What Does "Separation of Insureds" Mean—Part 1

Most liability insurance policies contain a "severability of interests" condition, which stipulates that coverage applies "separately" to each insured. This article, and the one that follows, examines coverage issues raised by this condition in the Insurance Services Office, Inc. (ISO), commercial general liability (CGL) policy.

Most liability insurance policies contain a "severability of interests" condition, which stipulates that the policy's coverage is to apply "separately" to each insured against whom a claim is made. Severability of interests guarantees that the policy will respond to a suit brought against one insured by another insured. It also makes clearer the meaning of exclusionary provisions in the policy that address acts or omissions of "the insured"; that phrase, interpreted in light of a severability of interests provision, must be read as applying only to the insured who is looking for coverage under the policy. "The insured" does not mean "any insured."

In standard Insurance Services Office, Inc. (ISO), coverage forms (businessowners, commercial property, commercial general liability), severability of interests is addressed in policy conditions entitled "Separation of Insureds"; or (in the ISO business auto policy) language equivalent to a separation of insureds provision is contained in the definition of "insured." In this IRMI Insights article, and in two to follow, I would like to take a look at coverage issues raised in particular by the Separation of Insureds condition of the ISO commercial general liability form. Because equivalent language is found in other standard insurance policies, however, the points raised here will have relevance to commercial property and commercial automobile insurance as well.

This first installment of the discussion will deal with subsection 1 of the commercial general liability (CGL) insurance policy's Separation of Insureds condition (Condition 7).

Except with respect to the Limits of Insurance, and any rights or duties specifically assigned in this Coverage Part to the first Named Insured, this insurance applies:

• a. As if each Named Insured were the only Named Insured.

The opening exception applies to the entirety of Condition 7, and its function is clear. The separate application of the policy's coverages to each insured does not include the limits of insurance. That is, each insured does not have a separate amount of insurance equal to the policy limits; all insureds share those limits. Nor does the application of insurance to each named insured as if it were the only named insured mean that each named insured becomes, in effect, the first named insured with respect to its own coverage. There is still only one first named insured under the policy.

Aside from these two exceptions, however, subsection "a" of the CGL Separation of Insureds condition means that, when there are two or more named insureds under the policy, coverage for Named Insured A will apply as if there were no Named Insured B. Under such circumstances, "you" means only Named Insured A. The effect of this provision is to restore coverage for several kinds of named-insured-versus-named-insured claims that would otherwise fall within one of the CGL policy's exclusions.

For example, there is no coverage under the CGL policy with respect to property damage to "property you own," a phrase which (according to the meaning of the term "you") means property owned by "any person or organization qualifying as a Named Insured under this policy." Imagine an occurrence in which the property of Named Insured A is damaged through the negligence of Named Insured B, and A makes a liability claim against B. The damaged property, technically speaking, is "property you [Named Insured A] own," and thus should trigger the policy's property damage exclusion. But because of the Separation of Insureds condition, the policy's coverage applies to Named Insured B as if there were no Named Insured A. Named Insured B therefore has coverage for the claim against it because, as the policy applies to B, the damaged property of A is not "property you own"—that is, not property owned by a named insured.

A similar coverage issue, with a similar resolution, would arise in the case of two CGL named insureds, one of which produces component parts for the other's product. If Named Insured A's component product causes damage to Named Insured B's finished product, CGL coverage for A's resulting liability would depend on the applicability of the "damage to your product" exclusion. That exclusion eliminates coverage for damage to "[a named insured's] product arising out of it or any part of it."

In our hypothetical example, the damage to Named Insured B's product arose out of a "part of it" which happens to be Named Insured A's product. Does the "damage to your product" exclusion therefore eliminate coverage for B's claim against A? The answer is no. "Separation of insureds" means that the policy's coverage applies to Named Insured A as if there were no Named Insured B, which means that B's product is not "your product." Named Insured A has coverage for the products liability claim against it, just as if its component had caused damage to any other (non-insured) manufacturer's product.

Reading the CGL policy "as if each named insured were the only named insured" can produce coverage results that, at first glance, are surprising. A decision of the U.S. Tenth Circuit Court of Appeals—West American Insurance Co. v AV&S, Inc., 145 S3d 1224 (1998)—illustrates the point. An employee of a pizza parlor, while driving his own car to make deliveries for the employer, struck and injured a pedestrian. The pedestrian sued the driver, the pizza parlor-employer, the corporation for which the employer was a franchise operation, and other franchisees of the corporation.

The corporation and all the franchisees were named insureds on the same businessowners policy (BOP), which contained coverage terms and exclusions identical to those of the standard CGL. One of those exclusions eliminated coverage with respect to "the ownership, maintenance, use or entrustment to others of any ... auto ... owned or operated by or rented or loaned to any insured." Since the owner-driver of the auto in question had insured status as an employee of the named insured pizza parlor, this auto exclusion was cited by the insurer as denying coverage for each of the claims brought by the injured pedestrian under the BOP.

In the resulting coverage dispute that ultimately came before the Tenth Circuit Court of Appeals, the franchising corporation and the other franchisees argued that the policy's separation of insureds condition—identical to the CGL's—prevented application of the auto exclusion to them. The circuit court agreed, focusing its analysis on the stipulation that the policy's coverages are to be applied "as if each Named Insured were the only Named Insured." If the franchising corporation, or any of the named insured franchisees other than the one whose employee caused the accident, were "the only named insured" under the policy, then the employee would not himself be the employee of a named insured under the policy, he would not therefore have "insured" status, and the auto exclusion would not apply. In the words of the court:

We find that because the Separation of Insureds clause treats each named insured separately as the only insured, the term "any insured" in the auto exclusion clause only applies to the single insured that actually owned the vehicle or whose employee operated the vehicle and the employees claiming insurance through that named insured. As a result, the policy only excludes from coverage claims for bodily injury against either ... the single named insured that actually operated or entrusted the automobile or [the driver], and does not exclude claims against [the franchising corporation] and the other franchisees, the other named insureds covered by the policy.

Some other lower appellate court decisions have attempted to make similar arguments based on item 2 of the Separation of Insureds condition, which states that the policy's coverage will apply "separately to each insured." (We will take a look at this second provision and its interpretation in a subsequent IRMI Insights article.) But the Tenth Circuit's decision in West American v AV&S is based on the much more sweeping and absolute language of item 1, applicable only to named insureds. The decision is a precise and literal reading of that language.

Under a CGL policy written for Named Insured A and Named Insured B, neither A nor B is "any insured" with respect to the other, if coverage applies "as if each named insured were the only named insured." The same would be true of B's employees as regards a claim against A, and of A's employees as regards a claim against B.