The "Silent" Excess Policy
In coverage litigation, the court most typically turns first (and sometimes only) to the words of the particular insurance contract to discern the scope and nature of the parties' respective rights, what the parties intended, or both. Nonetheless, various jurisdictions have focused on what the insurance contract does not say, or remains silent on, to clarify whether an excess policy is required to defend its insured. In fact, some courts have held that if an insurance contract does not contain a provision negating an excess insurer's duty to defend, the insurer may, under certain circumstances, be obligated to defend.[2]
For example, the Wisconsin Supreme Court, in resolving an issue of first impression under Wisconsin law, held in Johnson Controls, Inc. v. London Market, that an excess liability policy contained a duty to defend by virtue of a follow form[3] provision that incorporated a duty to defend found in the underlying policy issued by Travelers.[4] In support of its assertion that the policy provided only for indemnification, the insurer, London Market, pointed to the Insuring Agreement language that promised "subject to the limitations, terms and conditions hereinafter mentioned, to indemnify the Assured for all sums which the Assured shall be obligated to pay by reason of" certain liabilities.[5] The court acknowledged that the London Market policy itself was silent as to the duty to defend, but instead pointed to the follow form provision incorporating the "terms, definitions, exclusions and conditions" of the underlying Travelers policy that contained both a duty to defend and duty to indemnify. [6] Based on this, the court found as follows:
Given that Travelers imposes a duty to defend, and London Market's silence regarding that duty, a reasonable person in the position of the insured would interpret London Market's policy as incorporating the duty to defend found in the Travelers policies.[7]
Had there been a conflict in language related to the duty to defend between the Travelers and London Market policies, the outcome in Johnson Controls would likely have been different. In fact, the court pointed to a case, Home Insurance Co. v. American Home Products Corp.,[8] in which the Second Circuit held that an excess policy did not provide a defense, despite an underlying policy to which it followed form that provided for the payment of defense costs.[9] The Second Circuit in Home Insurance was concerned with trying to give effect to the underlying policy provision that conflicted with the excess policy itself (the underlying policy covered defense costs; the excess excluded "legal costs").[10] It ultimately found that these conflicts could not be reconciled and that the language of the excess policy controlled. It was the absence of any express language negating that defense obligation in the London Market policy that led the court in Johnson Controls to the contrary result.
On the other hand, courts have decided that certain clauses negate a duty to defend.[11] These courts have typically found provisions that provide the policy follows form "except for any obligation to investigate or defend" as sufficiently declaring it has no defense obligation.[12] Correspondingly, some courts have determined that "options to defend" clauses (right but not duty) are provisions designed to protect excess insurers, negating the insureds' attempts at creating an implied duty to defend.[13]
The key to understanding when an excess policy may be required to provide a defense is not only examining what the policy itself provides but, more important, what the underlying policies say if the excess policy follows form. Be mindful that there may be various follow form policies underlying the excess policy. Therefore, each and every underlying policy should be obtained and examined to discern whether it provides a duty to defend and whether any such provision reasonably conflicts with language of the excess policy. Only then can the excess policy's "silence" be attacked to show that no reasonable insured would expect an excess insurer to provide a duty to defend under any factual scenario. Finally, to the extent the excess policy contains a "consent to incur" provision, the insurer may be able to limit some of these defense costs if it can prove they were incurred without its consent.[14]
Excess Policy above a Self-Insured Retention
To most, self-insurance is the functional equivalent of a liability policy. Rather than paying premiums to an insurer to transfer risk, entities that self-insure voluntarily retain risk in exchange for lower or no premiums. In conjunction with a growing number of insureds using various methods of self-insurance to cover part of their initial risk, some courts have confronted the issue of whether these self-insurance mechanisms constitute "other valid and collectible insurance." This issue most often arises in the context of an insured seeking to avoid payment of its self-insured retention (SIR)—often a hefty one—by arguing it is "uninsured" and that the excess policy should therefore be considered next in line with a corresponding duty to defend. The issue of self-insurance can have a detrimental effect on an excess insurer that did not anticipate or properly defend its insured (especially if the dispute arises in a jurisdiction that imposes harsh penalties on insurers that outright refuse to defend).[15] Not all courts have followed what appears to be the majority of jurisdictions that have held that an insurer excess of an SIR has no duty to defend until the SIR is exhausted by the payment of judgments or settlements.[16]
In one such contrary case, Cooper Laboratories, Inc. v. International Surplus Line Insurance Co.,[17] an insured argued that the insurer was obligated to reimburse it for defense costs relating to the settlement and defense of a claim against a drug manufacturer. The products liability insurer, International Surplus Lines Insurance Company (ISLIC), had issued an excess policy to the insured in excess of a $1 million SIR. Upon settlement of the claim, the insured sought reimbursement related defense expenses, which ISLIC denied, claiming that because its policy was excess of the SIR, the insured had "the obligation to defend as do primary insurers as a matter of industry custom."[18] The Third Circuit disagreed:
This contention may be dismissed rather quickly. [The insured] is neither a primary insurer nor an insurer at all. A duty to defend is a matter of contract, and the reason why primary insurers provide a defense is that their policies require that they do so. An industry custom allocating responsibility when two carriers both may have a contractual duty is not applicable when one of the parties bears no obligation.[19]
The insured further contended that the insurer's obligation to defend arose when the personal injury plaintiff submitted its first demand of $3.5 million to the insured, an amount within the insurer's policy limits. The insured was not arguing that the "right and duty to defend" language of the excess policy imposed an unlimited obligation; instead, it was arguing that the language restricted its demand to claims "seeking damages in excess of the [SIR]."[20] The Third Circuit did, however, articulate when the insurer's duty arose:
It is clear enough that if the judgment sought against the insured is one that the carrier would be required to pay, then the duty to defend exists. . . . Application of that rationale leads to the conclusion that ISLIC's obligation arose when it was confronted with the demand which put its coverage at stake.[21]
On the other hand, given the realities of the relationship between an excess insurer and an insured with a "substantial retention," the court recognized there had to be some allocation of defense fees to reflect these competing interests.
A common theme among the courts that have found a defense obligation above an SIR is the fundamental belief that SIRs are truly incomparable to other types of insurance. For instance, the North Carolina Court of Appeals in Cone Mills Corp. v. Allstate Insurance Co. reasoned that "under a self-insurance scheme, no written insurance policy is issued by another individual or entity nor is a premium paid because obviously a business which is self-insured does not need to pay itself to protect against its own risk of loss."[22] The Louisiana Court of Appeals in Alwell v. Meadowcrest Hospital went so far as to find that an SIR "is in the nature of a deductible."[23] Although technically accurate, these comparisons neglect to account for the fact that an insured that makes use of SIRs is still making a conscious decision to absorb an initial assumption of risk for itself in exchange for not paying premiums to a third party—two necessary components of any insurance relationship. The insured should not receive a windfall for a gamble that ultimately does not pay off.
In any event, as a practical matter, these cases are often resolved on the basis of various factors including public policy implications and considerations (e.g., protection of the public versus allocation of loss among insurers); applicable state insurance statutes; whether the insured made a voluntarily decision to self-insure and took affirmative measures to set aside funds for this express purpose; and whether the SIR, when considered in the context of the excess policies above it, is in essence a deductible.[24] The best defense is first determining which factors the particular court typically finds most compelling in other insurance coverage cases and building from there.
Refusal to Defend by the Underlying Insurer
A final category of cases in which excess insurers have encountered—or have been pressured to accelerate—a defense obligation are cases in which a primary insurer has outright refused to defend. While most jurisdictions still adhere to the premise that a primary insurer's denial of coverage does not trigger an excess insurer's duty to defend, some courts have found that an excess insurer owes a duty to defend where the primary insurer refused to do so as long as the claim against the insured is potentially covered under the excess policy.
This was the holding by the Eighth Circuit in Hawkins Chemical, Inc. v. Westchester Fire Insurance Co.,[25] which involved a primary insurer, North River, and an excess insurer, Westchester, each of whom initially relied on pollution exclusions to deny a duty to defend a class action lawsuit filed against their insured, Hawkins, arising from a warehouse fire. The court in Hawkins was initially focused on North River's and Westchester's attempts to remove a hostile fire exception from their respective pollution exclusions, ultimately finding these attempts invalid under Minnesota law.[26] It then went on to address Westchester's contention that its defense obligation was not triggered due to the fact that North River, as the primary carrier, owed the primary duty to defend and had breached that duty. The court rejected this argument:
[T]he facts surrounding North River's refusal to defend [the insured] against the class action bring that lawsuit within the arguable scope of Westchester's umbrella policy. Although Westchester's policy unequivocally disclaims the duty to defend [the insured] when [its] underlying insurer breaches its own duty to defend, it was at least arguable that North River had breached no such duty to [the insured]. When North River refused to defend [the insured] against the class action, it relied upon the language of its pollution exclusion, which contained no hostile fire exception. The validity of that exclusion was not finally determined until we issued our opinion today. . . .North River's breach therefore does not excuse Westchester's refusal to defend [the insured] against the class action.[27]
The court ultimately held that because North River, the primary, had arguably abided by its contract with the insured and because Westchester did not validly remove the hostile fire exception from its own pollution exclusion, Westchester was obligated to defend Hawkins in the class action.
In a similar vein, the Wisconsin Supreme Court's somewhat recent holding in Johnson Controls v. London Market, discussed above, could have devastating effects for excess insurers if widely followed by other jurisdictions confronted with similar environmental coverage disputes. There, in addition to finding a second-level excess insurer had a duty to defend by virtue of an excess policy that contained no duty to defend provision (imported from an underlying follow form policy), the court held that such duty arose immediately upon the refusal of the underlying insurers to defend the pollution liability. The court pointed to nonstandard language in the underlying Travelers policy that provided if "the insurer affording other insurance to the named insured denies primary liability under its policy, [Travelers] will respond under this policy as though such other insurance were not available."[28]
While the majority in Johnson Controls refuted that their holding would encourage larger systemic issues such as encouraging primary insurers to try to avoid their defense obligations and more broadly obligating excess insurers to defend in many cases, the dissent predicted these exact results.[29] Pointing out that the majority's holding places the burden on the excess carrier to assume the defense, the dissent hits at the heart of the problem with the majority's reasoning for conditioning the defense on the underlying carrier's refusal because it now makes an excess carrier essentially a surety for the performance of the underlying insurer's policy or policies—even if a primary insurer has breached its duty to defend.[30] It remains to be seen whether other state appellate courts will follow this lead.
One of the reasons that courts may be more inclined to find such a defense obligation is the fact that such disputes are strictly between a primary and an excess insurer and should not result in an insured forfeiting its contractual rights to a defense. This was the impetus behind the Washington Supreme Court's decision in New Hampshire Indemnity Co. v. Budget Rent-A-Car Systems, which held that "if a primary insurer fails to assume the defense, for any reason, the excess insurer which has a duty to defend should provide the defense and, to do justice, should be entitled to recoup its costs from the primary insurer."[31] Allowing an excess carrier to seek recoupment of such defense costs at least, in theory, lessens the financial impact for an excess insurer saddled with this burden. The practical reality, however, may be to prolong the dispute between the primary and excess insurers through a secondary recoupment action.
Conclusion
While there are various circumstances under which an excess carrier can find itself encumbered with a duty to defend—even though its policy contains no explicit defense obligation—the circumstances discussed here can present obstacles for the unwary practitioner. Luckily, these cases generally do not serve as the majority rules among state and federal jurisdictions. Nonetheless, there is every reason to be aware of the unique circumstances under which these issues can crop up. A coverage practitioner representing an excess carrier at all levels of coverage must thoroughly locate and investigate all potentially applicable policies including those that offer primary coverage and to which the excess insurer follows form. Gone are the days when an excess carrier could comfortably monitor the underlying litigation from afar. In fact, passivity must give way to direct and proactive involvement to discern what the underlying insurers' coverage positions are and react accordingly. Otherwise, the duty to defend may be riding on such a gamble.
Keywords: insurance coverage, litigation, excess policy, duty to defend, defense costs, settlement
Pamela J. Tillman is a shareholder with Meissner Tierney Fisher & Nichols SC, in Milwaukee.
* Pamela J. Tillman is a shareholder with the law firm of Meissner Tierney Fisher & Nichols S.C. in Milwaukee, Wisconsin, where her main areas of practice are devoted to complex insurance coverage litigation and business litigation. She has lectured on various insurance coverage and litigation topics, including "Trying the Third-Party Litigation Case: A Coverage Lawyer's Perspective," "Bad Faith Insurance Claims in Wisconsin," "Understanding Liability and Casualty Insurance: A Primer for Wisconsin Closely-Held Businesses," and avoiding professional liability pitfalls for attorneys and health care professionals. She has previously authored and co-authored articles for the Wisconsin Defense Counsel and Civil Trial Counsel of Wisconsin on the effects of an insurer's failure to defend under Wisconsin law and other coverage topics. She was selected as a Wisconsin Super Lawyer for 2010 and 2011and was named a Wisconsin Rising Star in 2009.
[1] Ostrager & Newman, Handbook on Insurance Coverage Disputes § 6.03[b] (13th ed. 2011).
[2] See, e.g., Legacy Vulcan Corp. v. Superior Court, 185 Cal. App. 4th 677 (Cal. Ct. App. 2d Dist. 2010), review denied, (Sept. 1, 2010); Cadet Mfg. Co. v. Am. Ins. Co., 391 F. Supp. 2d 884 (W.D. Wash. 2005); Weyerhaeuser Co. v. Commercial Union Ins. Co., 15 P.3d 115 (Wash. 2000).
[3] "Following form" is a term used in the insurance industry to describe the type of policy form wherein an excess carrier insures the same risk covered by the underlying policy. In general, a "follow form" policy is "relatively brief," "incorporates by reference the terms of the underlying policy and is designed to match the coverage provided by the underlying policy." Johnson Controls, Inc. v. London Mkt., 2010 WI 52, ¶ 34, 325 Wis. 2d 176, 784 N.W.2d 579 (Wis. 2010).
[4] Johnson Controls, 2010 WI 52, ¶ 87.
[5] Johnson Controls, 2010 WI 52, ¶ 32 .
[6] Johnson Controls, 2010 WI 52, ¶ 35.
[7] Johnson Controls, 2010 WI 52, ¶ 42.
[8] 902 F.2d 1111 (2d Cir. 1990).
[9] Johnson Controls, 2010 WI 52, ¶¶ 44–45.
[10] Johnson Controls, 2010 WI 52, ¶ 45.
[11] See generally Matthew S. Foy, Excess Pressure! A Review of Issues Related to Whether Excess Insurers Have a Duty to Defend 205–206 (DRI Insurance Coverage and Claims Institute Apr. 2009).
[12] See, e.g., Cont'l Ins. Co. v. Synalloy, 667 F. Supp. 1563, 1570–71 (S.D. Ga. 1986); Stonewall Ins. Co. v. Nat'l Gypsum Co., 1992 U.S. Dist. LEXIS15234, at *4 (S.D.N.Y. 1992).
[13] See, e.g., Chubb/Pacific Indem. Grp. v. Ins. Co. of N. Am., 188 Cal. App. 3d 691 (Cal. Ct. App. 2d Dist. 1987); Inst. of London Underwriters v. First Horizon Ins. Co., 972 F.2d 125 (5th Cir. 1992); B&D Appraisals v. Gaudette Mach. Movers, Inc., 752 F. Supp. 554 (D.R.I. 1990).
[14] See, e.g., Great Lakes Chem. Corp. v. Int'l Surplus Lines Ins. Co., 638 N.E.2d 847 (Ind. Ct. App. 1994) (upholding consent-to-incur clause in excess policy); Asten Johnson, Inc. v. Columbia Cas. Co., 483 F. Supp. 2d 425 (E.D. Penn. 2007) (same), rev'd in part on other grounds, 562 F.3d 213 (3d Cir. 2009); Stonewall Ins. Co. v. Asbestos Claims Mgmt. Corp., 73 F.3d 1178 (2d Cir. 1995) (same).
[15] See, e.g., Emp'rs Ins. of Wausau v. Ehlco Liquidating Trust, 708 N.E.2d 1122 (Ill. 1999) ("If the insurer fails to take either of these steps [defend under a reservation of rights or seek a declaratory judgment] and is later found to have wrongfully denied coverage, the insurer is estopped from raising policy defenses to coverage."); Prof'l Office Bldgs., Inc. v. Royal Indem. Co., 145 Wis. 2d 573, 580, 427 N.W.2d 427 (Wis. Ct. App. 1988) (an insurer that breaches the duty to defend generally is held to have waived the right to raise coverage defenses).
[16] See Nabisco, Inc. v. Transp. Indem. Co., 143 Cal. App. 3d 831 (Cal. Ct. App. 4th Dist. 1983) (rejecting argument that insured was "uninsured" for the first $50,000 SIR and held that excess insurer had no duty to defend); Padilla Constr. Co. v. Transp. Ins. Co., 150 Cal. App. 4th 984 (Cal. Ct. App. 4th Dist. 2007) (excess insurer does not have duty to defend until primary insurance—even in the form of a self-insured retention—is exhausted); Mo. Pac. R.R. Co. v. Int'l Ins. Co., 679 N.E.2d 801 (Ill. Ct. App. 1997) (the insured's SIR constituted primary coverage that the insured was required to exhaust each policy year before looking to its insurers for coverage); Hormel Foods Corp. v. Northbrook Prop. & Cas. Ins. Co., 938 F. Supp. 555 (D. Minn. 1996), aff'd, 131 F.3d 143 (8th Cir. 1997) ("The difference between a self-insured retention and a deductible is usually that, under policies containing a self-insured retention, the insured assumes the obligation of providing itself a defense until the retention is exhausted."); USF&G v. Commercial Union Midwest Ins. Co., 430 F.3d 929 (8th Cir. 2005).
[17] 802 F.2d 667 (3d Cir. 1986).
[18] Cooper Laboratories, 802 F.2d at 675.
[19] Cooper Laboratories, 802 F.2d at 675.
[20] Cooper Laboratories, 802 F.2d at 675.
[21] Cooper Laboratories, 802 F.2d at at 676.
[22] 443 S.E.2d 357, 360 (N.C. Ct. App. 1994).
[23] 971 So. 2d 411, 415 (La. Ct. App. 2007).
[24] See generally 1 Couch on Insurance §10.1 (3d ed. 2000).
[25] 159 F.3d 348 (8th Cir. 1998).
[26] Hawkins Chemical, 159 F.3d at 351–52.
[27] Hawkins Chemical, 159 F.3d at 355.
[28] Johnson Controls, Inc. v. London Mkt., 2010 WI 52, ¶ 63, 325 Wis. 2d 176, 784 N.W.2d 579 (Wis. 2010).
[29] Johnson Controls, 2010 WI 52, ¶ 103.
[30] Johnson Controls, 2010 WI 52, ¶104.
64 P.3d 1239, 1243 (Wash. 2003).