When is $2 Million Less Than $1 Million?!
by Peter Schlactus, CIC, AAI[Back To Table of Contents]
What you don't know can definitely hurt you.
Hardly a month goes by when I don't have to explain to a distressed courier owner that he (or she) has only half the liability insurance he thought he did -- or why he does not comply with a large account's contractual insurance requirements, even though he thought he did.
I fear that one day I may have to explain why a courier company has no liability coverage for a claim even though it has a liability policy.
What, you may ask, is causing such confusion? After all, your liability insurance policies state clearly what your limit of liability is, right? Well, most of the time that is true but not always.
Test Your Limits
The root of the problem is a special limit of liability called the Aggregate Limit. While rarely seen on auto policies, it is common to find one or more Aggregate Limits on General Liability, Biker Liability, Umbrella Liability, and specialty liability policies (this last category includes Employment Practices Liability and Directors & Officers Liability).
What is an Aggregate Liability Limit? First, let's be clear on what a Limit is. An insurance policy Limit is the most money the policy will pay out in the event of a claim. For example, when a $1 million policy pays out $1 million in damages on your behalf, it has reached its "limit" and will pay no more.
When a policy reaches its limit the insurance company's obligation to defend you or pay for your legal defense generally ends too.
When people think of an insurance policy's Limit, they normally focus on the "Per Occurrence Limit." This is the most that the policy will pay as the result of a particular incident -- such as an accident.
The "Aggregate Limit" is the most the policy will pay as a result of all occurrences during the policy term (usually one year). In other words, the Aggregate Limit is like an annual cap on policy payments.
Let's assume the worst: your bicycle messenger runs into a pregnant woman on the sidewalk, terminating her pregnancy and leaving her paralyzed. Two months later, during the same policy period, a driver rushing back to his vehicle after a drop-off knocks over an elderly man. As a result the frail victim requires a series of expensive treatments for fractures, persistent internal bleeding, etc.
(I wish I could say that I fabricated these incidents, but when you read the insurance trade journals and talk to delivery companies every day you hear about a lot of depressing accidents...)
Let's further assume that your company has purchased a typical General Liability policy with a $1 million per occurrence limit and a $1 million aggregate limit.
How your policy would respond in each of the following scenarios?
Scenario A: Each accident results in damages of $500,000 against you plus legal fees of $50,000 per incident.
Scenario B: Each accident results in damages of $1 million against you plus legal fees of $75,000 per incident.
Scenario C: The first accident is settled for $750,000 and $60,000 in legal expenses while the second accident results in a $500,000 settlement with $50,000 in legal fees.
Scenario D: The first accident is $1.6 million and $160,000 in legal fees while the second is only $75,000 with $7,500 in legal fees.
Scenario A: You are covered. Neither claim is above the $1 million occurrence limit. For the first, your policy pays $500,000. It also pays 100% of legal fees. Only half of the Aggregate Limit is used up. Another $500,000 remains before you reach the annual cap. Therefore, the second claim is also covered. Again, all legal expenses are paid.
Scenario B: Big problem. While neither claim is above the $1 million occurrence limit, the first claim's payout exhausts the policy's $1 million aggregate limit, or cap. When the second claim hits your insurance company informs you that you are responsible for the entire cost of defense and all damages. Given the sums involved, most businesses would face insolvency.
Scenario C: This falls somewhere in between the first two. Your policy pays all damages ($750,000) and legal expenses for the first claim. $250,000 would remain in your Aggregate Limit. Therefore, if the second claim settles at $500,000 you will pay the amount above $250,000.
The insurance company may realize early on that the second claim will settle above the Aggregate Limit. If so, it can offer the full $250,000 remaining and discontinue its legal defense. You would have to pay all legal defense costs after that.
Scenario D: As before, the first accident uses up your Aggregate Limit so you are completely on your own for the second accident. In this case the first accident also exceeds the Per Occurrence Limit. For any single incident you are responsible for damages over $1 million. Legal fees would be handled as in scenario C.
Stretching the Limit: A Fix
Insurance offers two ways to reduce the likelihood that you could find yourself in these kinds of rare but disastrous situations: higher Aggregate Limits, and Umbrella Liability policies. Umbrella policies are best treated in their own space so we shall concentrate on increasing your policies' Aggregate Limits
Most better-quality insurance companies will provide a General Liability policy with a $2 million aggregate limit at little additional cost. A higher aggregate limit means that your annual cap is higher. The limit of insurance "per occurrence" is not affected.
Let's see how having a $2 million aggregate would change the outcome of our scenarios.
Scenario A: Since both claims were fully covered even before we raised the aggregate limit, there is no difference -- unless we consider that there could be a third claim!
Scenario B: Both claims are now fully covered since each is lower than the per occurrence limit and together they add up to $2 million, which is not more than the new aggregate limit.
Scenario C: As in scenario B, both claims are fully covered.
Scenario D: Better but not perfect. Together the two claims total less than your $2 million aggregate, but the first claim is greater than the per occurrence limit. In this case your policy pays the second claim as well as the first $1 million of the first. Additional damages and legal fees from the first accident remain your problem.
By raising the Aggregate Limit you gain a lot in return for for your extra few dollars of premium! Still, even a $2 million aggregate limit is a cap, not a benefit. As the title to this article alludes, you have less coverage with a $2 million Aggregate Limit than you do with 'only' a $1 million Per Occurrence Limit.
This is because a Per Occurrence Limit with no Aggregate Limit is a policy without a cap. Theoretically you could have a claim every day and, unless a single claim exceeded $1 million, all would be covered 100%!
Unfortunately, liability policies with no aggregate limit -- other than auto liability -- are hard to find.
Do not fool yourself into thinking that your $2 million Aggregate means that you have $2 million of insurance. You still have only $1 million to cover each loss.
As we have seen, higher Aggregate Limits are certainly superior to lower ones. Higher aggregates reduce the likelihood that multiple losses during one year will add up to your annual cap and leave you responsible for the excess.
However, in order to protect your business against catastrophic claims, you may need more than $1 million per occurrence in protection. That requires a separate policy, called an "Umbrella" or "Excess" Liability policy. While more expensive than higher aggregates, these policies are still very good buys.
More on this in a future column because, after all, two (topics in this case!) can be less than one.
Peter Schlactus, a Certified Insurance Counselor and Accredited Advisor in Insurance, is Co-President of KBS International Corp., which provides specialized insurance programs, benefits, and risk management services to courier companies and executives nationwide. Mr. Schlactus is available to answer inquiries at 1-888-KBS-4321 or via e-mail at firstname.lastname@example.org.
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