Policyholders purchase excess coverage with the reasonable expectation that they will not face a series of different coverage positions from multiple layers of insurers when seeking payment for claims, but that is not always the case. A trend has emerged where excess carriers disagree with lower-layer insurers’ coverage determinations.
There is a lack of extensive case law nationally to address how the interplay between primary and excess insurance should function.
On Sept. 14, the U.S. Court of Appeals for the Ninth Circuit, in an issue of first impression, took an important step toward constraining an excess insurer’s ability to second-guess decisions made by lower-layer insurers with respect to proper exhaustion.
However, the court suggested it was not prepared to go far enough to fulfill reasonable policyholder expectations by making clear that “follow form” coverage should always result in the excess insurers adopting coverage determinations made by lower-layer insurers.
In Axis Reinsurance Co. v. Northrop Grumman Corp., two underlying lawsuits were brought against Northrop Grumman Corp. alleging ERISA violations.
Northrop settled the first lawsuit, brought by the Department of Labor, by agreeing to pay certain amounts in exchange for a full release. The primary insurer, AIG, and first layer excess insurer, CNA, both determined that the DOL settlement was covered by their respective policies. AIG contributed all of its limits toward the DOL settlement and CNA paid the remainder without exhausting its policy limits.
The second lawsuit brought by other parties was also settled (the Grabek settlement). Because the DOL settlement exhausted AIG’s policy limits, CNA contributed its remaining policy limits to the Grabek settlement. Axis, the second-layer excess insurer, was called on to pay the remainder of the Grabek settlement.
Axis did not contest the settlement’s validity but argued improper erosion, i.e., “the underlying insurers’ improper payment of the DOL settlement prematurely triggered AXIS’s excess liability.”
Improper Exhaustion Theory
The Ninth Circuit found that an excess insurer may not challenge payment decisions of underlying insurers to argue improper exhaustion absent a showing of fraud or bad faith.
The court noted that excess insurers “may contract around this general rule by including specific language in their policies reserving a right to challenge prior payments.” Alternatively, the court stated that excess insurers “could request higher premiums to account for” the possibility that underlying insurers may pay uncovered claims.
While the Axis decision is a good step, it does not go far enough to enforce the letter and spirit of “follow form” coverage.
The Ninth Circuit noted that “an excess insurer remains free to contest claims submitted to it during the claims adjustment process even when an underlying insurer has already determined that the same claim falls within the scope of coverage.” Thus, the court differentiated between a previously paid claim where only an underlying insurer was responsible and a pending claim, which triggers primary and excess policies.
With respect to previously paid claims, the Ninth Circuit held that the excess insurer cannot second-guess the lower-layer insurer’s decision to pay the claim, even if it was not covered. To hold otherwise, the court stated, “would undermine the confidence of both insureds and insurers in the dependability of settlements, eliminating one of the primary incentives for obtaining insurance in the first place.
Furthermore, such a rule would introduce a host of inefficiencies into the insurance industry, with no obvious countervailing benefits to insurers or policyholders.”
The court also rejected the notion that “underlying insurers are motivated to pay uncovered claims even in the absence of fraud or bad faith. While such a possibility may exist, [the Ninth Circuit did] not think that there are many instances where an insurance company will pay out claims–let alone its policy’s limit–when it is not obligated to do so (at least in cases not involving fraud or bad faith).”
A Door Left Open
Regarding a pending claim that triggers multiple policies, the Ninth Circuit left the door open for excess insurers to diverge from lower-layer insurer coverage determinations for that claim.
The court did not address why the same logic for previously resolved claims did not apply with equal measure to pending claims. Follow-form excess coverage is supposed to provide policyholders with certainty that once a claim is deemed covered by an underlying insurer, all coverage within the tower must be made available as each layer of coverage exhausts.
Policyholders should carefully review excess policy language on renewal because excess insurers may seek to reserve the right to challenge underlying insurers’ payment decisions. Excess insurers also may continue ignoring the purpose of follow-form excess insurance by breaking ranks with primary insurers’ coverage determinations.
To reverse the trend, policyholders may be required to litigate. The Axis decision provides a strong foundation for the contractual and policy grounds on which coverage should be enforced so that policyholder reasonable expectations are fulfilled.
Reprinted with permission from the October 7, 2020, issue of Bloomberg Law. © 2020 The Bureau of National Affairs, Inc. All Rights Reserved.Click here to view the full article