee (additional insured).
Unfortunately, the CGL policy of ISO confuses the situation somewhat because the insurer has no obligation to provide defense but only to reimburse the defense costs, and the legal costs are part of the limits for damages, instead of in addition to damages, unless certain conditions can be met. In many fact patterns, these conditions are destined to fail.
This is another reason that additional insured status is so popular. The standard additional insured endorsements of ISO, at least, provide defense with the costs in addition to limits. Named insureds (indemnitors) often complain that adding additional insureds exhausts their policy limits faster. What needs to be explained is how much faster the limits are exhausted when only contractual liability coverage is provided in cases where the legal costs are within limits!
Not all insurers, of course, follow the ISO procedure of including legal costs within limits. Some insurers feel that they need to control the legal costs expended and would prefer to provide the defense as well. In these cases, the protection between contractual liability and additional insured status is more similar. What does differ is that an indemnitee is not an insured on the named insured's policy.
The source of confusion
What some insurers are doing, perhaps without giving some thought to the repercussions, is that they'll give broad form contractual liability coverage, as an automatic feature of their policies, but when an indemnitee desires to complement that coverage with an additional insured endorsement, the coverage will be less than equal.
For example, the broad form contractual liability coverage of the ISO policy includes coverage after operations are completed. Yet, its broadest additional insured endorsement to cover owners, lessees, or contractors encompasses sole fault but is limited to ongoing operations.
Likewise the commercial liability form GL-200 of AAIS automatically includes broad form contractual liability coverage, but its broadest additional insured endorsement for owners, lessees or contractors, while including completed operations, does not cover the sole fault of the additional insured.
In between these two coverage forms of ISO and AAIS are numerous other additional insured endorsements that include various limitations, regardless of what coverage is requested by contract. Some also give additional insured status on an excess basis and exclude products/completed operations. The shortage of coverage usually doesn't become evident until a coverage request is made. By then, it's often too late.
Why insurers give broad contractual liability coverage on the one hand, and limited additional insured status on the other is difficult to determine. One can only guess that some insurers haven't thought out the concept of belt or suspenders well enough and are treating each as total separate and unrelated forms of protection. Others know precisely what they're doing. They class underwrite. They give as little as possible, regardless of what demands are being made on a named insured indemnitor), instead of underwriting the coverage and charging the appropriate premium on an individual basis.
In the final analysis, indemnitors who can't meet the reasonable requirements of indemnitees are confronted with allegations of breach for failing to procure the appropriate coverage. This in turn generates litigation between the indemnitor and indemnitee, the insurer, and the producer. It also generates more work for the legal community, and high legal costs, just what the insurance industry doesn't want.
Some insurers have taken steps in the right direction: provide contractual liability coverage even for the broad form type of indemnity, with legal costs in addition to limits. Some insurers also provide blanket additional insured endorsements that provide sole fault coverage for both ongoing and completed operations on a primary basis--if required by written contract. If that broad coverage isn't specifically requested, then what is provided is "bare bone" protection. It's as if the insurer is saying, "Ask and you shall receive--for a price, of course."
What producers need to do, if possible, is to seek out those insurers that are willing to underwrite on an individual, rather than a class basis, and to provide reasonably broad coverage as required by written contract. If enough producers do this, there may come a day, as competition increases, when those insurers that are bent on providing as little as possible, will likely give the situation a second thought.
Some concluding thoughts
Generally, insurers will require a written contract of indemnity when they provide additional insured status. Their rationale is to provide no more coverage than what is being requested. For many years, additional insured status has been broader in coverage than the corresponding indemnity agreement.
In determining the scope of contractual liability coverage, one needs to read the contract in relation to the policy. In determining additional insured coverage, one needs to read the endorsement in relation to the policy. One doesn't go to the contract, unless the endorsement or policy requires it, or there's a question of intent.
The trend today is to use a blanket additional insured endorsement for covering owners, lessees, or contractors. Using a separate endorsement for each insured is no longer in vogue. The caveat is that blanket additional insured endorsements need to be read carefully as their wording may vary. *
The author
Donald S. Malecki, CPCU, is chairman and CEO of Donald S. Malecki & Associates, Inc. He is an active member of the CPCU Society, serves on the Examination Committee of the American Institute for CPCU, and is an active member of the Society of Risk Management Consultants.