Contractors, lessees of commercial real estate, those working in the energy industry, and others, often are required to add entities as “additional insureds” to their liability policies. The requirement that the named insured be able to afford other entities the benefits of its policy raises substantial financial issues. These issues need to be understood clearly if all those claiming the status of insureds under the policy are to acquire the protection they require, while at the same time the insurer does not increase the risk it has assumed without sufficient additional premium.
Policies permitting the named insured to add other entities to the coverage typically accomplish that task with the following clauses: (a) blanket additional insured endorsements; (b) separation of interest clauses; (c) supplemental payment provisions; (d) primary insurance designation clauses. This article will examine the financial impact of these provisions on both insurers and their insureds and suggest some solutions by way of wordings or otherwise which will address the pitfalls faced by both parties to the insuring agreement under widely used wordings.
Under the blanket additional insured endorsement, the insured receives the right automatically to add to the policy those entities to which it is obligated by contract to provide insurance. It may be under this clause that the named insured never needs to declare the additional insured to the underwriter for the coverage to become effective.
Often, then, the existence of such entities is disclosed only after a claim has arisen.
If the existence of the identity of additional insureds is considered material underwriting information, then the blanket endorsement should be amended to make that disclosure at the policy's inception, or alternatively, as contracts are executed during the policy term, a condition precedent to coverage. Likewise, the number of entities to which an assured is committed to naming as additional insureds are prolific; hence, such possibilities may be material to assessing the scope of the risk being undertaken.
Early disclosure is desirable from the insurer's perspective for another reason- some case law holds that exclusions are not effective unless communicated to the insured. For this reason alone, it may be desirable to condition coverage for the additional assured on proof by the named assured that it furnished its contractual partner a copy of the policy before the claim arose.
But the lack of information encumbers the additional insured as well. He may not know the identity of the insurer, the limitations or exclusions on cover or whether the additional aggregates apply, and he may be at a loss to ascertain the extent to which the aggregate has been eroded. Again, wording placing the burden on the named insured to make this data available to its contracting partners would avoid these issues.
Separation of interest clauses generally recite that each insured is treated separately and has the benefit of all coverage afforded under the policy, subject, however, to all terms, conditions and exclusions. Most importantly, this clause will provide that the addition of insureds does not increase policy limits. Also, judicial gloss on this language generally makes premium payments the responsibility of the named insured. Nor is an additional deductible inferred; moreover, on any given claim, the deductible is also the responsibility of the named insured. To the extent that the risk to the insurer has not been increased, these provisions may be viewed as entirely rational. If the risk is increased, these provisions might also be revisited.
One limit will affect all those entities enjoying the status of an insured under the policy. If the policy must identify more than one insured in a single occurrence and the claim exceeds the limit, the protection each insured receives is reduced. The named insured then will look to its excess programme claiming exhaustion or, if there is no excess insurer, find that it has become self-insured much more rapidly than anticipated. The additional insureds and their insurers face similar issues; all interests need to plan accordingly.
Questions of increased financial risk to insurers intertwined with scope of cover issues for the additional insureds arise with respect to both the defence and indemnity obligations that the named insured's underwriter assumes.
Defence and indemnity
The defence issue is a straightforward question whether defence costs are within limits or in addition to limits. Since the need to add entities to a policy grows out of the desire to avoid impacting the additional insured's insurance, primary insurance endorsements make the named insured's policy primary, and, hence, responsible for defence costs. Coverage for defence costs, of course, constitutes a significant impetus for the acquisition of liability cover. From the underwriter's perspective, if costs are in addition to limits, during the underwriting stage, he will need to decide how many defences the insurer will wish to fund as a result of any given occurrence, and factor the estimated costs into the premium calculation. Alternatively, deductibles may be adjusted as additional insureds claim their status, or even a separate limit imposed for defence costs. On the other hand, with a blanket additional insured endorsement, and an unknown number of additional insureds, wording clearly placing defence costs within limits may provide the limitation on additional exposure.
The supplemental payments provisions of the American ISO CGL form provides a qualified vehicle for limiting the cost of multiple defences, that is a separate law firm defending each insured. Under the specified circumstances, defence counsel for the named insured may also defend the additional insured. This option, however, raises difficult ethical issues regarding potential conflicts of interest for the defence firm. These issues, which the clause attempts to address, in practice, sharply limit its utility.
The scope of the indemnity cover afforded also bears substantially on the extent of the risk assumed under the policy from the underwriter's perspective. But these considerations also present issues for the additional insured and his own insurers. The description of the issue will illustrate clearly the financial implications of widely used wordings.
The following represents typical language adding an insured to a policy:
“The ‘Person Insured' provision is amended to include as an insured the person or organisation named below, but only with respect to arising out of operations performed for such insured by or on behalf of the named insured.”
Insurers argue, and some courts recognise, that this language is intended to provide coverage for the additional insured only to the extent it is held vicariously liable for the conduct of the named insured in the course of the latter's performance of its contractual obligations. See Harbour Ins. Co. v. Lewis,1 This construction, viewed in light of the absence of additional premium, increases the risk neither for the named insured, nor its underwriters, the additional insured or its insurers. The loss falls directly on the party ultimately responsible and the one who would respond in any event by way of an action for common law or contractual indemnity brought by the additional insured, absent the status of an additional insured.
Numerous courts, however, have refused to accept this principle and found that the insurer for the named insured has taken on liability to indemnify the additional insured, not only for its vicarious liabilities, but also its own misconduct.2 If the additional insured recovers for his own misconduct from the named insured's policy, the latter's insurers have taken on substantial additional risk for which the single limit is no protection, they have assumed nothing less than all the liabilities of a stranger to the insuring contract albeit only those that relate to the work of the named insured. By adding an insured whose actions may give rise to liability under the policy, the underwriter has increased the chances that there will be conduct giving rise to a claim under the policy which will need to be paid.
Courts reaching the foregoing result reason that if insurers wished to limit the exposure to vicarious liability, they should have explicitly so stated. The court in Harbor Ins. did limit the indemnity obligations because the policy provided:
“It is agreed that the insurance provided by this policy shall apply to the following additional insureds, but only to the extent of liability resulting from occurrences arising out of negligence of [the named insured].”
In order to clarify the scope of cover and minimise disputes over this issue, any qualifications on cover for the additional insured should be explicitly and clearly stated.
Courts which do not limit the coverage available to the additional insured to the vicarious liability incurred on account of the named insured's conduct have engaged in a risk shifting that is completely at odds with the intent of the parties. The parties sought to avoid any risk shifting and establish an insurance arrangement that left the liability with the party ultimately responsible – the named insured. One only need glance at the ultimate resting place of liability to understand the intent.
If a party is held vicariously liable for the conduct of another, the vicariously liable party is entitled to a recovery over from the one whose conduct created that liability. The limited reach of the additional insured clause may then be viewed as a means of cutting through the legal procedure and directly achieving the ultimate result. Both the insurer and the named insured have the benefit of the bargain – in exchange for the original premium, the insurer responds for the originally underwritten risk, and the named insured has discharged its obligation to the additional insured. The additional insured looks to its own insurer to respond to the risk it undertook, that is, to indemnify for its insured's own misconduct.
In conclusion, adherence to the old adage “follow the money” will serve all parties well when analysing the effect of additional insured provisions in a contract of insurance. Unless the parties understand the money trail and make certain that the wording does not inadvertently shift or increase the risks, expensive surprises and coverage disputes are sure to follow.
1 See Harbor Ins. Co. v. Lewis, 562 F. Supp. 800 (E.D.Pa. 1983).
2 See, for example, Merchants Ins. Co. v. USF&G Co., 143 F.3d 5 (1st Cir. 1998); McIntosh v. Scottsdale Ins. Co., 992 F.2d 251 (10th Cir. 1993); Phila. Elect. Co. v. Nationwide Mutual Ins. Co., 721 F. Supp. 740 (E.D.Pa. 1989).