Do you know if you have sufficient liability coverage to protect you against both legal defense expenses and any damages awarded to a plaintiff? Many companies are not adequately insured because they are unaware of the distinction between two different types of liability insurance.
Legal costs can quickly exhaust your policy limit leaving you to pay out of pocket for claims and settlement. In order to have protection against both claims and legal expenses, when purchasing or reviewing any of your liability policies, professional, general or product, you should determine whether the policy includes coverage for legal defense outside the limits or inside the limits of liability.
- Defense inside the limit means that all defense costs (attorney’s fees, court costs, investigation and filing legal papers) are deducted first from the policy limit, which cuts into the overall limit of dollars available to pay for monetary damages awarded by a ruling.
- With defense outside the limit coverage, there are separate limits available for legal defense costs and court-awarded damages. So, the defense costs outside the limits don’t erode your policy limits available to pay settlements resulting from a suit.
This should not to be overlooked because if your company is facing a law suit, the type of coverage you’ve elected will be pivotal in determining your potential financial responsibility.
To demonstrate the severity of the matter, consider the following:
Jury Verdict Research found that “In any employment case filed in federal court, there is a 16% chance the award (excluding attorney fees) will exceed $1 million and a 67% chance that the award will exceed $100,000.” According to the Insurance Information Institute the average cost of defense of a product liability claim is $876,000. These statistics reflect costly ramifications if you are not adequately insured.
So let’s look at a professional liability example to help you better understand the difference between inside and outside liability coverage limits and the importance of choosing the right amount of insurance.
Professional Liability Coverage Example – Employment Practices Liability Insurance (EPLI)
Most business owners like to think of their company as a close-knit group, many even consider their employees as family. This may be true when times are good, but how do you handle a situation when something goes wrong and an employee files a lawsuit against you?
Employment Practices Liability Insurance (EPLI) is a professional liability coverage that provides an employer with protection against claims of wrongful termination, sexual harassment, discrimination and other types of claims related to employment by current or potential employees.
Let’s assume you are the owner of Sam’s Sprockets, and you carry a $1 million EPLI policy. A group of employees sue the company for sexual harassment, and are awarded $900,000 by the jury. Let’s also assume the legal defense costs are $1 million dollars. If you had inside the limits liability coverage, your entire policy would be exhausted and you would be left with the responsibility to pay $900,000 in damages out of pocket, which can create a significant hardship for many companies. Alternatively, with defense outside the limits, all costs would be covered by your policy.
| Inside the Limits of Liability | Outside the Limits of Liability | |
| Liability Limit | $1,000,000 | $1,000,000 |
| Defense Costs (attorney’s fees, court costs, etc.) | $1,000,000 | $1,000,000 |
| Damages (claims, award, settlement) | $900,000 | $900,000 |
| Total Costs | $1,900,000 | $1,900,000 |
| Sam’s Sprockets Obligation | $900,000 | $0 |
Unfortunately, not all liability insurance carriers offer you the choice as to whether your defense coverage is inside or outside the policy limits. However, if you have an option, I strongly recommend that you add it to your existing policy. While the cost can be slightly higher, it will be minimal compared to the out-of-pocket expenses if your company is sued, especially in the event of multiple claims filed within a single policy period. If the option is not available, you may want to consider higher limits for your liability insurance.
FAQ
1. What is liability insurance and why is it important?
Liability insurance protects your company from claims related to injuries, damages, or wrongful acts committed by the business or its employees. Without adequate coverage, you could face paying substantial legal expenses and damages out of pocket, which can severely impact your company’s financial stability.
2. What’s the difference between “defense inside the limits” and “defense outside the limits”?
- Defense Inside the Limits: Legal defense costs (attorney fees, court costs, etc.) are taken directly from your policy’s liability limit. This reduces the amount available to cover any damages awarded to a plaintiff. If legal costs are high, they can quickly deplete the policy limit, leaving you responsible for paying the damages.
- Defense Outside the Limits: Legal defense expenses are covered separately from the policy’s liability limit. Your defense costs do not erode the funds available for any awarded damages, providing greater protection and reducing your out-of-pocket financial exposure.
3. Why is it crucial to understand how defense costs are covered?
The structure of your defense coverage can significantly affect the total out-of-pocket expenses your business faces in a lawsuit. If your defense costs come out of the same pool as your damages coverage, a lengthy or costly legal defense can leave little to no funds to pay a settlement or judgment, forcing you to cover the shortfall. Having defense costs outside the limits offers stronger financial protection.
4. Can I choose whether my defense coverage is inside or outside the limit?
Not all insurance carriers allow you to choose. Some policies are structured to include defense costs inside the limit by default. If you do have the option, selecting defense outside the limits may result in a slightly higher premium, but it can protect you from significant financial hardship if you face multiple or expensive claims.
5. What types of businesses should be concerned about this distinction?
All businesses, regardless of size or industry, should understand their liability coverage structure. High-turnover industries, companies susceptible to employment-related claims, firms with complex products, and organizations that regularly interact with the public or large client bases can be especially at risk. Understanding your coverage can help you better manage legal and financial risks.
6. How do these coverage structures apply to Employment Practices Liability Insurance (EPLI)?
EPLI protects employers from claims such as wrongful termination, harassment, and discrimination. In an example given, if a business faced $1 million in defense costs and a $900,000 award, a policy with defense inside the limit would exhaust the entire $1 million coverage on legal fees—leaving the employer to pay $900,000 out of pocket. With defense outside the limit, both legal costs and damages could be fully covered, significantly reducing the employer’s financial burden.
7. If I can’t select defense outside the limits, what else can I do?
If the option isn’t available, consider purchasing higher policy limits to ensure that you have enough coverage to handle both legal expenses and potential damages. Speak with your insurance advisor about supplemental policies, excess coverage, or other strategies to increase your financial protection.
Contact Us
If you have any questions about your organization’s existing defense liability limits, or need assistance with purchasing additional coverage, feel free to email me or my associate, Darrin Hawkins dhawkins@psafinancial.com. You can also reach out to us via our online contact form.
