Battling the perils of the classification limitation
This nonadmitted market endorsement can trip up unwary insureds and producers
By Donald S. Malecki, CPCU
When businesses find they are no longer eligible to obtain their insurance in the admitted insurance market, they need to exercise extra caution about how their policies are structured. Policies outside the admitted market are likely to contain some very restrictive language that can cause surprises at the time of claim.
This, of course, should not be taken to mean that the insurance available through the admitted market would necessarily meet the needs of those who are able to find willing takers. The way standard and independently filed forms are being changed periodically, they are nothing to brag about either. It is just that moving into the nonadmitted market could be worse.
Some examples may help to illustrate the reason for this concern. In one case, a fire at a building where a contractor was performing work resulted in injury to a firefighter. Suit was filed by this injured claimant against the contractor alleging that the contractor (1) negligently performed “certain construction, alteration, renovation, and/or demolition work, labor and/or other services” on the building, and (2) improperly removed pipe and used one or more torches in connection with the work.
It may have come as a surprise when this contractor found out that its insurer was denying coverage based on a “classification limitation” endorsement forming a part of its policy. This endorsement provided that the policy would apply only to losses arising out of operations listed in the “classifications” section of its commercial general liability (CGL) policy.
As the insurer explained it, the contractor had made misrepresentations in its application for insurance describing its business as “garbage, ash or refuse collecting,” when it was actually “supervising the removal of pipes.” Fortunately, in this case of Burlington Insurance Company v. Guma Construction Company, No. 208-04960 (Sup. Ct. N.Y. App. Div. 2009), the contractor was able to convince the court that the insurer owed it a defense because the allegations suggested a reasonable possibility of coverage.
In the case of United States Underwriters Insurance Company v. United Pacific Associates, LLC, et al., No. 05-CV-1012 (U.S. Dist. Ct. E.D. N.Y. 2006), a contractor was serving as a general contractor for the construction of residences. Pursuant to the contract, it was responsible for demolition and excavation, floor framing, exterior brickwork, roofing, plumbing and electrical work, among other tasks.
This dispute arose after a passerby slipped and fell on the sidewalk, where work was being performed, and filed suit alleging that his injuries were the result of negligent removal of snow and ice. The contractor’s insurer denied coverage and defense because the liability policy was subject to a classification limitation endorsement that limited coverage to two classifications: carpentry and carpentry-interior.
The insurer also asserted that even if the contractor (named insured) had been working on carpentry operations at the time of the accident, coverage still would not have applied because the accident was allegedly caused by negligent snow and ice removal, which had nothing to do with carpentry work.
Fortunately for the contractor, the court ruled that there were material issues that had to be resolved, namely, whether (1) the contractor was engaged in carpentry work on the day of the accident and (2) the removal of snow and ice on the date of the accident was in support of carpentry work.
Other businesses also affected
The classification limitation endorsement is not limited solely to contractors, although many are written subject to this endorsement. The endorsement’s use can surprise any number of businesses. In the case of Wickramasekra v. Associated International Insurance Co., 890 So. 2d 569 (La. Ct. App. 2003), the business description on the CGL policy’s declarations page, in conjunction with a classification limitation endorsement, limited coverage to damages resulting from loading and unloading of equipment.
While an employee was moving palm trees with a forklift, a friend of the employee who was visiting the workplace at the time was injured while assisting with that removal, and filed suit against the business owner. The court ruled for the insurer, noting that palm trees were not equipment.
The case of Colony National Ins. Co. v. Hing Wah Chinese Restaurant, No. 06-2524 (U.S. Dist. Ct. E.D. PA 2008) involved a restaurant whose classification limitation endorsement limited coverage to the operations that did not include food delivery.
Following an auto accident involving an employee operating his own auto while delivering food, the restaurant owner learned just how restricted its liability policy was. The court ruled for the insurer. In doing so, it held that the policy did not expressly provide coverage for food delivery, and that the word “restaurant,” as it appeared in the policy, was not ambiguous because food delivery is not an inherent or necessary part of operating a restaurant.
In many cases, when a classification limitation endorsement applies to a liability policy, it will be accompanied by a designated premises endorsement. The general purpose of this latter endorsement is to limit bodily injury, property damage, personal and advertising injury to the ownership, maintenance or use of the premises shown in that endorsement and operations necessary or incidental to those premises.
A case where both the classification limitation and designated premises endorsements were involved is First Specialty Insurance Corp. v. U.S. Aquaculture Licensing, et al., No. 1:07CV98-SA (U.S. Dist. Ct. N. Dist. MS 2008).
A university developed and bred a new strain of catfish, which another entity marketed. As part of the university’s license agreement, it was to be an additional insured on the other entity’s liability policy. Following the sale of fish to a fishery, most of the fish perished. The buyer therefore filed suit against the university, which, in turn, requested defense from the insurer of the entity that marketed the fish for the university.
The liability policy of the marketing entity, however, was subject to a classification limitation endorsement and a designated premises endorsement. The classification limitation was “lessor’s risk” only, which the marketing entity maintained was not applicable, because it was never a lessor. The designated premises endorsement, on the other hand, limited coverage to the entity’s premises, as described, which did not also encompass the production ponds where the fish were kept.
Despite numerous attempts to hold the endorsements ambiguous, the court ruled in the favor of the insurer. The court held that while operations were covered, they were limited to the premises designated in the endorsement and those premises, as identified, did not include the production ponds.
The designated premises endorsement is a product of ISO, while the classification limitation endorsement is not. The classification endorsement is common with all types of businesses whose liability insurance is written in the excess and surplus lines markets.
The underlying reason for issuing a classification limitation endorsement is likely to be known only by the insurer. Very possibly, however, it could be issued so that underwriters can limit their coverage to the specific operations they deem acceptable from an underwriting view—for businesses that have a bad track record for one reason or another, or are involved with risks that no admitted insurer desires.
Both endorsements restrict coverage. Recipients of liability policies subject to one or both endorsements must understand that coverage is not comprehensive even though insurers issuing these endorsements will use ISO forms or endorsements to form a complete policy.
Over the years, many businesses have come to learn that the standard ISO commercial general liability policy is comprehensive in nature; that is, it will automatically include new exposures that arise during the policy period until the next renewal when they should be declared.
Some insurers, however, do not necessarily agree with that concept and may even try to limit coverage to a classification despite the absence of a classification limitation endorsement. A case in point is Indiana Insurance Companies v. Granite State Insurance Co., 689 F.Supp. 1549 (U.S. Dist. Ct. So. Dist. IN 1988). The court held for the insured, holding that the description of hazards was a rating device and not a schedule of covered risks.
Although we will not go into any specific cases here, producers often get implicated in these cases. The usual reason is that if there is no coverage for some reason, the insured believes it is the producer’s fault. It does not matter whether the producer has met the standard of care or not. It does help if there is evidence that such care was exercised.
If a liability policy is issued with a classification limitation endorsement, producers must be mindful that the classification(s) designated matches the nature of the named insured’s operations. This means that the application must accurately reflect the nature of the named insured’s work. If it does not, problems can result.
Named insureds also must be notified about how restrictive the classification limitation endorsement is. In many cases, insurers may change the classification if informed. Much will depend on whether the new operations meet their underwriting requirements and the named insureds are willing to pay the additional premium.
The designated premises endorsement is an ISO product. It, too, cuts back on coverage. Unless an underwriter is willing to delete it, producers should call this to the named insured’s attention, despite the fact that it is the policyholder’s, and not the producer’s, obligation to read the policies. This is suggested merely as a precautionary step that could reduce some problems if there were to be any argument over a claim.
Donald S. Malecki, CPCU, has spent 50 years in the insurance and risk management consulting business. During his career he was a supervising casualty underwriter for a large Eastern insurer, as well as a broker. He currently is a principal of Malecki Deimling Nielander & Associates LLC, an insurance, risk, and management consulting business headquartered in Erlanger, Kentucky.