General Liability Policies - Horizontal vs. Vertical Exhaustion
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Have you heard of "horizontal" versus "vertical" exhaustion of primary general liability policies? It's a topic that construction companies and their insurance providers are starting to address with more regularity.
In most states including Illinois, Florida, California and New York, courts have ruled that all primary general liability policies available to an insured party must be exhausted or paid before any excess or umbrella liability will contribute to the payment of a claim. This is commonly referred to as a “horizontal” exhaustion or payment rule.
In states like Wisconsin, New Jersey and Washington, courts favor a “vertical” exhaustion or payment rule. “Vertical” exhaustion allows an insured to seek coverage from an excess or umbrella liability policy under circumstances where a primary general liability policy is actually scheduled on the excess or umbrella liability schedule of underlying policies and that scheduled primary general liability policy has been exhausted or paid. Unlike the “horizontal” exhaustion rule, the insured does not have to seek payment or exhaust any other primary general liability policies available to them before they seek payment from the aforementioned excess or umbrella liability policy.
So why is this becoming more of an issue for construction companies and their insurers?
It’s because more companies are recognizing the exposure created by “horizontal” exhaustion to their program, and as a result, are demanding an increase in primary general liability limits above the norm of $1,000,000 per occurrence by parties that are providing Additional Insured protection to them. Raising the limit above $1,000,000 per occurrence is not the customary way to structure insurance limits, and there's little uniformity amongst insurance companies on how to deal with it.
Insurance companies that can or will accommodate it (not all will) vary substantially in the pricing. Some insurers will price it on a project basis, but most want to do it on a blanket basis. The pricing on a blanket basis can be an additional 5 to 20% of the $1,000,000 per occurrence primary general liability annual policy premium. If it's on a project basis, the cost is usually less but subject to more underwriting based on the hazards involved, length or time of a project and the contract amount. At a minimum, higher limits will add a material additional cost to most company’s insurance programs.
So is having higher primary general liability policy limits good or bad? The answer depends on where you are in the risk transfer chain.
If you’re included as an Additional Insured on another company’s insurance policies with higher general liability limits, it's likely a good thing – particularly if you’re in or exposed to a jurisdiction that favors a “horizontal” exhaustion rule. As an Additional Insured and, assuming it's on a primary and noncontributory basis (which is usually the case), your own policy will likely not have to contribute to the payment of losses until the higher limits on the primary general liability policy are exhausted or paid. The Additional Insured’s own general liability policy will be better protected from loss payments, more insulated from future rate increases, and the payment of any applicable deductibles/retentions will be avoided, helping prevent potential cancellation.
Conversely, if you’re adding another party as an Additional Insured to your policy, it will expose your primary general liability policy to greater loss payment and consequences like future rate increases, deductible/retention payments and cancellation.
Whether it benefits your company or not to have higher primary general liability limits, it will increase insurance costs. In all situations the extent of the additional cost needs to be weighed against the benefits gained.
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