In business insurance, a severability of interests clause (also called separation of insureds) is a provision that treats each insured party as having separate coverage under the policy.
This means the actions or knowledge of one insured generally won’t affect the coverage of other insureds.
This differs from contractual severability clauses, which allow parts of a contract to remain valid if other sections are deemed unenforceable.
The severability clause serves as a protective mechanism in business contracts and insurance policies. In the context of business insurance, this clause is sometimes referred to as a “severability of interests clause” or “separation of insureds” provision. It essentially declares that the insurance applies to each insured as though a separate policy were issued to each party covered under the policy.
When included in an insurance policy, a severability of interests clause typically affects how coverage applies to multiple insureds.
It prevents the actions, knowledge, or misrepresentations of one insured from automatically invalidating coverage for other innocent insureds.
This protection is particularly important in policies covering multiple individuals or entities under a single contract.
Without such clauses, the misconduct or misrepresentation of one insured party could potentially invalidate coverage for all other parties named in the policy.
Many business owners don’t realize that the actions of one stakeholder could jeopardize insurance protection for everyone else in the organization.
The practical function of a severability clause becomes particularly important in Directors and Officers (D&O) insurance, where multiple individuals are covered under a single policy.
In these policies, severability provisions typically take one of two forms: severability of the application and severability of exclusions.
The former prevents misrepresentations by one insured from invalidating coverage for innocent insureds, while the latter ensures that policy exclusions apply only to those insureds whose conduct triggered the exclusion.
Severability of Limits
The standard severability provision in most insurance policies specifically states that while the policy applies separately to each insured, the limits of insurance are not separate for each insured.
This means that all insureds share the same policy limits, rather than each insured having their own separate limit equal to the full policy amount.
This concept is clearly outlined in the CGL (Commercial General Liability) policy’s Separation of Insureds condition, which explicitly states that the separate application of the policy’s coverages to each insured does not include the limits of insurance.
All insureds collectively share those limits, which has significant implications for coverage adequacy when multiple insureds are making claims against the same policy.
The Marsh Affinity resource further clarifies this point, stating that a severability of interests clause means the insurance policy applies separately to each insured party as if separate policies were issued, while the overall liability limit remains unchanged.
For example, if a policy has a $10 million liability limit, it remains at $10 million regardless of how many insureds are covered by the policy.
This distinction is important, as it affects the actual amount of protection available when multiple parties are insured under the same policy.
Unlike severability of application (which prevents one insured’s misrepresentations from affecting others’ coverage) and severability of exclusions (which ensures exclusions apply individually to each insured), the non-severability of limits means that the policy’s financial protection is a shared resource among all insureds.
This limitation could create significant exposure if multiple insureds face substantial claims simultaneously, as they would all be drawing from the same pool of funds rather than having individual limits.
Business owners should carefully consider whether shared limits provide adequate protection for their specific risk profile, especially in policies covering multiple entities or individuals with potentially divergent interests.
Examples of Severability
Example 1: Restaurant Partnership Dispute
Consider a small restaurant owned by three partners: Alex, Ben, and Caroline. They purchase a commercial general liability policy that includes a severability clause.
Later, it’s discovered that Ben knowingly provided false information on the insurance application regarding previous claims at another business he owned. When a customer suffers a severe allergic reaction and sues the restaurant, the insurance company investigates and finds Ben’s misrepresentation.
In this scenario, the application of the severability of interests clause would be more nuanced than simply preserving coverage for Alex and Caroline. The specific language of the severability provision would be crucial. If the policy contains a “full severability” provision for the application, it would typically state that knowledge possessed by one insured person cannot be imputed to other insureds for determining coverage.
However, many policies contain “limited severability” provisions that only extend this protection to certain individuals or under specific circumstances.
The insurer might still attempt to rescind the entire policy if they can demonstrate that Ben was acting as an agent of the business when completing the application, or if the misrepresentation was material to the risk being insured.
The severability clause would more clearly come into play regarding exclusions. For instance, if the policy contained an exclusion for intentional acts, and Ben intentionally served an allergen to the customer, the severability provision would ensure that this exclusion only applies to Ben’s coverage, not to Alex and Caroline who had no involvement in the intentional act.
They would still have defense coverage and potential indemnity for their portion of liability in the lawsuit, subject to other policy terms and conditions.
Example 2: Manufacturing Company with Multiple Locations
A manufacturing company with facilities in three states has a commercial property policy covering all locations. The policy includes a severability clause.
During policy renewal, the CFO incorrectly reports fire safety measures at one facility, stating they have a sprinkler system when they actually don’t. Six months later, a fire damages inventory at a different location that was accurately represented in the application.
During the claims investigation, the insurer discovers the misrepresentation about the first facility.
With a severability of interests clause, the insurance company can deny coverage only for claims related to the misrepresented facility while maintaining coverage for properly disclosed locations. This protects the company from having its entire coverage voided due to an error regarding one specific location.
Pros and Cons of Severability Clauses
The primary benefit of severability clauses is their ability to salvage agreements that might otherwise be deemed entirely unenforceable. For businesses with multiple stakeholders or locations, this provision offers crucial protection by insulating innocent parties from the actions or misrepresentations of others.
Severability clauses also promote fairness within insurance relationships by ensuring that only those responsible for breaches face consequences.
However, severability clauses also present challenges.
The interpretation of these provisions can vary significantly between jurisdictions and individual judges, creating uncertainty about how they’ll be applied in practice.
Some courts may refuse to enforce severability if they determine that the unenforceable provision was so central to the agreement that the contract’s fundamental purpose would be undermined by its removal.
There’s also the risk that partial enforcement might result in an agreement that doesn’t fully reflect the parties’ original intentions. Furthermore, insurers may include limited severability provisions rather than full severability, which offer less protection for innocent insureds, particularly if certain executives had knowledge of misrepresentations.
Did You Know?
Insurance carriers vary significantly in how they structure severability provisions, particularly in D&O policies. Some restrict severability protection only to specific senior executives (known as ‘limited severability’), while others extend it to all insured persons (full severability).
This variation means that two seemingly identical policies from different insurers might provide vastly different levels of protection for innocent insureds when misconduct occurs.
Sources and further reading:
severability of interests clause – IRMI
Severability: Definition, 2 Key Parts to Clauses, and Examples
What is a Severability Clause? – Contractbook
What is Severability in a D&O Policy? – The Coyle Group
Severability of insurance: clause meaning | PSIC – Pacific Specialty
limited severability provision – IRMI
Severability of Interests Clause
What is Severability in a D&O Policy? – YouTube