Definition:Eroding limits
📉 Eroding limits — sometimes called "wasting limits" or "burning limits" — describe an insurance policy structure in which defense costs, legal fees, and other allocated loss adjustment expenses reduce the total limit of liability available to pay settlements or judgments. This structure is most commonly found in professional liability, directors and officers, errors and omissions, and cyber policies, where litigation defense can be prolonged and extraordinarily expensive. Unlike CGL policies, which typically provide defense "outside the limits," eroding-limits policies effectively force the insured and the insurer to share a single pool of money for both defense and indemnity.
⚙️ Consider a D&O policy with a $10 million aggregate limit and eroding-limits language. If the insured incurs $4 million in legal defense costs during a protracted securities class action, only $6 million remains to fund any settlement or award. Each invoice from defense counsel literally chips away at the total protection. Underwriters factor this dynamic into pricing by modeling expected defense-cost ratios, severity trends, and litigation duration for the specific line of business. Sophisticated insurance buyers often purchase excess layers or dedicated Side A towers to ensure adequate limits survive after defense spending.
🔑 The practical consequence of eroding limits is that a policyholder can find itself with depleted coverage precisely when it needs protection most — at the settlement table or in front of a jury. Brokers and risk managers must model worst-case defense-cost scenarios during the placement process to right-size the program. Awareness of this structure also shapes litigation strategy: insureds may push for early mediation or settlement to conserve limits, while plaintiff attorneys may intentionally prolong proceedings to pressure a settlement as remaining coverage dwindles.
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