By Donald S. Malecki

It is quite common for businesses to depend on more than one producer to handle their insurance portfolio. (In fact, individuals and families also follow this practice.) It makes good sense, business owners and operators rationalize, to spread their insurance needs among friends and customers. In other cases it is necessary because producers do not all have the same market capabilities and cost-effective programs to offer.

While the opportunity to write some of a client's business may appear to be better than none at all, producers need to be careful what "piece of the pie" they are being offered. Although it seems perfectly acceptable to divide the insurance among lines so that one producer handles the property insurance program and another the liability insurance portfolio, dividing these lines among different producers is going to present problems to the client as well as the producers.

Some years ago, this column carried an article about the plight of two producers who handled the property and liability insurance program of a family. One producer handled both the homeowners and automobile insurance policies, while the other producer handled the personal catastrophe (umbrella) policy.

One of the youthful drivers in the household was a poor driver whose auto insurance had to be written with a substandard insurer for the minimum limits required by the financial responsibility law. The problems of finding a market for this youth and having to pay the hefty premium did not change his driving habits. In fact, his driving habits resulted in more trouble than one probably would have ever dreamed. He was involved in another accident, because of his alleged negligence, where the other motorist was killed.

Since the youth had no assets but was still living with his parents who were still responsible for his conduct, suit was filed against the parents seeking in excess of $1 million in damages. They felt somewhat relieved by the fact that they had purchased a personal umbrella policy some years earlier when their kids were first learning to drive.

What the parents failed to realize, however, was that they had a huge gap in coverage between the personal umbrella policy limit of $1 million and the minimum underlying required auto insurance limit. While the family maintained a $500,000 combined single limit on their auto policy, their son's substandard auto policy was written for financial responsibility limits of $25,000 combined single limit. The parent quickly learned the fundamentals of personal umbrella coverage, because they had a gap of $475,000 in coverage.

It is uncertain how this case was resolved. But it might have been avoided or the parents might at least have been put on notice about the surprise they had encountered, if they had used only one producer instead of two. In this case, the producer who handled the umbrella policy never gave any thought about the change in underlying auto limits, and the producer who handled the primary liability insurance program apparently did not give any thought to the personal umbrella policy exposure.

Commercial insurance scenario

This kind of a scenario can also occur with respect to commercial insurance businesses. An actual case in point is A.J. Cameron Sod Farms, Inc. v. Continental Insurance Company, et al., 700 Atl.2d 290 (Sup.Ct.N.H.1997).

The general manager of Cameron Sod Farms [hereinafter, the named insured] obtained the company's insurance through two different producers. One producer handled all of the primary liability and auto insurance coverages, and the other producer handled the umbrella policy. Initially, the business auto policy (BAP) was written for a combined single limit of $1.5 million.

As it turned out, the producer who handled the primary liability insurance severed his relationship with the existing insurer. At renewal, the producer issued a binder with the new insurer for the BAP. The new insurer, however, advised the producer that it would not issue a BAP in excess of a $1 million limit. The producer therefore issued a second binder for a $1 million limit. After having done that, the producer received more bad news: the insurer notified the producer that it would not write the BAP for any more than a $500,000 combined single limit.

The producer therefore issued a third binder reflecting this lower commercial auto limit. The producer also put a handwritten note on the third binder stating: "Insd. knows $500,000 limit in effect and has increased umbrella..." The umbrella policy limit was increased at inception from $2 million to $3 million and again to $5 million eight months later.

Unfortunately, both the umbrella insurer and its producer were unaware of the change in insurers as well as the decrease in BAP limits. The underlying schedule of limits attached to the commercial umbrella policy did not reflect the reduction in underlying auto limits.

As luck would have it, a worker was injured when he fell from atop bales of hay on a truck leased from the named insured. In assessing the available insurance, it turned out that yet another BAP was written for limits of $500,000 by the producer who controlled the underlying coverages. With the available BAP limits at $1 million, there still was a gap of $500,000 in umbrella liability coverage.

Parenthetically, a great deal of argument was devoted to the issue of whether the commercial general liability (CGL) policy of the named insured, in the amount of $1 million, also applied. Given that the CGL policy excludes any liability (including liability assumed under contract) arising out of the ownership, maintenance, use, including loading or unloading of any automobile owned or operated by, rented or loaned to any insured, no coverage should apply. This also was the court's decision in this case. It is not unusual, however, for insureds to seek coverage involving auto-related accidents under the CGL policy; even some insurers will make such arguments not realizing that some day these kinds of maneuvers may come back to bite them.

The issue concerning the gap between the business auto policies and the umbrella liability policy fell on reformation. The named insured argued that the underlying required limit of the umbrella policy should have been reformed based on the mutual mistake of the parties.

However, in order for the umbrella policy to be reformed to reflect a $500,000 attachment point, the named insured was required to show that the umbrella insurer or its agent actually agreed to reduce the attachment point to that amount. On the date the umbrella policy was renewed, the named insured actually had $1.5 million in underlying business auto insurance. The agent representing the umbrella insurer was not aware of the later reduction in coverage limits, nor was it asked to lower the attachment point of the umbrella policy.

The agent who handled the primary insurance testified that he contacted the agent handling the umbrella policy to request an increase in the umbrella policy which, in fact, was increased. The testimony indicated that within the insurance industry, this sort of instruction operates to increase the upper liability limits of an umbrella policy, rather than lower the attachment point of liability. Noting insufficient evidence to demonstrate mutual mistake among the parties, the court declined to reform the umbrella policy.

The gap of $500,000 between the BAP and umbrella policy remained insofar as this case went. From a risk management perspective, this gap commonly is referred to as a "passive retention" or surprise! How this gap was eventually resolved and with whom is beyond this case and article.

Producers who have the opportunity to control solely an umbrella policy should give thought to whether it is worth it in the long run. Certainly there is the outside chance with one's foot in the door, all of the other coverages may one day shift to one producer. In the meantime, producers need to be very careful about handling this kind of coverage division. Those producers who have been caught up in litigation will tell you it is not worth the hassle to handle the umbrella policy without the other underlying coverages. It boils down to assuming a lot for a little.

However, in recent years, the leading primary insurer usually requires that it also provide the first layer umbrella policy. This kind of requirement is likely to avoid the foregoing arguments over insufficient limits but raise arguments over insufficient coverage. It's an exposure that producers need to heed and can be best described as: Placing all the "eggs in one basket."

While this is a subject of a future article, it is necessary to mention in closing that umbrella policies written by the same insurer of the underlying liability coverages seldom are "follow form." In fact, based on this writer's experience, you can expect some gaps to appear between the two coverage layers where no amount of sufficient limits will be of any help. It is a problem that producers should be cognizant of. *

The author

Donald S. Malecki, CPCU, is chairman of Donald S. Malecki & Associates, Inc. He is chairman of the Senior Resource Section 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.