How Umbrella Policies Started Part 1: Early Liability Coverage

Origins of Liability Insurance

Liability insurance is an insurance industry response to the need for protection that arose only after changes in English and American common law that began during the nineteenth century. After passage of an employers liability law in Germany in 1871, in 1880 the English Parliament passed the Employers' Liability Law. These were the first acts permitting injured workers to be compensated without having to sue to prove that the employer's negligence caused their injury.

This was followed by the passage of similar laws in the United States, starting in the 1880s, leading up to the first workers compensation laws in the early twentieth century. Employers liability (EL) insurance thus was the first distinct liability hazard coverage.

In 1886 the Endicott & Macomber Agency in Boston, became the U.S. manager and general agents for Employers Liability Assurance Corporation, Ltd., an English company that had entered the accident and employers liability insurance business after passage of the 1880 English law. One of the firm's principals, George Monroe Endicott, had established a relationship and secured the appointment with the company's general manager in London, Samuel Appleton, earlier in 1886.

The firm subsequently issued the first liability policy in the United States, effective November 1, 1886, to The Gender and Paeschke Manufacturing Company of Milwaukee, Wisconsin. The first EL policy issued in New York was effected through the Dwight & Hilles agency, by Edmund Dwight, who was the company's general agent for New York State. It was effective December 31, 1886, for Otis Brothers & Co. (later the Otis Elevator Company).

In 1887 different sources report that between $150,000 and $200,000 in "employers liability" premiums were written in the United States. The year 1887 was the year in which Lloyd's underwriter Cuthbert Heath introduced nonmarine insurance business to Lloyd's of London, an event that would come to offer great opportunities for U.S. organizations seeking coverage arranged specifically to suit their needs, instead of the fragmented approach offered by U.S. insurers in the early twentieth century.

For the next 30 years, all liability policies often were called "employers liability." Liability coverages also were sometimes referred to as "accident insurance," according to the labels used at that time to classify different types of insurance coverage insurers wrote. In addition to policies insuring against claims by employees, by 1915 other forms of liability insurance included the following.

• Manufacturers employers liability
• Manufacturers public liability
• Contractors public liability
• General liability (later renamed owners, landlords, and tenants liability)
• Theater liability
• Elevator liability
• Owners contingent and contractors contingent
• Vessels employers and public liability
• Automobile liability
• Teams liability
• Druggists liability
• Physicians and surgeons liability
• Hospital liability

The pattern that evolved was to create a new liability insuring form for each specific hazard or risk type that emerged with a need for coverage. In part, this was caused by an emerging American system of insurance regulation that licensed insurers to write only specific classes of insurance which were narrowly defined.

In addition to the forms listed above, by the 1920s there were specific "standard" policy forms for aviation liability, products and completed operations liability, miscellaneous professional (errors and omissions) liability, and excess liability. Directors and officers liability forms appeared in the 1930s, although this coverage had been preceded by the use of "director's liability bonds" from Lloyd's before 1920. Comprehensive general liability, which was discussed thoroughly and developed during the late 1930s, was introduced nationwide in 1941. The earliest "standard" umbrella forms appeared during the 1950s. Environmental impairment liability forms were introduced in the 1970s.

Throughout the history of liability insurance, progressive insurance professionals have developed such special coverage forms whenever they identified a need that existing forms did not meet.

Early Policy Limits

In the 1880s, the early EL policies had limits of $1,500 per injured worker and $5,000 for injuries to all persons injured in a single accident (although the first policy was written for $1,500/$3,750). By about 1910, standard ("basic") limits on liability policies were set at $5,000 per person and $10,000 for all persons injured in a single accident. Liability policies only covered bodily injury. There is no mention in early references to coverage for property damage liability, until late in the decade before the 1920s, but the basic property damage (PD) limit was eventually established as $5,000.

The need for higher limits of liability helped to create additional liability insurance markets. In the 1920s, most insurers were very conservative about providing liability limits. U.S. excess liability markets emerged to meet the need, along with excess of loss reinsurance for primary insurance policies, if the primary insurer was willing to provide higher limits. However, the U.S. approach still relied on having separate, "schedule" policies for each hazard insured, and often a separate set of schedule policies for each location. "Blanket" excess insurance forms that could follow multiple underlying policies were generally unknown.

Agents' publications in the 1920s frequently contained references to higher limits as a way to increase insurer premium volume or agents' commission income. Some insurers also promoted high limits for risk management reasons, asserting that companies needed more coverage than the minimum policy limits (5/10) to be adequately protected against the types of claims that could arise. For example, any elevator owner needed higher limits of elevator liability because of the frequency and severity of elevator accidents.

There are numerous reports of verdicts in insurance publications during the 1920s and 1930s demonstrating that even then it was common for juries to award damages of up to $100,000 (and occasionally more) to injured claimants. Verdicts continued to escalate during the Great Depression of the 1930s. Many businesses during this period began to purchase increased limits, usually selecting 25/50, 50/100, or 100/300. Higher limits (at least up to $1 million) were available, but rarely requested.

The First Excess Liability Market

As limits increased, so did the market for excess insurance. Concurrently, the increase in exposures and losses required a reinsurance market to spread and adequately capitalize insured risks. With great foresight in these matters, Cuthbert Heath was one of the founders of the British company, Excess Liability Insurance Company, Limited, in 1894. He wrote later,

Feeling that nonmarine business was growing and would grow at Lloyd's ... I therefore formed the Excess Insurance Company which with a capital of £5,000 fully paid up was used as a backing for two of my names, every risk being reinsured with it.

The purpose set out for the company was "to write marine, fire and accident [liability] business and reinsurance," along with fidelity. The company later participated in a group of aviation insurers formed in the United Kingdom in 1913, 2 years after Lloyd's issued the first aviation policy. The Excess reinsured the coverages underwritten by the Heath syndicates at Lloyd's for many years, and was still participating on excess and umbrella coverages placed in London in the 1960s.

Excess of Loss Reinsurance

Shortly after the San Francisco earthquake of 1906, Heath created the first excess of loss cover for the Hartford. The company had recognized a need for a different form of reinsurance because of its San Francisco claims experience. The cover contained the basic elements of "layering," as we know it today, which made possible the methods still used to tap market capacity for high liability limit placements.

Anthony Brown, in his 1980 biography, Cuthbert Heath: Maker of the Modern Lloyd's of London, describes it as follows.

Under it, the direct insurer would retain the responsibility for all the smaller losses himself. Larger losses above an agreed maximum figure would be paid by the reinsurer up to a second agreed limit, after which the liability reverted to the original insurer, who could then buy further reinsurances for the upper limits. As a further sophistication of the system, the reinsurer could himself buy reinsurance-known as a retrocession-in respect of the responsibilities he now assumed.

As excess reinsurance concepts developed, Guy Carpenter helped to create the market for excess of loss reinsurance in the United States during the late 1920s, when he was insurance manager of the Cotton Insurance Association of America. Carpenter developed the concept of "burning cost" for reinsurance pricing, and he placed the cover with Cuthbert Heath at Lloyd's acting as the lead underwriter. These reinsurance plans are the seeds from which the high liability limits of late twentieth century casualty insurance programs grew.

Excess Insurance Company of America began writing excess coverage in 1927. The most frequent method of providing higher limits was through excess of loss reinsurance for direct insurers of primary policies. This was often executed as a subscription endorsement added to the primary policy. Excess Insurance Company was one of several domestic insurers that provided following form excess coverage under separate excess policies.

Advertisements for Excess Insurance Company appeared frequently in trade journals directed toward agents and brokers in the 1920s and 1930s. The Excess therefore appears to have been influential in promoting both higher limits and coverage concepts that ultimately became standards. One of the other pioneering excess markets was Indemnity Insurance Company of North America (INA).

The other markets reported to have provided specific excess coverage in the 1920s were all formed as professional reinsurance companies, including Employers Reinsurance Corporation, American Reinsurance Company, and General Reinsurance Corporation. There were no U.S. markets known to write any excess liability coverage before about 1918, even for modest limits. One source states that in 1916, Lloyd's was the only market for excess casualty insurance.

Direct U.S. Placements at Lloyd's

In the years before 1910, Heath also pioneered the practice of writing nonmarine risks for U.S. companies as "direct" business, not just through reinsurance. The first Lloyd's "Motor Policy" on a U.S. risk, one of the first direct placements of nonmarine business for a U.S. insured, was written by Heath in 1907 for Rollins Burdick Hunter (RBH), on behalf of the White Sewing Machine Company. It was a physical damage policy valued at $2,500.

Based in Chicago, RBH also placed insurance for many of the meat packing houses in that city. One of the largest meatpackers, Swifts', formed its own insurance company in 1907, Interstate Insurance Exchange. This was an early forerunner of "captive" insurance companies, as we know them today.

Eventually RBH placed the reinsurance for Interstate at Lloyd's, using Cuthbert Heath as the lead underwriter. These placements opened the door for many associations between U.S. companies and the London market that became particularly important in the development of excess and umbrella liability insurance during the 1930s and 1940s.

Excess Coverage Developments

The developments described above provided a foundation, but further improvements in the way coverage was provided were needed before umbrella coverage could emerge. Blanket excess liability coverage was one such need.

Insurance buyers faced a difficult, complex task in arranging coverage under the American system of insuring specific hazards in separate policies. If they picked the wrong form, their company would not be insured for the particular hazard. It was difficult to know whether a company's insurance program was sufficiently complete. Because of the variety of types of policies, it was easy to end up with many gaps in coverage, and an inconsistent set of coverage limits. Liability coverage was badly in need of a "blanket" coverage form, comparable to blanket, all-risk property insurance.

There are no documents that "verify" the existence of blanket catastrophe liability insurance before the early 1930s. However, some knowledgeable insurance professionals believe that large utilities, oil companies, and railroads may have placed blanket liability coverages at Lloyd's with limits of at least $1 million as early as the 1920s. The earliest time for which there are any sources concerning catastrophe liability insurance (blanket insurance with limits of $1 million or more) is about 1934. INA was one of the few American markets for blanket excess liability coverage before 1950, along with the professional reinsurers already mentioned.

In the early years of excess coverage, it was common to buy only the difference between the primary limits and some higher amount, such as $500,000, $750,000, or $1 million. Such arrangements persist today in "gap layer" covers, which occasionally may be required to bring the total amount of primary insurance up to the attachment point of the first umbrella layer. It is sometimes the only way to satisfy the underlying insurance requirement imposed by umbrella underwriters.

So-called gap or difference between covers were seldom used after umbrella policies with limits in multiples of $1 million became common in the 1960s, because underlying limit requirements usually were no higher than 100/300. Underlying limit requirements began to increase significantly in the late 1970s, which reinvigorated the market for straight excess gap insurance.

It took a long time for the insurance industry, and most insurance buyers, to recognize that there was a real need for limits greater than $1 million. A 1928 report in The Casualty Insuror about a gas tank explosion that caused $5 million in damages stated that:

no conceivable insurance policy could cover that amount of damage... [O]ne cannot imagine an assured admitting the necessity of a $5 million limit on one accident and paying the premium on such a policy.

One of the more interesting aspects of this remark is the suggestion that a company should be reluctant (if not ashamed) to admit a need for high limits of liability insurance! A possible explanation for the tone of this remark is the writer's failure to separate theoretical exposure to loss from the probability that the loss will occur. The writer also overlooked the fact that a loss of such magnitude had already occurred, which meant that it should be relatively easy to imagine a similar loss happening in the future. It would be logical for businesses to want sufficient coverage limits for such potential losses.

The demand for higher limits in the 1930s appears to have been concentrated in specific industry groups, such as utilities, railroads, oil and gas production companies, and some heavy industrial companies. A market emerged for catastrophe policies, using two types of coverage forms: straight excess following form contracts and stand-alone blanket catastrophe liability policies.

Some sources suggest that the most common upper limit of coverage at this time was $1 million. Lloyd's and other British companies provided a market for both types, but most U.S. insurers provided a market only for the straight excess coverage. This conservatism of the U.S. insurance market drove many large companies to seek relationships in London so they could obtain the broader coverage available there.

The Emergence of Self-Insurance

Only the largest businesses used large self-insured retentions (SIRs) or purchased catastrophe policies in the 1930s or before. Most businesses could easily secure the limits they wanted in the domestic insurance market, although not necessarily in the most desirable coverage arrangement. Limits of 100/300 were available for about 50 percent more than the 5/10 basic limits provided in liability rating plans of the late 1920s. There was additional straight excess following form coverage available up to $1 million, but apparently it was seldom requested.

Stand-alone excess policies were introduced to provide coverage over a self-insured retention during the 1920s. Since there was no underlying insuring agreement or other policy terms for the contract to follow, the stand-alone policy had to have its own insuring agreement, exclusions, and conditions. The U.S. insurance industry (insurers, agents, and regulators) did not support the stand-alone excess policies because they viewed an SIR as a deductible, a form of self-insurance. Lloyd's, domestic (U.S.) professional reinsurance companies, and specialty market insurers like Excess Insurance Company of America and Indemnity Insurance Company of North America provided the market for this coverage.

Stand-alone excess policies were written for lower premiums than first-dollar insurance, reducing the premiums and commissions that could be earned by insurers and agents. Fully insuring risks of loss was a known, respectable, traditional method of risk finance in business circles. Self-insurance was generally disfavored, but grudgingly acknowledged, by various agents' groups and publications.

Agents had greater power and influence over insurance companies and insurance regulators at that time than they do today. Therefore, self-insurance (in the form of an SIR) was not an option for any but the largest businesses, because of their greater bargaining power.

But large businesses with specialized insurance needs were precisely the type of client that the Lloyd's market wanted to attract. Lloyd's was not constrained by the fragmented and conservative approach of U.S. insurers toward providing liability insurance. The blanket liability policy was a perfectly logical alternative to the administrative headache of mixing multiple primary liability policies and SIRs.

The size of the typical SIR in the 1930s was $25,000, and was as high as $300,000 for some companies (at least for certain hazards). Even $25,000 was considered to be a significant amount of self-insurance, since it exceeded the basic limits of the standard liability policies (5/10) that most businesses purchased. In contrast, an SIR of $1 million was relatively common in the 1990s, and a few very large organizations had SIRs exceeding $5 million.

This discussion will be continued in Part 2 of this article.