Guides
Defense costs inside vs outside policy limits: why it matters
Whether legal fees erode your liability limit changes what a policy is worth. Which forms pay defense on top, which erode the limit, and what to ask first.
Under an "outside the limits" policy, the insurer pays your legal defense in addition to the policy limit, so a $1 million limit is still $1 million available for a judgment or settlement. Under an "inside the limits" policy, every dollar spent on lawyers reduces the limit, and the policy is sometimes called an eroding, wasting or burning limits policy. The difference can turn an adequate $1 million of coverage into $600,000 of real protection without anyone noticing until a claim.
The standard ISO commercial general liability form pays defense outside the limit. Most professional, management and cyber liability policies do not. Your declarations page does not always say which kind you bought, so you have to look.
How the two structures work
Take a hypothetical claim against a business with a $1 million limit. Legal fees run $400,000 and the case settles for $800,000.
| Defense outside the limit | Defense inside the limit | |
|---|---|---|
| Limit | $1,000,000 | $1,000,000 |
| Defense costs paid | $400,000, on top of the limit | $400,000, reducing the limit |
| Left to pay the settlement | $1,000,000 | $600,000 |
| Insurer pays toward the $800,000 settlement | $800,000 | $600,000 |
| You pay | $0 | $200,000 |
| Total insurer outlay | $1,200,000 | $1,000,000 |
The numbers are illustrative, not a typical claim. The pattern is what matters: when the defense runs long, the gap lands on the policyholder. The same erosion applies to the aggregate. A second claim in the same policy year finds whatever the first one left.
What the standard CGL says
In the ISO CGL (CG 00 01), the Supplementary Payments section lists amounts the insurer pays in addition to the limit. It includes expenses the insurer incurs, which covers defense counsel's fees, along with reasonable expenses you incur at its request (including lost earnings up to $250 a day under the current form), court costs taxed against you, and some interest. The section says these payments do not reduce the limits, a point confirmed by IRMI's commentary on the clause. Commercial auto and employers liability forms treat defense similarly, and so do most business owner's policies, which build on the CGL.
Outside the limits does not mean unlimited. The insurer's right and duty to defend ends when it has used up the applicable limit paying judgments or settlements, so defense stops at exhaustion; see the insurer's duty to defend: what triggers it and when it ends for how that works. A big judgment paid at the limit leaves you with no insurer-funded lawyer for an appeal.
Which policies usually do which
| Policy | Usual treatment of defense | Caution |
|---|---|---|
| General liability, BOP liability | Outside the limit | Endorsements and some surplus lines forms change it |
| Commercial auto liability | Outside the limit | Duty to defend ends at exhaustion |
| Employers liability (workers' comp Part Two) | Outside the limit | Check the policy, not the assumption |
| Umbrella and excess | Varies by form | Some pay defense on top once they take over; follow-form excess takes the underlying treatment |
| Professional liability (E&O), lawyers | Often inside | Read the definition of "loss" or "claim expenses"; see Professional liability (E&O) insurance explained |
| D&O, EPLI, fiduciary, management liability packages | Usually inside | A shared limit across coverage parts can be drained by one claim |
| Cyber, pollution, media | Often inside | Check the sublimits for each coverage part too |
Treat the table as a starting point, because wording varies by insurer and program. Many errors and omissions policies pay defense inside the limit, unlike the CGL, and a combined-limit management liability package can mean that one employment defense bill erodes the protection available to directors. Some insurers offer an outside-the-limits option, often at extra premium. Many of these forms also include consent-to-settle terms like the the hammer clause: what happens if you refuse a settlement, which interact with defense spending.
The CGL can be changed by endorsement
This is where the buyer in construction and other hard-to-place classes gets caught. Some surplus lines CGL forms carry a defense-within-limits endorsement. A 2022 Miller Nash article described one titled "Limited Coverage for Bodily Injury, Property Damage or Personal and Advertising Injury Involving Efficient Proximate Cause (Defense Within Limits)" that sets a $100,000 sublimit with defense costs counting against it, so once $100,000 is spent on defense, nothing remains for indemnity. The base limit on the declarations page can look generous while an endorsement shrinks it for the claims that matter. Check the endorsement list, not just the face of the policy.
Where state law steps in
A few states regulate defense within limits. Nevada's AB 398, effective October 1, 2023, bars insurers from issuing or renewing liability policies with provisions that reduce limits by defense costs; permanent regulations (NAC R029-23) took effect November 6, 2023. According to a January 2025 Bradley analysis, the ban reaches commercial general liability, healthcare professional liability, and auto and homeowners policies from admitted insurers, while professional liability outside healthcare, risk retention groups and nonadmitted insurers are outside it. Connecticut took a different route in a September 2022 notice: defense within limits is allowed only on claims-made liability policies in lines such as D&O, E&O, cyber and employment practices, with conspicuous disclosure and an offer of options with defense outside the limit, according to Insurance Journal. Most states have no such rule, and details change, so a policy bought in Nevada or Connecticut is worth discussing with your broker.
What to ask before you buy or renew
- Find the sentence. Look in the Limits of Insurance section and the definitions of "damages," "loss" and "claim expenses" for whether defense is included.
- Ask your broker in writing: "Do defense costs erode the limit, the aggregate and the retention?" Ask about each coverage part in a package, and ask whether the limit is shared across parts.
- Check the retention. Many forms apply the deductible or self-insured retention to defense costs, so you pay the first lawyers' bills yourself; see deductibles vs self-insured retentions: who pays first.
- Price the alternatives. Ask for a quote with defense outside the limit, a higher limit, or a separate defense limit, and compare the cost with the added protection.
- Plan limits around the defense bill. On an eroding policy, decide the limit you need after estimating legal fees, not before. See commercial policy limits: per occurrence, aggregate and sublimits and, for the occurrence and claims-made difference, occurrence vs claims-made policies.
- Check contract requirements. A customer or lender asking for $2 million may not realize that on an eroding policy your $2 million limit could be $1.5 million by the time the case settles. Raise the issue before signing.
- Review every endorsement, especially sublimits that mention defense.
Key takeaways
- The ISO CGL, commercial auto and employers liability forms pay defense in addition to the limit; many professional, D&O, EPLI, cyber and similar forms pay defense inside it.
- On an eroding policy, legal fees reduce both the per-claim limit and the annual aggregate, which can leave you funding part of a settlement.
- Defense outside the limit still ends when the limit is exhausted by judgments or settlements, so it is not unlimited.
- Endorsements and surplus lines forms can turn a CGL into a defense-within-limits policy; read the endorsement schedule.
- State rules differ. Nevada bars defense within limits on certain admitted-market lines, and Connecticut allows it only on claims-made lines with disclosure.