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Risk Management

Caveat emptor

"Step down" provisions are not a step up for policyholders

By Donald S. Malecki, CPCU

A common question posed by producers is how to sell auto insurance when the current insurer is especially competitive. Considering that consumers are interested in price, the winner usually is easy to determine. Price, however, usually means that something has to give on coverage.

The question is, what can an insurer take away in coverage that would enable it to better compete on price? That is a difficult question because it requires a review of the competitor's policy, followed by a comparison with the policy that the producer is marketing.

One way to cut short that time-consuming exercise is to look to see if the competitor policy contains a “step-down” provision. A “step-down” provision? What is that? Considering that some producers do not know what a “step-down” provision is, and there are many who do not, an explanation is necessary.

Briefly, a “step-down” provision in an automobile policy states that the limits applicable to a permissive user will not be what the policy declarations reflect but, instead, the limits of the financial responsibility of the law of the state in which the accident occurs.

As purchasers of insurance know, or should know, financial responsibility limits are minimums and generally far less in amount than most responsible motorists or businesses will select.

Where these provisions grow

It is not unusual to find “step-down” provisions in substandard automobile policies written for individuals and family members who cannot obtain their coverage from standard markets, although these provisions also appear in some independently filed (non-standard) personal auto policies of some insurers in the regular market.

“Step-down” provisions also are incorporated into commercial auto policies, such as garage liability and auto dealership policies, as well as policies on automobile leasing and rental firms. It also would not be surprising to find these provisions in high-risk commercial policies, such as public livery vehicles, both for the operators and their passengers.

Since the applicability of these “step-down” provisions comes as a surprise to those seeking damages following an auto accident, litigation over the validity and enforceability of these provisions usually ensues. A case in point is Windsor Insurance Co. v. Lucas, et al., 24 S.W. 3d 151 (Mo. App. E.D., 2000).

The owner of an automobile gave her boyfriend permission to operate it. While using the automobile, the boyfriend was involved in an accident that generated claims by several individuals alleging negligent operation. The policy limit for bodily injury was $100,000 per person and $300,000 per accident.

This policy, however, contained a “step-down” provision which limited permissive user coverage to $25,000 per person and $50,000 per accident. At the time, these were the minimum insurance limits in Missouri applicable to injury caused by a “non-relative” driver who also was a permissive user.

The trial court stated that the language providing for reduced coverage of permissive users was found in the definitions section of the policy, rather than in the limits of liability section and, therefore, declared that the provision was ambiguous. On appeal, the insurer maintained that (1) the “step-down” provision was also articulated in the limitations of liability section of the policy and, therefore, was not ambiguous, and (2) Missouri law, as well as the laws of other states, has recognized and enforced such clauses in the past.

In considering the insurer's first argument, the court referred to that part of the limits of liability provision that recited the “step-down” provision and stated that the provision was not ambiguous and did not create any uncertainty. This provision read: “Regardless of the limits of liability shown in the Declarations page the bodily injury and property damage liability . . . for each insured, other than you and a relative, will equal the limits of the Financial Responsibility Law of the state in which the accident occurred.”

The court stated that there was no prohibition under Missouri law for an insurance contract to set forth the maximum amount the insurer will pay, so long as the provisions did not create an ambiguity. In pondering whether the “step-down” provision was contrary to state law, the court stated that Missouri courts, at least, recognize freedom of contract in liability insurance. This court, in reversing the decision of the trial court, upheld the validity to the “step-down” provision.

At the time of this court case, the following states, in addition to Missouri, permitted the enforcement of the “step-down” provision: Arizona, California, Florida, Indiana, Nevada, New Jersey, New York, Pennsylvania, South Carolina, and Utah. Both Wisconsin and Utah prohibited these provisions. The supreme court of the Commonwealth of Kentucky, in the case of Bidwell v. Shelter Mutual Insurance Co., 2010-SC-000560-DG (KY Sup. Ct. 2012), likewise ruled that this provision violated the doctrine of reasonable expectations. A point to keep in mind is that, since court cases can be reversed or overturned, they may not serve as permanent precedent.

Commercial policies

One of the cases upholding the use of a “step-down” provision in a garage liability policy is Universal Underwriters Insurance Co. v. Hill, et al., 955 P.2d 1333 (Kansas App. 1998). This appeal involved a dispute over the amount of coverage available to an auto dealership. While awaiting delivery of his newly purchased automobile, a customer was given a “loaner” auto in which he was involved in an accident injuring another motorist.

A suit by the injured motorist ensued against the dealership and customer, which was intervened by the injured motorist's insurer. The parties stipulated that the injured motorist, who maintained underinsured motorists coverage limits of $100,000, suffered $300,000 in damages, including nearly $173,000 in non-economic loss and over $89,000 in future economic loss.

The primary issue before the trial court was whether the auto dealership's policy contained a limit of $25,000 for permissive users, such as its customers, or whether the general limits of $300,000 were available. The policy's limits of insurance provision read:

THE MOST WE WILL PAY—Regardless of the number of INSUREDS or AUTOS insured by this Coverage Part, persons or organizations who sustain INJURY, claims or suits brought, the most WE will pay is:

1. With respect to GARAGE OPERATIONS and AUTO HAZARD, the limit shown on the declarations for any one OCCURRENCE.

With respect to persons or organizations required by law to be an INSURED, the most WE will pay is that portion of such limit needed to comply with the minimum limits provision of such law in the jurisdiction where the OCCURRENCE took place. When there is other insurance applicable, WE will pay only the amount needed to comply with such minimum limits after such other insurance has been exhausted.

The injured motorist's insurer, which intervened in this case, argued that the above policy provision violated the Kansas Automobile Injury Reparations Act (KAIRA) because it incorporated the minimum limits of “the law in the jurisdiction where the OCCURRENCE took place.” As pointed out by this insurer, Kansas statutes required policies issued in compliance with KAIRA to provide coverage for the “ownership, maintenance or use of any such vehicle within the United States of America.”

The auto dealer's insurer rebutted this argument by showing that (1) there was no dispute that the accident occurred in Kansas; (2) the “step-down” provision complied with the KAIRA, because the Kansas amendatory provision specifically provided the limits required by Kansas law; and (3) its policy provision was not void, because the KAIRA required that the policy “be construed to obligate the insurer to meet all the mandatory requirements and obligations of the act.” The coverage, the insurer therefore maintained and the court upheld, was $25,000, which was mandated by law.

Some businesses whose automobile-related policies contain these “step-down” provisions probably do not even know they exist until a dispute arises. In many instances, these provisions may not necessarily work to the disadvantage of the businesses whose policies incorporate these provisions. However, to some of the unwary, it may turn out to be more than they have bargained for, particularly in cases involving contractual assumptions of liability for high limits.

Obstacle to producers

Producers who want to compete by pointing out these “step-down” provisions of policies have to know which insurers are relying on them. Obtaining policies may be difficult because the custom and practice is for insureds to not receive their policy until after it has been purchased! When one considers that practice, it seems a bit unfair and contrary to the protection of the insurance consumer.

In any event, one way for producers to obtain the “edge” is to search out the names of insurers, other than those mentioned with reference to this subject, that have relied on the “step-down” provisions. Insurers in this category include State Farm, Shelter Mutual Insurance Company, Philadelphia Insurance Company, Liberty Mutual Insurance Company, Mid-Century Insurance Company and Farmers Insurance Exchange.

Whether the producers obtain the business or not, pointing out these “step-down” provisions will be doing a service and will likely be appreciated by prospective insureds, who may keep such producers in mind for future needs. The service provided, therefore, may be worth the effort.

The author

Donald S. Malecki, CPCU, has spent more than 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.


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