What issue may arise when liability insurance is placed in a series of layers on a costs-inclusive basis?

When liability insurance is structured in layers on a costs-inclusive basis, one of the significant concerns is that high legal costs can contribute to limit erosion. This means that the substantial legal expenses associated with defending claims can quickly diminish the total available limit under each layer of coverage. In a costs-inclusive approach, the legal costs necessary to defend against claims are paid out of the limit of liability, thereby reducing the amount left to cover any actual settlements or judgments.

If legal costs are high, they can consume most, if not all, of the liability limits, which leaves less available for the actual damages arising from claims. This situation can lead to insufficient coverage when a significant claim is made or several claims occur, ultimately exposing the insured to greater financial risk. The layered approach, while providing a framework for coverage, can become problematic if not carefully managed concerning legal expenses.

The other options would not directly relate to the mechanics of how costs-inclusive layers impact the available coverage limits and the potential for policyholders to be undercovered in the event of substantial claims due to escalating legal costs.