Excess insurance plays a critical role in protecting policyholders in a time where litigation and verdict sizes are on the rise. These insurers often provide substantially more in limits than the primary insurer, yet their role in the litigation itself is quite limited. Generally, excess insurers do not pay defense costs, do not appoint counsel to defend the claim, and do not participate in strategic decisions or in settlement discussions unless the claim is likely to pierce the excess coverage. As a result, excess insurers may not even discover a claim has settled until after the deal is done.
Excess insurers sign up for this limited role, but they do not sign up to pay for uncovered losses. Yet sometimes, excess insurers bear that risk. Whether it is for business reasons to terminate the duty to defend or just carelessness, primary insurers make uncovered payments that erode or exhaust their policies. Excess insurers bear the brunt of these payments when there are additional claims against the insured in that policy period. Excess insurers have had mixed success when challenging whether a primary insurer’s payment properly exhausted or eroded the primary. This article explores those decisions and provides recommendations to claims professionals and attorneys alike when faced with this circumstance.
Excess Insurer Obligations in Multi-Claim Settings
Most excess policies follow form to the primary policy, meaning that they generally provide coverage on the same terms as the primary policy. Excess policies, however, do not bind an excess insurer to the underlying insurer’s interpretation of those terms. Thus, even if an excess policy follows form, an excess insurer is not bound by the actual or implied coverage decisions of the primary carrier. [See, e.g., Aspen Specialty Ins. Co. v. RLI Ins. Co., 194 A.D.3d 206 (N.Y. App. Div. 1st Dep’t 2021); Shy v. Ins. Co. of the Pa., 528 Fed. Appx. 752 (9th Cir. 2013); Allmerica Fin. Corp. v. Certain Underwriters at Lloyd’s, London, 871 N.E.2d 418 (Mass. 2007); Cristal USA Inc. v. XL Specialty Ins. Co., 2017 Md. App. LEXIS 210 (Md. Ct. Spec. App. Feb. 24, 2017) (unpublished)].
Notwithstanding broad agreement among courts that excess insurers are not bound by a primary insurer’s coverage determination in a claim implicating both policies, courts have reached disparate conclusions when deciding whether an excess insurer can challenge if a payment made by the primary insurer on a different claim properly erodes or exhausts the primary policy.
The most recent, and most troublesome, decision is from the U.S. Court of Appeals for the Ninth Circuit: AXIS Reinsurance Co. v. Northrop Grumman Corp., 975 F.3d 840 (9th Cir. 2020). AXIS arose from two separate lawsuits against Northrop alleging Employee Retirement Income Security Act (ERISA) violations. Northrop settled both suits. One of those suits was by the Department of Labor (DOL). At the time, Northrop had a $15 million primary policy with National Union, a $15 million excess policy with CNA, and a $15 million second layer excess policy with AXIS.
Under the AXIS policy, the insurer was required to drop down and provide coverage only when the combined $30 million limit of liability of the underlying policies was exhausted by a covered loss. National Union determined that one of the settlements fell within its policy, so it paid its limit. CNA agreed that its policy also afforded coverage and paid the remainder of the settlement. Thereafter, CNA exhausted its limit through payment of Northrop’s second settlement. When it was AXIS’ turn to pay, it paid its share, but reserved the right to seek reimbursement because the settlement with the DOL was not covered.
In the coverage action, AXIS established that the payment for the DOL settlement was uncovered, but the court of appeals rejected the premise that AXIS had the right to challenge improper erosion of the lower-level policies. Instead, it adopted the rule that “unless there is an indication that the payments were motivated by fraud or bad faith, excess insurers generally may not avoid or reduce their own liability by contesting payments made at prior levels of insurance.” In adopting this approach, the court focused on public-policy concerns and purported inefficiencies in the claims handling process and discounted the district court’s concerns that such a conclusion would render the terms of AXIS’ policy meaningless.
The AXIS court believed that the “weight of authority” supported its view. But that is not so. There is not only ample authority supporting the contrary view, but also the cases that the AXIS court relied on are more limited and do not support excising the policy terms in favor of theoretical policy concerns.
For example, in Costco Wholesale Corp. v. Arrowood Indem. Co., 387 F. Supp.3d 1165 (W.D. Wash. 2019), the insurer conceded that the losses were covered, but argued that because the insured failed to obtain its consent prior to incurring $15 million in defense cost and fees, they were not loss recoverable under the policy. In Edward E. Gillen Co. v. Ins. Co. of the State of Pa., case no. 10-c-54, 2011 U.S. Dist. LEXIS 48119 (E.D. Wis. May 3, 2011) (unpublished), the court noted the “absence of a specific contractual arrangement” that supported the excess insurer’s position. In ARM Props. Mgmt. Group v. RSUI Indem. Co., 2008 U.S. Dist. LEXIS 108624 (W.D. Tex. 2008) (unpublished), the court rejected the excess insurer’s challenge because the subject excess policy included no language that required the payment by the primary insurer to be for a covered loss.
Those courts that have permitted excess insurers to challenge improper erosion grounded their decisions in the policy language. For example, in Royal Indemnity, 2009 Minn. App. Unpub. LEXIS 772, the excess insurer relied on the definition of “loss” to assert that a payment by the underlying insurers did not reduce its attachment point. That policy provided that the excess insurer’s “[l]iability for any covered loss…shall attach…only after the insurers of the underlying policies shall have paid in legal currency the full amount of the underlying limit and “[i]n the event…of the…exhaustion of the underlying limit by reason of the insurers of the underlying policies paying in legal currency loss, this policy shall…continue in force as primary insurance.”
Under this language, the “excess insurer attaches when the liability limits of the underlying policy have been exhausted because the underlying insurers have made payments for loss. Therefore, if [the underlying insurers] made payments that did not fit within the definition of ‘loss,’ the [insured] cannot rely on those payments to establish that the underlying policies have been exhausted.”
The commonalities in each of the decisions where an excess insurer has been permitted to challenge the primary insurer’s payment are two-fold. First, unequivocal policy language in the excess policy providing that payment by underlying insurers of uncovered losses does not reduce its attachment point. Second, there must be clear evidence that the primary insurer’s payment was for an uncovered loss.
The starting point to consider an improper erosion challenge must be the policy language. The stronger the language, the better. But as the AXIS decision demonstrates, the policy language is no guaranteed panacea since the language in the AXIS excess policy was quite clear that AXIS would drop down only when the underlying policies were reduced or exhausted by a covered loss.
Disputes over improper erosion can lead courts to look to public-policy concerns. In these instances, it is critical to remind courts of their obligations to render decisions based on policy language alone. More often than not, they have stood on that premise in deciding other types of coverage disputes. The facts are also critical in deciding whether to challenge the primary insurer’s payment—particularly egregious facts. For example, if the primary insurer paid a claim that was potentially subject to an exclusion, then it may be difficult for an excess insurer to present a compelling case for improper erosion. On the other hand, where the primary insurer clearly paid an uncovered loss, either through carelessness or perhaps to prematurely exhaust a policy that would ultimately be eroded, the case for improper erosion is far stronger.
Ultimately, whether to challenge a primary insurer’s payment involves a panoply of considerations. The more holistic the approach, the better.