How would you change your personal lines underwriting if you could establish different limits for different causes of bodily injury or property damage (BI/PD)?

You probably haven’t considered the question because admitted insurers have never had such discretion.

For decades, it was presumed that a homeowners or personal liability policy would provide coverage for BI/PD up to the full liability limit, plus defense costs, for any type of bodily injury or property damage for which the insured might be liable.

Until relatively recently, exception was allowed only for damage and injuries arising from intentional acts or from activities presumed to be insured separately, such as those involving autos, aircraft, and business activities.

The expectation that a personal liability policy would respond to any type of damage or injury has been based on two principles:

• Innocent third parties should not be left without compensation for damage or injuries they sustain; and

• Insureds should have confidence they are protected from severe financial loss if they are liable for accidental damage or injury to others.

One result of this has been that admitted carriers have generally been forced to take an “all or nothing” approach to personal liability risks. They could either accept an entire exposure for BI/PD under a single limit, or they could turn it down. They might vary the amount of the limit, but there was no picking or choosing which types of damage or injury could be covered, or for how much.

Shifts over time

In recent years, however, there are indications that agents, carriers, and regulators recognize that, for practical reasons, there can be limits to the “all or nothing” approach to personal liability coverage.

More recently, insurers in most states have been permitted to implement sublimits for bodily injury and property damage arising from mold. (Exceptions in the mold limitations provide coverage to the full liability limit for food poisoning, consumption of fungi [e.g., mushrooms] cultivated for consumption, and slips and falls on slick, moldy surfaces.)

The significance of the mold limitations is that the cause of an injury is allowed to determine the extent of insurer liability for damages.

To illustrate, suppose someone contracted a serious illness from a non-fungal substance negligently spilled by an insured. The insured could be covered up to the full per occurrence limit, say, $300,000.

If, however, a claimant contracted a similar illness from mold that was somehow propagated by the insured’s negligence, coverage could be limited to perhaps $50,000 under annual aggregate mold sublimits now permitted in most jurisdictions.

Mold limitations were approved by the states in response to the rapid rise in cleanup costs driven by a new “cottage industry” of mold remediation firms, says Eric Nordman, director of research for the National Association of Insurance Commissioners (NAIC).

“You had an astronomical amount of money associated with the compensation of a few people,” Nordman says. Given that the danger of market disruption appeared to outweigh the threat to public health, the mold limitations were approved as an exception to the standard expectations for personal liability coverage.

While Nordman cautions that the mold limitations should not be regarded as a precedent, there are indications that some insurers are exploring personal liability sublimits as a way to address market problems.

Biting back on dogs

Since the onset of the hard market in homeowners insurance, there have been increased reports of consumers being rejected, cancelled, or non-renewed because of the presence of a dangerous pet in a household.

Dog bites are the largest source of liability loss in homeowners insurance, and insurers today have the added concern of insureds adopting exotic animals, such as pythons and jungle cats.

It was long assumed that a homeowners policy would automatically cover liability arising from an insured’s pets. Admitted carriers are prohibited from excluding pets in general, and states generally prohibit the use of general exclusions or underwriting restrictions for breeds of dog (e.g., “pit bulls”).

There is evidence, however, that insurers are increasingly able to exclude specific animals that have been identified as dangerous.

Virginia, for example, recently enacted a law allowing insurers to exclude coverage for personal liability arising from a specified animal that had attacked or threatened humans or other animals.

Two of the country’s largest insurers say they already follow that practice in many states.

“We’ll write a house with any breed of dog,” says Mary Flynn, media relations manager for Farmers Insurance Group, Los Angeles, “but if a dog has bitten or attacked someone, we’ll ask the customer to sign a waiver excluding the dog from the policy.”

State Farm does essentially the same thing, according to spokesman Dick Luedke: “We do not underwrite for breed, but if we determine that a dog has a history of biting, we may add an endorsement [excluding liability coverage for the dog] and ask the policyholder to sign it.”

When coverage is restricted in the admitted market, applicants must turn to surplus lines carriers.

Business is booming for the Lester Kalmanson Agency, Maitland, Fla., which sells monoline animal liability coverage to individuals whose pets have been excluded from their homeowners policy.

“We’ve been selling this for 20 years, but it’s really been in demand the past 3-5 years,” says Mitchell Kalmanson, the current agency principal. “It’s very rare today to find [a major carrier] that doesn’t have a solid animal exclusion.”

According to Kalmanson, his agency had virtually no competitors for years in monoline animal liability. But in April 2004, Prime Insurance Syndicate, Inc., a surplus lines agency with offices in Chicago and Salt Lake City, introduced a new animal liability program, another indication of the demand for the product.

So, if admitted homeowners insurers can exclude liability coverage for certain pets, and coverage with its own limits is being purchased in the surplus lines market, does it follow that admitted carriers will be allowed to establish sublimits for BI/PD arising from specified animals?

The answer to that question is unknown, but two companies have approached AAIS seeking advice on establishing sublimits for dogs.

AAIS does not advocate for regulatory positions on such matters. If approached, AAIS advises insurers on its understanding of the regulatory policies of states they seek to file in and the policy language needed to achieve their intent.

It’s fair to say that any proposed sublimit for liability arising from dogs or other animals will be rigorously scrutinized to determine if it is adequate to compensate injured claimants in most cases.

In the opinion of AAIS product development staff, any effort to establish a sublimit must address at least the following questions:

• Will the sublimit apply to specific animals or categories of animals (e.g., dogs)?

• Will the coverage extend to animals not owned by an insured? (This could be an issue if an insured’s child is baby-sitting some children and negligently allows them to be attacked by an animal.)

• Will there be a per-occurrence limit, or will it be an annual aggregate?

Fuel tanks

Animal sublimits would address a leading source of bodily injury claims under homeowners. As are other organizations, AAIS is also working on a response to a problem of personal liability coverage for property damage.

There is a threat of disruption of insurance and real estate markets in the Northeast due to the presence of leaking fuel tanks. The Northeast has relied heavily on oil for home heating over the years, and many older residences have leaking fuel tanks, both above and below ground.

Homeowners face the possibility that they could be liable for tens of thousands of dollars in remediation costs if a tank on their property is found to be leaking fuel into the ground or into the groundwater.

The insurance department in New Jersey has responded to the problem in that state by prohibiting admitted homeowners insurers from using the presence of a fuel storage tank as an underwriting criterion for denying, canceling, or non-renewing coverage.

In its response to New Jersey regulations, Allstate Insurance Co. has filed coverage endorsements for “oil tank liability protection” that implements a separate sublimit for the coverage.

Personal liability sublimits for fuel tanks may find “traction” because they might add coverage beyond what is typically available in a standard homeowners policy, says Rey Becker, vice president of personal lines for the Property Casualty Insurers Association of America (PCI).

Just as sublimits for animal liability can be contemplated now that carriers can exclude coverage for certain pets, sublimits for fuel tanks are a viable idea because, in some cases, coverage for fuel leaks is subject to a pollution exclusion.

The Allstate filing also implements a deductible based on the age of a tank.

Collection of deductibles on third-party claims is always difficult, as insurers are expected to pay an injured party all of an award, up to the policy limit, and settle any deductibles with the insured later.

Still, third party deductibles are “worth a try” in personal liability insurance, says Michael O’Laughlin, president of Paragon Asset Recovery Services, a suburban Pittsburgh firm that specializes in helping insurers maximize deductible collections on commercial accounts.

Paragon hasn’t sought personal lines business yet, but would consider doing so for a large-enough book of business. “Deductibles get the price of a policy down and deal with the moral hazard,” says O’Laughlin.

As it is, liability deductibles, called “retentions,” are used in personal umbrella insurance.

Is it a trend?

Becker and others see sublimits and deductibles for personal liability exposures as potential means to depopulate residual market plans and deregulate personal lines rating without creating uninsured exposures for individuals or society.

“I would not be surprised if it started happening,” Becker says. “Deductibles, sublimits, and measures of that sort provide viable compromise positions.”

“Ten years ago we wouldn’t have been talking about mold limitations,” says Marsha Harrison, regulatory affairs manager for the National Association of Mutual Insurance Companies (NAMIC). “We wouldn’t have been talking about the dog bite measures that have come up.”

Any general effort to implement personal liability sublimits and deductibles will encounter resistance, however.

“I find it to be very concerning,” says Robert Hunter, insurance director for the Consumer Federation of America, who believes that internal limitations are “out of character” for personal liability forms.

“I’ve been concerned about the mold limitations as a precedent to put in other internal limits,” he says. “It doesn’t seem to me to be the right way to go about it.”

Insurers serve as “sentinels of safety,” Hunter says, because of the expectation that they will assume liability on an open-ended basis.

Regulators will be less than enthusiastic about pricing liability hazards unless you can demonstrate that liability sublimits and deductibles can help consumers, says Nordman at the NAIC.