By Donald S. Malecki, CPCU

The term "step-down" in relation to automobile-related coverages may be foreign to most people, barring those permissive users who, in seeking protection, have encountered such a provision under an auto owner's policy.

With auto insurance having been available since around the turn of the last century, many individuals have come to learn just how advantageous it is to have the opportunity to rely on the policy of the auto being driven as primary protection.

The insurers incorporating the step-down provisions cannot underwrite the permissive use exposure. They also realize they cannot eliminate coverage for the permissive user entirely, so that the only way they may be able to reduce their loss experience is to cut the limits down to the minimum permitted by law.

From the standpoint of personal auto coverage, permissive users would be persons not related to an auto owner. The limits available to these permissive users are the minimum required by auto financial responsibility laws, despite the actual limits purchased and as shown on the policy declarations page.

It is uncertain what particular auto policies might be credited as being the genesis of the step-down provision. However, it likely was with some substandard auto policies, where an insurer may not have wanted to provide the same protection to non-family members as it did for the named insured and his/her family members.

An auto owner who grants permissive use of his/her personal auto may not care whether the policy contains a step-down provision, particularly when the permissive user can rely on his/her personal auto policy for excess protection. However, some auto owners may find themselves in situations where they, too, are confronted with lower limits, since the use of step-down provisions has expanded to other auto-related coverages, such as auto rentals and leases, and garage liability.

Are these provisions against public policy?

A likely question about these step-down provisions is whether or not they are permitted by law. It may come as a surprise, but a growing number of jurisdictions allow step-down provisions limiting the liability insurance of permissive auto users to the statutory minimum, in absence of a statute prohibiting them.

In one recent case, the following jurisdictions were included in a list as having approved the use of this provision: Arizona, California, Florida, Idaho, Indiana, Missouri, Nevada, New Jersey, New York, Pennsylvania, South Carolina, and Utah. It is important to note that the above status of jurisdictions--based on court decisions--could change depending on the fact pattern of a given case.

One of the recent arguments over the step-down provision and the public policy issue appears in Windsor Insurance Co. v. Lucas, 24 S.W.2d 151 (Mo.App.E.D. 2000) where the state of Missouri did not consider the step-down provision to be against public policy, and where the court did not find that any ambiguity existed so as to preclude the step-down provision's application.

Briefly, this case arose after the insured gave her boyfriend permission to use her auto and he was involved in an accident involving several claimants. The insured maintained auto limits of $100,000 per person and $300,000 per accident. However, the policy also included a step-down provision that limited coverage to $25,000 per person and $25,000 per accident, the minimum required by Missouri law, in the event of injury caused by a non-relative driver. The trial court ruled that the policy was ambiguous. On appeal, the decision was reversed.

Other policies affected

As long as there is no statutory prohibition for the use of step-down provisions, there is no reason not to expect insurers to insert these provisions in other auto-related policies, which may also impact on persons other than permissive users.

For example, 10 years earlier in the state of Missouri a passenger in a rental truck operated by a negligent driver, was injured when the truck overturned. The truck rental company maintained basic limits of $1 million and provided insurance to "any other person while using an owned automobile ... with the permission of the named insured."

This policy also provided that "the insurance afforded to [a] renter ... shall also be subject to the terms, including the ... limits of liability, conditions, restrictions, and limitations in the lease/rental agreement." The rental agreement with the driver provided limits of liability "up to the requirements of the state financial responsibility law in which the accident may occur or $10,000/$20,000 bodily injury ... if no financial responsibility law applies."

The Missouri court found that, since both documents clearly reflected the intention to provide exactly what the law required, namely the liability mandated by that state's financial responsibility law, the language of the rental agreement limiting liability for renters and lessors was enforceable. Therefore, the truck rental firm's insurer was required to pay only this state's financial responsibility law of $25,000 per person.

Sometimes unenforceable

Sometimes the use of these step-down provisions is rejected by courts as being unenforceable for any number of reasons. For example, in the case of Mid-Century Insurance Co. v. Honorable D. L. Lyon, Director, South Dakota Division of Insurance, 562 N.W.2d 888 (Sup.Ct. So. Dak. 1997), the court held a step-down provision to be invalid.

It did so on the basis that a "restrictive endorsement," within the meaning of a statute permitting an auto policy to contain a restrictive endorsement reducing limits, if the vehicle is operated by a named person or class of persons, must be on a separate page added or attached to the policy.

If one ponders this concept of the step-down provision, there actually is no limit to the situations where it may be used. As mentioned earlier, an owner of a personal auto may not care whether his/her policy contains a step-down provision.

However, the use of step-down provisions in commercial policies may be a different story. Suppose, for example, a business owner requires an independent contractor to maintain auto insurance and to add the business owner as an additional insured for limits of not less than a certain amount, which may require a combination of an auto and an excess or umbrella liability policy.

Suppose the excess or umbrella policy, unbeknown to the independent contractor (named insured), includes a step-down provision so as to limit the business owner's coverage (as an additional insured) to less than the limits required by the business owner's contract.

This type of situation is one where an independent contractor would care that a step-down provision applies, because if the policy provides less limits than required by the contract, the independent contractor may be held accountable for the difference, which is not generally insurable.

Because the use of step-down provisions has grown, it therefore is necessary to take note of their use in forms. These provisions, incidentally, are not limited to non-standard or independently filed coverage forms. Some have been noted in commercial standard forms, such as the contingent liability of rental or leasing concerns endorsement.

The author

Donald S. Malecki, CPCU, is chairman and CEO of Donald S. Malecki & Associates, Inc. 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.