Transition from Primary to Excess Coverage: Effortless Step or Grand Canyon Leap?

Each of these possible methodologies is explored in more detail below.

Exhaustion through payment. The most basic method for proving an underlying policy’s exhaustion is to show that the underlying policy’s applicable limit has been paid out on covered claims—whether through direct claim payments, a final settlement between the insured and the underlying insurer, or a combination thereof. Typically, courts permit this method of proof.[4] Giving effect to good-faith payments and allocations, these courts reason, encourages timely payment of claims and “furthers the strong public interest in promoting settlement.”[5] One federal decision, however, has interpreted New York law to prohibit an insured from using this method of proof.[6] The court quoted Treadwell but distinguished it on the basis that, in the Treadwell matter, “[t]he district court specifically noted . . . that the non-settling excess insurer had declined an invitation to participate in the settlement negotiations.”[7] Finding such circumstances absent, the court held that a non-contribution clause in the excess policy[8] required that, “[t]o the extent that the [underlying settlement] agreement allocated more money to the relevant policy years than New York law would otherwise dictate, that money did not exhaust the underlying policies for purposes of the New Hampshire [excess] policies.”[9]

The Air & Liquid Systems decision appears inconsistent with East 51st Street Crane Collapse, which permitted proof of exhaustion based on an underlying insurer’s good-faith settlement payment without considering whether the excess insurers had an opportunity to assert their interests in the settlement.[10] Setting aside the Air & Liquid Systems decision, the remaining analysis of this methodology assumes that a court would permit underlying exhaustion to be demonstrated by establishing that the underlying policy’s applicable limit has been paid out (in bankruptcy or as deemed by applicable settlement terms).

This “exhaustion-through-payment” method contains up to three elements. First, the insured should establish the fact of payments or other considerations under the policy up to its applicable limit. Second, courts do not deem payments under an underlying policy to impair excess coverage when the underlying insurer “simply ‘open[s] the faucet,’” attempting to minimize its defense obligations by burning quickly through its limit applicable to indemnity.[11] Excess insurers frequently litigate this issue. As a practical matter, an insured may be compelled to develop evidence that the payments and allocations to the underlying policy were made in good faith. Third, excess insurers also have contended that, even if made in good faith, payments under the policy do not impair their applicable limits to the extent that they exceed the policy’s allocation under currently governing law. Issues typical in this type of litigation are addressed below.

Exhaustion through allocation of covered loss (including accounting for unreimbursed amounts). Another method for demonstrating an underlying policy’s exhaustion is to show that, irrespective of the underlying insurer’s payments, the covered losses allocable to the primary policy reach or exceed its applicable limit of liability. Among other considerations, this method requires examining whether the claims underlying the contention of exhaustion (A) trigger the policy and (B) properly are allocable to its applicable limit under governing law. A policyholder, for example, might demonstrate exhaustion through summary or statistical evidence but must be prepared to rebut excess insurers’ counter-evidence where submitted. This methodology typically accounts for unreimbursed recovery with an overarching restriction to prevent double recovery. Certain challenges related to the evidence necessary for these purposes are discussed below.

Proving Exhaustion Through Payment of the Underlying Policy’s Limit

Establishing exhaustion through payment of the underlying policy’s applicable limit on past claims involves addressing up to three elements: (1) the fact and amount of payments; (2) that the payments were made and allocated in good faith; and (3) if the primary insurer’s allocation was in good faith but differs from the court’s, that the insurer’s allocation should remain undisturbed.

The fact and amount of payments. In litigation between an insured and its excess insurer, the insured advances evidence to demonstrate that an underlying policy’s applicable limit has been paid.[12]

Some courts have held that an insured need not, however, introduce each check, wire transfer confirmation, or other direct evidence of each underlying insurance payment. Indeed, several decisions use alternative evidence, including (1) payment logs showing the payment date and amount and (2) the insurer’s fact testimony confirming at a general level the fact and amount o f payments.[13] However, other courts have required more detailed evidence.[14]

Primary insurer’s unreasonableness in making payment. In some instances, excess insurers will challenge whether payments made by a primary insurer were reasonable and properly exhausted the underlying coverage. For example, in Viking Pump, the insureds settled with their primary insurer, Liberty Mutual, and the excess insurers challenged the primary policies’ exhaustion. The insureds presented the following evidence regarding the payments’ reasonableness, and the jury found in favor of exhaustion:

Good-faith allocations under a methodology consistent with governing law. A court might adopt a different allocation methodology than what one or more underlying insurers used when allocating claim payments across their policies. In RTV Phase II, for example, CNA and Hartford long acknowledged that they issued primary policies for successive years from 1962 through 1986.[17] They entered a claims-handling agreement under which they allocated asbestos bodily injury claims against the insured to their 1962–1986 policies.[18] Their payments under the agreement eventually exceeded their 1962–1986 policies’ collective limits.[19] The insured, however, contended that CNA or Hartford, or both, also issued primary policies for the periods 1956 to 1962. CNA eventually stipulated to much of that coverage.[20] An excess insurer then challenged the Hartford primary policies’ exhaustion, contending that the claims-handling agreement improperly compressed the allocation period from a start date as early as 1956 to a start date as early as only 1962, thereby accelerating the policies’ exhaustion.[21]

CNA and Hartford defended their allocation methodology by producing (1) Hartford and Resolute claims-handlers to testify as fact witnesses that CNA’s allocation start date had been 1962 “because that was the first policy that CNA had a complete copy of to confirm and verify coverage”; (2) expert witnesses to testify that the parties’ allocation method was reasonable and consistent with industry standards; (3) an excess insurer’s claims handler to testify as a fact witness that “in evaluating the claims her company used the same allocation block as employed by Hartford and CNA, though subject to a reservation of rights”; and (4) evidence that CNA did not conceal the 1956–1962 policies.[22] The court noted that the claims-handling agreement preceded Connecticut appellate authority clarifying the state’s allocation law.[23] In addition, “thousands of underlying actions ha[d] been filed against the plaintiff over the course of several decades.”[24] “It [wa]s not disputed that the primary insurers have expended millions of dollars of defense and indemnity payments relative to the claims brought against the plaintiff.”[25]

The court noted that, as a general principle, “[t]here is no logic that compels a conclusion that an umbrella/excess carrier whose contractual relationship is with its insured, can, in retrospect, dictate to a primary carrier what allocation method the primary carrier should have followed.”[26] Finding the primary insurers’ allocation agreement objectively reasonable and in good faith, the court held that it “will not compel Hartford and CNA to retroactively re-allocate their indemnity payments at this point.”[27]

Similarly, in Maryland Casualty Co. v. W.R. Grace & Co.,[28] an excess insurer contended that its insured was entitled “to no further insurance coverage with respect to pre-June 1973 asbestos-related property damage claims because it has already received payments from other carriers that exceed its pre-June 1973 insurance coverage.”[29] The insured had settled with numerous other insurers for, collectively, approximately $738 million.[30] The total amount of its pre-June 1973 coverage was $447 million.[31] The excess insurer contended that an “installation” trigger must apply and would require allocating all loss to the pre-June 1973 period.[32] Under this theory, the excess insurer concluded, additional proceeds from pre-June 1973 coverage would result in a double recovery.[33] The court rejected this argument, reasoning that the settlements predated the adoption of an “installation” trigger rule and that

Exhaustion by Allocation of Covered Loss to the Underlying Policy

To establish an underlying policy’s exhaustion through the allocation of covered loss, the insured typically demonstrates that its exhaustion calculations properly apply governing law regarding trigger and allocation. Excess insurers have disagreed with insureds employing this method with challenges to claims’ trigger and allocation periods, among other issues. For example, the Illinois Supreme Court has ruled that in the context of asbestos bodily injury claims, insurance coverage is triggered at three points in time: (1) exposure; (2) sickness (e.g., impairment); and (3) disease (e.g., manifestation or diagnosis of an asbestos-related disease).[35] Excess insurers typically argue that to demonstrate exhaustion under the “triple trigger” rule, a policyholder must show evidence of (1) the particular claims paid, (2) the trigger dates for each paid claim, and (3) an allocation of each indemnity payment received from underlying insurers to the policies triggered by each claim. Other challenges advanced by excess insurers may include the following:

This article cannot, and does not attempt to, summarize all of the challenges that an excess insurer might bring under this method.

Conclusion

Excess insurance applies when primary insurance has been exhausted by payments or other measurable value considerations by either the policyholder or primary insurer. Courts continue to evaluate and resolve a myriad of issues regarding how the parties demonstrate or rebut the exhaustion of underlying policy limits. As courts continue to encounter cases involving potential attachment of excess policies, they will likely further clarify what is necessary to demonstrate exhaustion of underlying policies and the corresponding obligations of the excess insurers in responding to claims.

Keywords: litigation, insurance coverage, excess insurance, primary policy, exhaustion

Patrick J. McGrath is with Navigant Consulting, Inc., in Chicago, Illinois.

[1] This white paper was created with the assistance of policyholder and insurer counsel to present various issues from both perspectives. Navigant Consulting, Inc., makes no representations or warranties, expressed or implied, and is not responsible for the reader’s use of, or reliance upon, this paper, nor any decisions made based on this paper. This paper does not represent any opinions, expressed or implied, of Patrick McGrath, Navigant Consulting, Inc., or any of its clients. The content herein is provided with the understanding that this presentation is general in nature and does not relate to any specific project or matter.
[2] See Iolab Corp. v. Seaboard Sur. Co., 15 F.3d 1500  (9th Cir. 1994) (finding that all primary insurance triggered by a multi-year loss must be exhausted before liability attaches under any secondary policy); Cont’l Cas. Co. v. U.S. Fidel. & Guar. Co., 516 F. Supp. 384  (N.D. Cal. 1981) (holding that the primary insurer is not allowed to force the excess insurer to cover part of the primary insurer’s obligations; if the primary were allowed to do that, pricing of primary and excess insurance would have to undergo a fundamental change); Samuels v. State Farm, 939 So. 2d 1235  (La. 2006) (finding that the very nature of excess insurance is that a predetermined amount of underlying coverage must be exhausted before excess insurance applies); Crossman Communities of N.C., Inc. v. Harleysville Mut. Ins. Co., 2015 WL 340772 (S.C. Ct. App. Jan. 28, 2015) (policyholder failed to meet burden of demonstrating underlying exhaustion when it “submitted no information specifying the portions of . . . payments that related to covered property damage as defined under the policies compared to the costs related to defective construction, which were not covered under the policies”); see also Michael A. Knoerzer, Introduction to Excess Insurance and Reinsurance, 652 PLI/Lit 115, 136 (2001).
[3] In the seminal case Zeig v. Massachusetts Bonding & Insurance Co., an excess policy provided that underlying insurance must be “exhausted in the payment of claims to the full amount of the expressed limits.” 23 F.2d 665, 666  (2d Cir. 1928). The insured settled with its underlying insurer for below policy limits but sought coverage from the excess carrier only for an amount in excess of the full underlying limits. See 23 F.2d at 666. The excess insurer contended that the below-limits settlement prevented the underlying policy from exhausting as defined in the excess policy, barring the insured from the excess coverage. The court rejected this argument, holding that the excess insurer “had no rational interest in whether the insured collected the full amount of the primary policies, so long as it was only called upon to pay such portion of the loss as was in excess of the limits of those policies.” 23 F.2d at 666. “To require an absolute collection of the primary insurance to its full limit,” the court continued, would “involve delay, promote litigation, and prevent an adjustment of disputes which is both convenient and commendable.” 23 F.2d at 666. In addition, “[t]here is no need of interpreting the word ‘payment’ as only relating to payment in cash.” 23 F.2d at 666. Subsequent decisions have held that stricter language in an excess policy may prevent an insured from accessing the excess coverage after settling with an underlying insurer for below limits. See, e.g., Forest Labs., Inc. v. Arch Ins. Co., 953 N.Y.S.2d 460, 465–66 (Sup. Ct. 2012) (accepting excess insurer’s defense under provisions requiring “actual payment . . . pursuant to the terms and conditions of the Underlying Insurance”). The following analysis assumes that settling with an underlying insurer for below its policy’s applicable limit will not affect whether the allocation of the policyholder’s covered loss triggers its excess coverage.
[4] See In re E. 51st St. Crane Collapse Litig., 103 A.D.3d 401, 403–4, 960 N.Y.S.2d 364 (2013) (determining that an underlying insurer’s payment of a good-faith settlement with the insured for the underlying policy’s applicable limit exhausted the policy); RTV Phase II, 2014 WL 1647135, at *21 (Conn. Super. Ct. Mar. 28, 2014) (“[T]he court finds . . . the Hartford . . . and the CNA primary policies . . . to be exhausted [because] both Hartford and CNA have paid the limits of their primary policies. . . .”); see also, e.g., U.S. Fid. & Guar. Co. v. Treadwell Corp., 58 F. Supp. 2d 77, 107  (S.D.N.Y. 1999) (“treating a primary insurer’s settlement with an insured as binding for allocation purposes, at least in the absence of evidence of collusion to defraud an excess insurer”).
[5] Treadwell, 58 F. Supp. 2d at 107; accord, e.g., RTV Phase II, 2014 WL 1647135, at *17.
[6] See Air & Liquid Sys. Corp. v. Allianz Underwriters Ins. Co., Civ. A. No. 11-247, 2013 WL 5436934, at *52 (W.D. Pa. Sept. 27, 2013).
[7] Air & Liquid Sys. Corp., 2013 WL 5436934, at *52 (quoting Treadwell, 58 F. Supp. 2d at 110).
[8] In Air & Liquid Systems, the non-contribution clause at issue provided:

This insurance does not cover any loss or damage which at the time of the happening of such loss or damage is insured by or would, but for the existence of this Policy, be insured by any other existing Policy or Policies except in respect of any excess beyond the amount which would have been payable under such other Policy or Policies had this insurance not been effected.

2013 WL 5436934, at *51.
[9] Air & Liquid Sys. Corp., 2013 WL 5436934, at *51.
[10] See In re E. 51st St. Crane Collapse, 103 A.D.3d at 403–4.
[11] An insured that has settled with an underlying insurer may elect to demonstrate the policy’s exhaustion on this basis notwithstanding their settlement agreement. If it does so, federal courts in the Second Circuit have held, the settlement amount and any good-faith allocation of it to particular claims will not reduce excess insurers’ liability. That is, so long as an insured’s prior recoveries have not made it whole, an excess insurer will not receive a setoff from its liability under a ground-up allocation if the settling underlying insurer’s good-faith payment exceeds what it would owe under the ground-up allocation. See E.R. Squibb & Sons, Inc. v. Lloyd’s & Cos., 241 F.3d 154, 173  (2d Cir. 2001) (applying New York law); United Techs. Corp. v. Am. Home Assurance Co., 237 F. Supp. 2d 168, 172  (D. Conn. 2001) (applying Connecticut law).
[12] See, e.g., Chrysler First Fin. Servs. Corp. of Am. v. Chi. Title Ins. Co., 595 N.Y.S. 2d 302, 306  (N.Y. Sup. Ct. 1993) (“insured has the burden of establishing the extent of the loss”); RTV Phase II, 2014 WL 1647135, at *19 (noting this general principle but that the underlying insurer voluntarily assumed the burden).
[13] See Viking Pump, Inc. v. Century Indem. Co., 2013 Del. Super. LEXIS 615, at *93 (Del. Super. Ct. Oct. 31, 2013) (upholding, under New York law, a jury’s finding that policies were exhausted based on detailed loss runs showing claims’ “payments, reimbursements, etc.” and insurer witnesses’ testimony regarding the company’s claim evaluation process, payment guidelines, and loss runs); RTV Phase II, 2014 WL 1647135, at *21–22 (upholding exhaustion on similar proof; refusing to “go back and recalculate precisely what amounts were paid on which claims, during which periods of time, whether allocation to that time frame was appropriate, and whether the payments [on particular claims] were made reasonably and in good faith. Such an undertaking would lie between arduous and Sisyphean.”).

Although more readily distinguishable, no-fault coverage cases also have looked to detailed summary payment records to support an insurer’s assertion of exhaustion. See, e.g., N.Y. & Presbyterian Hosp. v. Allstate Ins. Co., 814 N.Y.S.2d 654, 654 (App. Div. 2006) (“The insurer made a prima facie showing, through the affidavits of its claims representatives, the ‘denial of claim’ forms . . . , and its payment log listing all payments made . . . under the subject policy, that it had exhausted the policy’s coverage. . . .”); Westchester Med. Ctr. v. Allstate Ins. Co., 17 Misc. 3d 1134(A), 851 N.Y.S.2d 75, at *2 (Sup. Ct. 2007) (table) (“Allstate has presented prima facie proof that its coverage limits have been exhausted. This is supported by the statement of its claims representative [and] a payment log. . . .”).
[14] See Sid Harvey Indus., Inc. v. Commerce & Indus. Ins. Co., 836 N.Y.S.2d 503 (Sup. Ct. 2006) (“Because C & I has not provided this Court or the parties with evidence to support its claim that [its] policies are exhausted, other than summary tables [the court does not describe what information the summary tables contained], it has rendered it impossible to determine whether Sid Harvey will ultimately succeed on the merits of this case.”); Westchester v. Liberty Mut. Ins. Co., 2010 N.Y. Misc. LEXIS 2712, at *5–6 (“Liberty has not presented prima facie proof that its coverage limits have been exhausted [prior to the underlying claim at issue]. . . . Neither the payment history . . . nor the affidavit of its representative state the dates the claims [on which Liberty purportedly made payments] were received, the dates services were rendered nor, importantly, does Liberty explain why they were all paid after the claim of NYHMC had been submitted to and received by Liberty if the policy limits were reached by that time.”).
[15] See Viking Pump, 2013 Del. Super. LEXIS 615, at *31.
[16] See Viking Pump, 2013 Del. Super. LEXIS 615, at *25.
[17] See RTV Phase II, 2014 WL 1647135, at *2, 16.
[18] See RTV Phase II, 2014 WL 1647135, at *18. The claims-handling agreement was between CNA and Hartford, the primary insurer for the nine-year period beginning March 3, 1977. See 2014 WL 1647135, at *18. The court noted that the insurer-insurer claims-handling agreement was “for the benefit of the insured,” suggesting that it would have treated no differently a good-faith claims-handling agreement between a primary insurer and its insured.
[19] See RTV Phase II, 2014 WL 1647135.
[20] See RTV Phase II, 2014 WL 1647135, at *11.
[21] See RTV Phase II, 2014 WL 1647135, at *18.
[22] See RTV Phase II, 2014 WL 1647135, at *17–18.
[23] See RTV Phase II, 2014 WL 1647135, at *18.
[24] RTV Phase II, 2014 WL 1647135, at *18.
[25] RTV Phase II, 2014 WL 1647135, at *18.
[26] RTV Phase II, 2014 WL 1647135, at *18.
[27] RTV Phase II, 2014 WL 1647135, at *18. Accord Owens-Ill., Inc. v. United Ins. Co., 650 A.2d 974, 994 (N.J. 1994), superseded by statute on other grounds; IMO Indus. Inc. v. Transamerica Corp., 101 A.3d 1085, 1112 (N.J. Super. Ct. App. Div. 2014) (“Allowing excess insurers to contest coverage [after refusing to associate in the insured’s defense] is not feasible for long-tail, multi-claim coverage cases. . . .”).
[28] No. 88 Civ. 2613, 1996 U.S. Dist. LEXIS 2963 (S.D.N.Y. Mar. 12, 1996).
[29] W.R. Grace & Co., 1996 U.S. Dist. LEXIS 2963, at *40.
[30] W.R. Grace & Co., 1996 U.S. Dist. LEXIS 2963, at *40.
[31] W.R. Grace & Co., 1996 U.S. Dist. LEXIS 2963, at *40.
[32] W.R. Grace & Co., 1996 U.S. Dist. LEXIS 2963, at *40.
[33] See W.R. Grace & Co., 1996 U.S. Dist. LEXIS 2963, at *40.
[34] W.R. Grace & Co., 1996 U.S. Dist. LEXIS 2963, at *42.
[35] See Zurich Ins. Co. v. Raymark Indus., Inc., 118 Ill.2d 23, 44–46 (Ill. 1987).

_{Copyright © 2015, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).}