1. Forms
2. IL
3. IL-01-20

Form IL 01 20: Pennsylvania Changes - Defense Costs Outside Policy Limits

1. What the form is

Form IL 01 20, titled "Pennsylvania Changes - Defense Costs Outside Policy Limits," is an endorsement used in Pennsylvania to modify the standard provisions of commercial insurance policies regarding how defense costs are handled in relation to the policy's limits of liability. Typically, commercial general liability policies provide that defense costs are paid in addition to the policy limits (often referred to as "defense outside limits"). This endorsement can alter this, potentially stipulating that defense costs will erode or reduce the policy limits available to pay for settlements or judgments ("defense inside limits" or "eroding limits"). It's crucial to note that this endorsement reflects a significant shift from the traditional approach where defense costs were supplementary. In some instances, this form might be used to expressly state the insurer's right to reimbursement for defense costs if it's later determined that none of the claims are covered under the policy, a topic clarified by the Pennsylvania Supreme Court in the American and Foreign Ins. Co. v. Jerry's Sport Center, Inc. case, which generally disallowed such reimbursement absent specific policy language. This endorsement can provide that specific contractual language.

2. Classes of business it applies to

This endorsement can be attached to various commercial liability policies in Pennsylvania. While not limited to specific industries, it is more likely to be seen in lines of business or with insureds where defense costs can be substantial and insurers are looking to manage their total exposure. Examples include:

• Professional Liability (Errors & Omissions - E&O): For professionals like architects, engineers, consultants, and lawyers, where defense against negligence claims can be lengthy and expensive.
• Directors and Officers (D&O) Liability: Protecting corporate leaders from lawsuits related to their management decisions, which often involve complex and costly legal battles.
• Employment Practices Liability (EPLI): Covering claims related to wrongful termination, discrimination, or harassment, where legal defense is a primary component of the loss.
• Cyber Liability: As data breach and cyber-attack claims often involve significant forensic and legal expenses.
• High-Risk Industries: Businesses in sectors prone to litigation, such as construction (especially for design-build or large projects), manufacturing of high-risk products, or environmental services.

For instance, a large engineering firm in Pennsylvania facing a complex design defect claim could see its policy limits significantly impacted if this endorsement makes defense costs deplete those limits. Similarly, a tech company with D&O coverage might find its coverage for settlements reduced by extensive legal fees if IL 01 20 is applied to make defense costs fall within policy limits.

3. Special considerations

Several important factors must be considered when Form IL 01 20 is part of a policy:

• Impact on Policy Limits: The most significant consideration is how this endorsement affects the available policy limits. If defense costs are inside the limits, substantial legal expenses can drastically reduce the funds available to pay a settlement or judgment, potentially leaving the insured with an unfunded liability.
• Clarity of Language: The exact wording of the endorsement is critical. It must clearly state how defense costs will be treated. Following the Jerry's Sport Center decision, insurers in Pennsylvania may use endorsements like IL 01 20 to explicitly reserve their right to recoup defense costs for non-covered claims. Policyholders should be aware that insurers might add such language to their policies.
• Regulatory Landscape: While Pennsylvania law allows for flexibility in how defense costs are handled if clearly stated in the policy, agents and insureds should understand that this endorsement represents a specific contractual agreement. The Pennsylvania Supreme Court has affirmed that an insurer's duty to defend is broader than its duty to indemnify.
• Negotiation Point: For sophisticated insureds, the terms of defense cost coverage (inside vs. outside limits) can be a significant point of negotiation. The presence of IL 01 20 should trigger a discussion about its implications and whether alternative arrangements are possible.
• Real-World Example: Consider a Pennsylvania-based non-profit organization with a D&O policy. If a lawsuit arises alleging mismanagement of funds, the legal defense could be extensive. If Form IL 01 20 is attached and stipulates defense costs are within limits, the millions spent on lawyers could mean less money available to settle the actual claim, potentially exposing the organization's assets if the claim value exceeds the depleted limits.

4. Key information for agents and underwriters

• Pricing and Risk Assessment: Policies where defense costs are inside the limits (potentially facilitated by this endorsement) might be priced lower initially, as the insurer's maximum exposure is more clearly capped by the policy limit. However, underwriters must carefully assess the potential for high defense costs for the specific risk. For certain professions or industries, the likelihood of expensive litigation might make "defense inside limits" a riskier proposition for the insured, even if the premium is lower.
• Coverage Gaps: Agents must clearly explain the implications of this endorsement to their clients. If defense costs erode the policy limit, a significant coverage gap can emerge, especially in complex litigation. This could leave the insured underinsured for the actual indemnity payment.
• Underwriting Guidelines: Underwriters will need to evaluate the insured's loss history, the litigiousness of their industry, and the typical costs of defending claims in their specific area of operation in Pennsylvania. For risks with a high probability of incurring substantial defense expenses, applying this endorsement to make defense costs fall within limits requires careful consideration of the adequacy of the proposed policy limit.
• Alternative Options: Agents should explore whether offering a policy with defense costs outside the limits is feasible, even if at a higher premium, especially for clients with significant exposure to costly litigation. If IL 01 20 is used to allow recoupment of defense costs for non-covered claims, this should be explicitly discussed.
• Disclosure and Documentation: It is crucial for agents to document that they have explained the function and potential impact of Form IL 01 20 to the insured, particularly if it changes the defense cost provision to be within policy limits or allows for recoupment of defense costs. This helps manage expectations and avoid errors and omissions claims against the agency.