This document provides an overview of various types of commercial insurance policies and concepts, including: - Commercial Package Policies that bundle various coverage parts like general liability, property, and business income. - The distinction between first-party insurance that pays the policyholder, and third-party insurance that pays others. - The importance of reading the policy (RTFP) to understand what is and isn't covered, including any sub-limits or exclusions. - Differences between excess policies, umbrellas, towers of coverage, and how policies may follow-form or have standalone terms. - Concepts of self-insurance, large deductible plans, captives, reinsurance, fronting

1. Insurance for Lawyers 201Introduction to Advanced Risk Management

2. ReviewSo far, we have been discussing the Insurance Service Office and the Commercial Package Policy.The CPP is a bundle of coverage parts.Commercial General LiabilitySpecial Liability PartsProperty CoverageBusiness Income

3. ReviewThe big distinction in insurance is between First Party and Third Party.Keeping the distinction in mind helps avoid confusion.First Party Insurance pays the policyholder or its designees.Third party insurance pays people other than the policyholder.No cross-insured coverage

4. ReviewRTFPThere is no substitute for reading the policyCertificates and indications do not mention the exclusions.Even without exclusions, there can be sub-limits that can make coverage less valuable.It’s the only way to know what is and what is not covered by the insurance.

5. Excess and UmbrellaThese are not the same, even though clients and courts sometimes use these terms interchangeably.Insurance Companies contribute to the confusion: there are policies out there that are called Umbrellas even though they don’t cover anything that is not covered by the primary.In our discussion, I will refer to true umbrellas as such and to excess as such as well.

6. UmbrellaUmbrellas serve three purposes:Increased amounts of coverage under primary policies (CGL, Auto, etc)Replace primary coverage if aggregate exhaustedBroaden coverage for some risks not covered by primaryUnder an excess policy, if a risk is not covered by the primary, it’s not covered by the Excess.Umbrellas cover risks not covered by the primary, and not excluded by the Umbrella, but subject to a self-insured retention (typically $250,000)

7. Tower of Coverage

8. ExcessTwo basic policy forms exist:Follow FormStandaloneFollow Form incorporates the underlying insurance into the excess policy:In consideration of the payment of the premium and in reliance upon all statements made in the application including information furnished in connection therewith, and subject to the terms, definitions, conditions, exclusions and limitations of this policy, the Insurer agrees to provide insurance coverage to the Insureds in accordance with the terms, definitions, conditions, exclusions and limitations of the Followed Policy, except as otherwise provided herein.

9. ExcessA standalone policy contains all of the terms and conditions within its four corners.Some policies are hybrids, covering some risks on a Follow Form basis, and others as Standalone.Excess policy is triggered when the underlying insurance is reduced or exhausted.Excess policy pays the amount of covered losses in excess of the reduced coverage from the underlying insurance.If primary is exhausted, the excess drops down and becomes primary insurance, subject to a self-insured retained amount (usually $250,000).

10. Specific/Aggregate ExcessSpecific Excess is seen with Self-Insured Workers’ Compensation.Policyholder retains an amount, say $100K, per workers’ compensation claim.If a claim comes in that costs $150K, then the policyholder pays the SIR of $100K and the excess pays $50K.If ten claims come in for $99,000 each, the policyholder pays $990,000 because none of the claims exceeded the $100K per claim trigger.

11. Supported/Unsupported UmbrellaSupported Umbrella sits excess of the insurance company’s primary policy.Disadvantage: some companies do not want to take on this large a share of the risksAdvantages:Underwriting can be coordinated to avoid gapsClaims handling can be expeditedExcess insurance company can reside confidence in the information it receives regarding the primary risk and coverage

12. Umbrellas Are Variable…RTFP Some umbrella forms provide for Part A and Part B coverage. This does not mirror the CGL’s Part A and Part B. Instead, umbrellas that use this format are combination policies, in which Part A addresses coverage when the underlying policy covers the loss, and Part B addresses coverage when the underlying policy excludes the loss.Look carefully when reviewing ANY umbrella policy to understand whether and when it drops down, and what retention applies to a dropping down.

13. More Variations….Ultimate Net Loss may include defense costs, a backhanded way of making defense inside the limit. The umbrella may have its own definitions of bodily injury, property damage, personal injury, and advertising injury that may not line up exactly with the underlying policy. This creates headaches when trying to show that the underlying limits have been exhausted, but bear in mind that if the Umbrella covers an injury to “bodily injury” that is excluded from the CGL layer, then the Umbrella should drop down. The policyholder takes the hit for a larger self-insured retention, but the umbrella should respond.The umbrella may have a different trigger than the underlying policy: the excess is triggered by the wrongful act rather than the injury. Gaps may result. Moreover, if the policyholder has changed insurance companies, you might omit to give notice to the correct insurance company. Other policies adopt the trigger of the underlying policy. If that includes a claims made policy, pay attention to the retro dates of the policies (they should match).

14. Still More Variations…Umbrella same as UnderlyingUmbrella omits some exceptions. E.g. auto, which is excluded from CGL, but umbrella is often written to be excess of auto coverage. Other umbrellas omit exclusions in order to broaden coverage (e.g., pollution, dram shop, accidents outside the US and Canada)Umbrella uses less restrictive versions of underlying exclusions. Watercraft and aircraft; property in care, custody or control often excluded (absent an express agreement to insure, signed before the loss occurs), but this loosening of the policy is generally endorsed-out in the case of contractors’ policies.Umbrella uses more restrictive versions of underlying exclusions. Pollution is sometimes excluded but at other times is covered. RTFPPunitive DamagesCross-liability exclusionBroad as Primary endorsementContractors’ Limitation EndorsementFollowing-form endorsements

15. Excess and Umbrella Final ThoughtsMaintenance of Underlying InsuranceSome umbrellas will not drop down if required underlying coverage not maintainedOthers respond “as if” it had been maintained, i.e., policyholder absorbs all payments and costs that would have been coveredIf defense is outside the limit, this can be very expensive, because defense costs continue under the primary until the limit is met by indemnity payments. Concurrency. Inception and expiration of underlying and excess/umbrella should match. Otherwise the years will be confused and it will be challenging to find the trigger.Coverage Territory: often worldwide coverage so long as suit is filed in US or CanadaStructuring the Liability Insurance ProgramLayering. Buffers. Gaps.Are the limits adequate?DON’T ADVISE ON LIMITS UNLESS PRESCRIBED BY LAW

16. Self-InsuranceFundamentally, no insurance at all.When a risk is uninsured, it is said to be a retained risk.Risk retention can be accidental, as when the risk was supposed to be covered but isn’t, and planned, as when a policyholder decides to pay for workers’ compensation losses up to $100K per claim.

17. Self-InsuranceSelf-Insurance is planned.It reflects the policyholder’s tolerance for risk.Self-insurance is generally not a solution for policyholders exposed to catastrophic losses.Some categories of loss are predictable. Slip-and-fall losses are largely a function of the volume of foot traffic. A combination of self-insurance with targeted coverage on Black Swan events is a common goal.

18. Self-InsuranceCan be as informal as “going bare” or as complex as hiring a TPA to administer claims, give notice to umbrella and excess layers.Loss control takes on special significance in a self-insured program.Some excess insurers simply will not write in excess of “nothing,” so policyholders sometimes purchase a million-dollar policy with a million-dollar deductible. The market for excess coverage over self-insurance is much narrower than the market for excess over primary coverage.

19. Self-insurance

20. Self-InsuranceSome self-insurance programs are limited by law (workers’ compensation, auto liability) or practical concerns.Some clients may be uneasy with self-insurance.In construction, the policyholder can include insurance premiums in the cost of the work; but self-insured reserves and allowances may not be chargeable: it may be more profitable to buy insurance than to self-insure in these cases.Tax treatment of self-insurance may be troubling. Policyholder may take a contra-income charge (similar to an allowance for bad debts) but most of these advanced techniques call for tax counsel as well as risk management.

21. Large Deductible PlansLarge Deductible PlansDeductible amounts of $250,000 and more are in this category.Resembles self-insurance butinsurance company administers claims andthe program does not require state approval.Frequently a component of construction insurance wrap-ups.Aggregate cap or “stop loss” provisions are often included to prevent the deductibles from ruining the policyholder.

22. Large Deductible PlansInsurance company pays the loss even if the policyholder does not reimburse.But RTFP: some “large deductible” endorsements actually create a self-insured retention, which can have a major impact on wrap-up programs.When the plan has a true deductible, the insurance company will demand an escrow or other financial assurance that the deductible will be reimbursed.Often seen in conjunction with Retrospectively-rated programs.

23. CaptivesInsurance company owned by one or more parents that insures only the parents.Similar to mutual insurance but much smaller and policyholder-owners contribute the captive’s capitalCaptive can be owned by a single company = “Pure” Captive. Alternative is a “Group” CaptiveCan be “direct” or “indirect.” Direct captives issue policies to their policyholders and frequently reinsure their exposures. Indirect Captives are reinsurers. D. Risk Retention Groups are a special form of captive in which all of the owners must be policyholders, and all policyholders must be owners. RRG and the closely-allied Risk Purchasing Groups are part of the federal response to the “Tort Crisis” and covered by the Liability Risk Retention Act of 1986. Statute permits an RRG licensed in one State to cover risks in all States.

24. Captives Pros:ControlTailoring coverage to the owner’s needsCost stabilization: cost of insurance does not rise due to hard market conditionsTaxation. Captives enable access to a variety of tax advantages tied to the timing and recognition of expenses. Calls for its own presentation.. ConsExpensive to set upRequired capital must be maintained.Requires management attention. Captives must be run like true insurance companies.Some captives accept business from non-parents in order to satisfy Treasury Regs on deductibility of premiums paid to captives. This practice has been known to result in the captive failing financially due to the less-controlled risks introduced by the outsider.

25. ReinsuranceA way for an insurance company to spread the risk around is to purchase insurance from another company to cover part of a loss.Important for catastrophic exposures.Reinsurance companies are often “offshore.”May permit an insurance company to offer higher limit of liability than permitted by company practice or state controls.

26. ReinsuranceTwo Types of ReinsuranceTreaty or Cession: the seller of reinsurance commits to take on an agreed percentage of risks that are covered by the treaty.Individual risks are not rated, but are accepted automatically.Facultative: seller of reinsurance evaluates each policy on its own merits.Ceding company retains a percentage of the premium as a commission.

27. ReinsuranceIn keeping with the role of reinsurance as insurance for insurance companies, two coverage extensions are available:ECO: the costs related to a "declaratory judgment" ruling if a coverage dispute develops with an insureror a bad faith award (including punitive damages) against the insurer resulting from its alleged improper claims handling practices.XPL: excess of policy limits—pays losses in excess of policy limits

28. ReinsuranceProportionalQuota share: ceding company transfers the agreed percentage of each policy covered by the treaty.Surplus share: ceding company transfers a percentage of each policy in excess of a retained.NonproportionalExcess of Loss insurance indemnifies the primary insurer for losses in excess of a stated retention.The limits can be per occurrence, per risk, or aggregate.

29. ReinsuranceThe beneficiary of the reinsurance policy is the insurance company that wrote the underlying layer.Policyholder has no privity of contract with the reinsurance company and therefore cannot maintain an action.“Cut-through” or “Direct Access” terms can be endorsed onto the reinsurance policy but for a price.

30. FrontingUsed by non-admitted insurers to issue policies on New York objects and activities.Policyholder actually purchases the coverage from an admitted insurance company that would not touch the risk…Company cedes (reinsures) the risk, or most of it, to the non-admitted insurance company.

31. FrontingCan be used by a company that needs insurance services but not insurance coverage.Policyholder promises to indemnify insurance company for any losses incurred.Functionally similar to a policy where the limit of liability is equal to the dediuctible.For example, one can do this with Equipment Breakdown Insurance in order to obtain the boiler inspection services these companies provide.Also may obtain loss control services, claims management, crisis services and like add-ons to the basic core insurance services (defense and indemnity).

32. FrontingCan be used by self-insurers to provide legal evidence of insurance.Gives the policyholder access to a broader market for excess insurance, because the primary layer is written by a “real” insurance company.Can conceal the financial weakness of the real insurance company

33. FrontingIn New York, use by non-admitted insurance companies should cease.This is because the “Free Trade Zone” in New York has undergone tremendous expansion.Any commercial lines policy that generates $50,000 in annual premium or $25,000 for any coverage part or line of coverage, may be sold directly on a surplus lines basis.Henceforth, Fronting should be scrutinized carefully.

34. Retrospectively-rated Policies“Rating” is the process of determining the price to be paid for the coverage.Ratings are normally based on the nature of the policyholder’s business and its volume.Insurance company is always going to charge less for sheep herders than for people who blow things up.Multiply the two factors together and you calculate the “deposit premium” that is subject to audit.

35. Retrospectively-rated PoliciesThese are different because the deposit premium gets adjusted based on the actual loss experience encountered.