LEGAL EXPENSE CUT OFF PROVISION
Some liability policies contain clauses that allow the insurance company to tender the policy limits. Once that tender is made, the insurance company has no further obligation to provide a defense or pay for legal expenses. Be careful of these clauses! Liability insurance coverage, including E&O coverage, is designed to provide the policyholder with two types of insurance in one policy. The first type is indemnity against any judgment may be rendered against the agency. The second insurance coverage is legal insurance. If the insurance company can discharge its legal insurance obligation by simply tendering the policy limits, an important component of your liability coverage will have been destroyed. Always reject these types of clauses.
DIMINISHING LIMITS POLICIES
As stated earlier, liability policies are, in essence, two policies in one. The indemnity portion of the policy has a policy limit, but the legal expense coverage does not have a policy limit. In many cases, the legal expense coverage is more important than the indemnity coverage. This is especially true in relatively small claims. In order to secretly impose a limit on legal expense coverage, some insurance companies have devised the diminishing limits provision.
Under a diminishing limits clause, the legal expenses are counted against the indemnity policy limit. For example, if an agency had a limit of $500,000.00 on its E&O coverage and it was sued, the legal expenses incurred by the insurance company would serve to lower the policy limits by the amount of legal expenses. If the legal expenses were $100,000.00, then the policyholder would have $400,000.00 in indemnity limits, instead of $500,000.00. Be careful of diminishing limits clauses!
Just as self-insured retentions and diminishing limits can serve to reduce your liability coverage, aggregate limits can do the same. For example, the declaration page of your E&O policy may state that you have one million dollars in policy limits. Most policyholders think that one million dollars in policy limits means there is coverage up to one million dollars for each claim or occurrence. Be careful!
If your policy has aggregate limits, it could provide that your coverage is for a total of one million dollars for all claims during the policy period. For example, if your agency was subjected to a claim at the beginning of the policy period in the amount of $500,000.00 that was paid by your E&O carrier, your policy limits for the remainder of the policy period are reduced to $500,000.00. Therefore, if you have multiple claims during a single policy period, you can quickly run out of coverage. This is especially true if your policy has the perfect storm of a high self-insured retention, diminishing limits and aggregate limits.
If your E&O agent states that you have one million dollars in coverage, always ask whether those limits are diminishing and whether they are aggregate. It is much more beneficial not to have aggregate limits and to have a policy that specifies the limits are per claim/occurrence.