Defense Costs
Legal expenses incurred in defending a covered liability claim, which may be inside or outside the policy limits depending on the form.
What It Is
Defense costs are the legal expenses incurred in investigating and defending a claim covered by the liability policy. These include attorney fees, expert witness fees, court costs, and other litigation expenses. How defense costs are treated relative to the policy limits is one of the most important structural differences between policy forms.
Under the standard ISO CGL form, defense costs are paid as supplementary payments — outside of and in addition to the policy limits. This means the full per occurrence limit and aggregate are available for damages, and defense costs do not erode those limits.
However, many specialty policies, excess policies, and some carrier-proprietary CGL forms treat defense costs as inside the limits (also called "eroding limits" or "burning limits"). In these forms, every dollar spent on defense reduces the amount available for settlement or judgment. This distinction can have a massive financial impact on claims outcomes.
Why It Matters for Brokers
Brokers must clearly identify whether defense costs are inside or outside the limits on every liability policy they place. A $1M policy with defense inside limits might effectively provide only $400,000-$600,000 for damages after defense costs in a litigated claim. This is especially critical for umbrella and excess policies, where defense-inside-limits is common. Failing to disclose this difference to clients is a significant E&O exposure.
Real-World Example
Two contractors each face a $700,000 bodily injury lawsuit. Contractor A has a standard ISO CGL with $1M per occurrence and defense outside limits — the carrier spends $185,000 on defense and pays the full $700,000 settlement, totaling $885,000 in carrier spend. Contractor B has a carrier-proprietary CGL with $1M per occurrence and defense inside limits — the carrier spends $185,000 on defense, leaving only $815,000 available for damages, which still covers the $700,000. But if the claim had been $900,000, Contractor B's policy would have been $85,000 short.
Common Mistakes
- 1Assuming all CGL policies treat defense costs as supplementary payments outside limits — many carrier-proprietary forms include defense within limits.
- 2Not flagging the defense-inside-limits structure on umbrella and excess policies, where it is far more common than on primary CGL.
- 3Failing to factor defense cost erosion into limit adequacy recommendations for clients with litigation-prone operations.
How brokerageaudit.com Handles This
Policy Checker identifies whether defense costs are inside or outside the limits for every liability policy and flags this as a critical coverage characteristic. It generates an alert when comparing policies where one has defense inside limits and the other has defense outside limits. Submission Intake includes defense cost treatment as a comparison field in multi-carrier quote worksheets.