By Douglas R. Richmond, Senior Vice President, Aon Risk Services
Businesses and individuals seeking liability protection have varying insurance coverage needs. One concern is the amount of coverage required to shield against potential losses. Some insureds may see the breadth of coverage as a concern. In other cases, the cost of insuring against potentially severe losses may be a factor. Insureds may address all of these concerns through tiered insurance programs that combine primary liability insurance policies with excess insurance or umbrella policies.
This chapter examines critical excess insurance and umbrella coverage issues. It begins in Section 24.02 by characterizing liability insurance in three essential ways: primary, excess and umbrella.
A primary policy provides the first layer of insurance coverage. Primary coverage attaches immediately upon the happening of an occurrence, or as soon as a claim is made. The primary insurer is first responsible for defending and indemnifying the insured in the event of a covered or potentially covered occurrence or claim.
An excess policy provides specific coverage above an underlying limit of primary insurance. A true excess policy does not broaden the underlying coverage. While an excess policy increases the amount of coverage available to compensate for a loss, it does not increase the scope of coverage. Excess coverage generally is not triggered until the underlying primary limits are exhausted by way of judgments or settlements. An excess policy may be written on either a “stand alone” or “following form” basis. A stand-alone policy relies exclusively on its own insuring agreement, conditions, definitions and exclusions to grant and limit coverage. A following form policy, on the other hand, incorporates by reference the terms, conditions and exclusions of the underlying policy.
An umbrella policy is like an excess policy in that it is written in addition to a primary policy to protect the insured against liability for catastrophic losses that would exceed the limits of affordable primary coverage. An umbrella policy differs from an excess policy in a critical aspect: an umbrella policy typically insures against certain risks that a concurrent primary policy does not cover. An umbrella policy is thus a gap filler; by design it provides first dollar coverage where a primary policy and an excess policy do not. For example, an umbrella policy may insure against “personal injury” when a primary policy only insures against “bodily injury” and “property damage.” By dropping down to provide primary coverage, or by filling a gap in primary coverage, an umbrella policy broadens the insured’s primary coverage where an excess policy does not. The terms “excess policy” and “umbrella policy” are not synonymous.
Section 24.03 addresses notice of loss as a condition precedent to coverage. Excess and umbrella policies, like primary policies, contain notice requirements. An insured’s obligation to give notice of a loss to an excess or umbrella insurer exists separate and apart from the insured’s duty to give notice of a loss to a primary insurer. Giving notice of a loss to either a primary or excess insurer does not relieve the insured of the obligation to give notice to the other.
The insured is normally obligated to notify its insurer notice of a loss. This is a simple proposition, since the insured is a party to the contract imposing the notice requirement, and a policy expressly assigns the obligation to the insured. Notice requirements in excess and umbrella policies are a valid condition precedent to coverage; they are not just fluff that an insured can ignore or act on at its convenience. An excess or umbrella insurer often has a huge financial stake in litigation. It may want to involve itself in the insured’s defense even if it is not obligated to do so. Timely notice allows an excess or umbrella insurer to inject itself into settlement negotiations at a point when its contributions, whether strategic or financial, can be most meaningful.
What of the mechanics of notice to an excess or umbrella insurer? Does a primary insurer have a role in notice to an excess or umbrella insurer? The majority position holds that the insured, not the primary insurer, is obligated to give an excess or umbrella insurer notice of a loss that implicates the excess or umbrella carrier’s policy. This is consistent with the language of the excess or umbrella policy, which imposes the notice obligation on the insured. The primary insurer and excess or umbrella insurer, on the other hand, have no contractual relationship on which a duty to notify might be premised. The same principle operates by extension in a multi-level insurance program in which there are several excess or umbrella insurers. There, notice remains the insured’s obligation and is not owed by a lower-level excess or umbrella insurer to a higher-level excess or umbrella insurer.
Occasionally a court will impose on a primary insurer a direct duty to notify an excess or umbrella insurer of a loss based on the dependent relationship between the excess and primary insurer. This is a minority position. A more sensible construction of the minority position, however, is that a primary insurer’s duty to notify an excess carrier of a loss potentially affecting the excess carrier’s limits supplements the insured’s duty to give notice to the excess carrier but does not supplant it. This approach gives meaning to the notice language in the excess policy—which clearly requires the insured to notify the excess insurer of a loss—while still recognizing the unique relationship between the primary and excess insurer that is at the heart of the minority rule.
Section 24.04 analyses excess and umbrella insurers’ defense obligations. As a rule, it is a primary insurer’s duty to defend an insured against a claim or suit. An excess insurer typically has no duty to defend its insured until the limits of the underlying coverage are exhausted. This is true even where the amount of third-party’s claim against the insured exceeds the primary policy limits, such that any judgment might implicate the excess or umbrella insurer’s duty to indemnify the insured. An excess insurer may, however, elect to participate in its insured’s defense where its policy limits are implicated.
Because an excess insurer has no duty to defend, it cannot later be estopped from raising coverage defenses, or be said to have waived those defenses, if it fails to reserve its rights when notified of a claim or suit potentially implicating its coverage. It is, after all, an insurer’s duty to defend which compels it to reserve its rights, and without a duty to defend an excess insurer has no obligation to issue a reservation of rights letter. These same principles apply where an umbrella policy affords excess coverage. An excess insurer may assume a duty to issue a reservation of rights letter if it is the insurer’s custom to do so. That custom, however, must relate to the particular insured arguing for coverage based on estoppel or waiver; what the excess insurer does or does not do vis-à-vis other insureds is irrelevant.
Some excess policies provide that in certain circumstances the insurer may be obligated to reimburse the insured for its defense costs. The duty to reimburse defense costs and the duty to defend are not equivalents. An excess insurer may incur a duty to reimburse defense costs without assuming a duty to defend. Indeed, a policy provision granting an excess insurer the option to participate in its insured’s defense contradicts any possible duty to do so. Similarly, excess policies often give the insurer the option to associate in the defense of covered suits. The mere fact that this option exists, however, does not mean that an excess insurer can be compelled to pay for some or all of the insured’s defense before any underlying primary coverage is exhausted. An excess insurer that chooses to associate in the insured’s defense to protect its interests while the primary insurer is still defending does not through that association terminate the primary insurer’s defense obligation. Rather, the excess insurer is responsible for paying the lawyers that it hires and it typically agrees to bear some portion of other defense expenses, such as court reporter fees, expert witness fees, and the like.
There are cases in which the insured’s potential exposure clearly exceeds the primary insurer’s policy limits, but the primary carrier cannot avoid what will surely be an expensive defense because the plaintiff will not settle and the excess carrier will not accept the primary carrier’s tender of the defense. In such cases the primary insurer is forced to defend for the excess insurer’s benefit. Should not the excess carrier be required to bear some portion of the defense costs on equitable grounds? The answer to this question may depend on the language of the excess policy. If the excess policy is a following form policy, or includes language that arguably suggests a duty to defend, the excess insurer may be required to share in the defense costs on some pro rata basis. The forced sharing of defense costs by an excess insurer absent exhaustion of the primary insurer’s policy limits is a minority position, however, as it should be.
Unlike true excess policies, umbrella policies typically provide that the umbrella policy will afford primary coverage for certain claims or occurrences that are not within the ambit of the insured’s primary policy. With primary coverage come a primary insurer’s duties. Thus, an umbrella insurer may have a duty to defend its insured where a true excess carrier would not. Of course, there must be a potential for coverage under the umbrella policy in order for the umbrella carrier to have a duty to defend.
Section 24.05 discusses insurers’ duty of good faith and fair dealing in the excess and umbrella context. Excess insurance policies, including those that provide only for indemnity, impose a duty of good faith on the insurer. An excess insurer’s duty of good faith exists throughout the term of the policy. If the carrier breaches this duty, of course, an insured may sue the carrier for bad faith.
While it generally makes sense to limit an insurer’s duty of good faith to its insured, excess insurance presents a special need. A primary insurer may decline to settle a claim within its policy limits secure in the knowledge that it cannot be held liable for bad faith to its insured because any judgment that exceeds its limits will be paid by the excess carrier. Here the primary insurer is gambling with the excess insurer’s money instead of the insured’s. A primary insurer’s failure to settle a case within its policy limits when the facts should require it to do so, thereby exposing its insured to personal liability, is the essence of third-party bad faith. A primary insurer’s wrongful failure to settle a case within it policy limits is no less offensive when an excess insurer must bear liability for the resulting judgment above the primary carrier’s limits. Allowing excess insurers to sue primary insurers for bad faith encourages reasonable settlements, prevents primary insurers from obstructing settlement, prevents unfair distribution of losses among primary and excess insurers, and reduces the cost of excess insurance.
The theory on which an excess or umbrella carrier pursues a primary insurer for bad faith may be pivotal. For example, courts typically reject equitable contribution in this context because excess and primary policies do not cover the same risk. A few courts hold that a primary insurer owes an excess insurer a direct duty of good faith and fair dealing. These courts reason that when a primary insurer refuses to settle in bad faith, the excess insurer is in the same position as an insured. Fairness dictates the imposition of a direct duty of good faith on the primary insurer, inasmuch as the excess carrier relies on the primary carrier to discharge claims handling and defense obligations.
Most courts reject the direct duty theory. Under the majority rule, the duty to settle that a primary insurer owes an excess insurer derives from the primary insurer’s duty to the insured, such that an aggrieved excess insurer may sue on an equitable subrogation theory. Generally, the measure of damages in an equitable subrogation action is the difference between the amount the excess insurer would have contributed to the settlement that the primary insurer unreasonably refused, if anything, and the amount the excess insurer ultimately paid to satisfy the judgment. As between direct duty theory and the equitable subrogation approach, the latter represents better contract law and insurance law.
Some courts decline to recognize a cause of action for excess insurers against primary insurers, whether by way of equitable subrogation or pursuant to a direct duty theory, even where the primary insurer’s conduct clearly is blameworthy. These courts reason that excess insurers that are forced to indemnify their insureds for judgments greater than their primary policy limits have suffered no injury. Rather, the excess judgments about which they complain are exactly the risk for which they bargained and collected premiums. This approach is misguided. Certainly, excess insurers bargain for the risk they accept above the limits of underlying primary insurance and they collect premiums for the risk they assume. But their willingness to assume risk and to price it reasonably is at least to some extent predicated on rational behavior by their underlying primary insurers.
Section 24.06 analyses the key excess insurance concept of exhaustion. Generally, for an excess insurer to have any obligation to its insured, the primary insurer must pay its policy limits toward the satisfaction or settlement of the claim or judgment against the insured. A primary insurer that properly pays its policy limits is said to have “exhausted” its limits.
Most problems arise in cases involving continuous or progressive injuries or losses spanning several policy periods. A loss that spans years may “trigger” multiple insurance policies. “Triggering” occurs when a loss implicates a policy’s coverage, subject to the policy’s terms and exclusions, and any other coverage defenses the insurer may raise. Courts can pick from several coverage triggers. Most courts now employ the “continuous trigger” or “triple trigger.” Under this approach, any policy on the risk at any time during the continuing loss is triggered, meaning that the issuing insurer must be prepared to defend or pay up to its policy limits as the case may be.
One of the most hotly contested issues in continuous loss cases is whether an insured is obligated to exhaust its liability coverage “vertically” or “horizontally.” This issue arises when several primary policies or lower level excess policies are triggered, and a court must determine whether the limits of the underlying policies for one year (“vertical”) or all years (“horizontal”) must be exhausted before a particular excess policy must pay. Special problems may arise when an underlying insurer becomes insolvent, or an excess insurer is otherwise required to “drop down” to provide a level of coverage lower than that for which it bargained.
“Vertical exhaustion” allows an insured to pick and choose policy periods triggered by a continuous loss. Under vertical exhaustion theory, first-in-time primary and excess policies are exhausted before the next-in-time primary and excess policies are tapped. “Horizontal exhaustion” means that the primary insurance must be exhausted across all of the triggered policy periods before the next layer of coverage, whether excess or umbrella, must respond to a continuous loss. Horizontal exhaustion best comports with the continuous trigger theories favored in many jurisdictions.
Whether a court will apply vertical or horizontal exhaustion principles in a continuing loss case is a question that is sometimes answered by looking at the language of the excess policy (or policies) at issue. A court will typically require vertical exhaustion when the limits of a specifically scheduled primary policy are exhausted and the excess policy provides that it shall be excess only to that specific underlying policy. Where excess policies are not so specific, horizontal exhaustion is preferred.
Unfortunately, primary insurers sometimes become insolvent. In such a case, may an excess insurer be forced to “drop down” and fill the coverage gap created by the underlying insurer’s insolvency? The answers to drop down questions typically are answered by the terms of the subject excess policy. The majority rule, however, is that absent obligatory policy language, an excess insurer is not required to drop down and cover that portion of a loss once within an insolvent primary insurer’s coverage, nor must it drop down to provide the defense that an insolvent primary insurer was to fund. Excess insurers simply are not guarantors of the solvency of underlying insurers.
Section 24.07 examines the allocation of losses among multiple excess or umbrella insurance policies. Insurers contend that allocation is mandated by the terms of their policies, which specify coverage periods. Thus, in the case of a continuing loss, an insurer should be allowed to limit its indemnity obligation to damage occurring during its policy period. Insureds argue strenuously against allocation, fearing that their SIR obligations and other gaps in coverage will leave them responsible for portions of a continuing loss (so-called “orphan shares”).
Insureds generally make two arguments against allocation. The first is tied to standard language in most primary policies by which the insurer promises to pay “all sums” the insured becomes obligated to pay as damages by reason of specified liabilities, or “those sums that the insured becomes legally obligated to pay as damages.” Insureds argue that because standard policies do not specify that they will pay “all sums” or “those sums” attributable to damage caused during the policy period, if any portion of a loss is covered the insurer must pay the entire loss up to the limits of its coverage.
Policyholders’ second argument against allocation is cloaked in terms of joint and several liability. This argument has two variations. First, because each of several consecutive insurers provides coverage at relevant times, each has an independent obligation to insure the entire loss. Second, an insured may argue that because it faces joint and several tort liability for the loss for which coverage is sought (as in environmental cases), its insurer’s liability is also joint and several.
The “all sums” and “joint and several” approaches make little sense. Among other things, they require an incorrect presumption that all damage occurred in one policy period. Insurers are wrongly held liable for damages occurring outside their policy periods, while insureds, who purposely reduce their insurance costs at different times by way of SIRs and varying limits, receive coverage for which they did not bargain. Pro rata allocation makes far more sense because it confines insurers’ obligations to losses occurring during their policy periods.
Because of the scientific complexities that characterize many continuing losses, as well as the extended period of time that damages may go undiscovered and the many parties potentially involved, it often is impractical to hold each insurer responsible only for those damages occurring during its policy period. Some courts therefore allocate losses based on insurers’ “time on the risk.” Under the time on the risk method, a loss is allocated in proportion to the amount of time that an insurer’s policies were in effect (the numerator) as a percentage of the total months or years during which the loss occurred (the denominator).
“Other insurance” clauses in competing insurance policies sometimes factor into allocation controversies, although they rarely are determinative. “Other insurance” refers only to two or more policies insuring the same risk and the same interest, for the benefit of the same person, during the same period. “Other insurance” clauses in policies only operate when there is concurrent coverage. Consecutive policies cannot constitute “other insurance” because while they many insure the same type of risk, they do not insure the same risk.
Liability insurance policies may contain any one of several “other insurance” clauses, one of which is an “excess clause.” An excess “other insurance” clause provides that the insurer’s liability is limited to the amount of the loss exceeding all other valid and collectible insurance, up to the insurer’s policy limits. When two policies both contain an excess “other insurance” clause, most courts treat the excess clauses as mutually repugnant and prorate the loss between the competing insurers. But excess and umbrella policies clearly differ in purpose from primary policies containing excess “other insurance” clauses. Excess and umbrella policies are therefore regarded as true excess coverage over and above all primary policies, including those with excess “other insurance” clauses. The presence of an excess “other insurance” clause in a primary policy does not transform that policy into an excess policy vis-a-vis a second carrier providing true excess or umbrella coverage.
Finally, Section 24.08 discusses malpractice claims by excess and umbrella insurers against the defense lawyers engaged by primary insurers. In some ways malpractice claims by excess insurers against defense counsel make little sense. An excess insurer typically does not share an attorney-client relationship with the defense attorneys that a primary carrier hires. To avoid the strict privity rule common the legal malpractice doctrine, courts that allow an excess insurer to sue defense counsel hired by a primary insurer for malpractice typically hold that the excess insurer is equitably subrogated to the insured’s rights against the attorneys. Other courts have declined to allow excess insurers to sue defense counsel for malpractice even on an equitable subrogation theory. This is not surprising, for a number of courts have generally rejected equitable subrogation in the legal malpractice context. These courts tend to view equitable subrogation as the assignment of a legal malpractice claim and such assignments are generally impermissible.
The development of excess insurers’ rights against defense attorneys hired by primary carriers is far from complete. The law in many states is uncertain, and there are good arguments both for and against recognizing excess insurers’ right to sue defense attorneys they did not hire for malpractice.
In conclusion, there is no questioning the importance of excess insurance and umbrella coverage. Such policies protect insureds against catastrophic loss at prices that most businesses and individuals can comfortably afford. Excess and umbrella coverage is in fact quite common, and these policies spawn numerous and varied controversies and questions. Unfortunately, many lawyers and courts do not fully appreciate or understand excess and umbrella insurers’ differing obligations. But that understanding must come because litigation involving excess and umbrella insurers is now common.
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Douglas R. Richmond is Senior Vice President in the Global Professions Practice of Aon Risk Services, the world’s largest broker of insurance for professional services firms. Before joining Aon in Chicago, Mr. Richmond was a partner with Armstrong Teasdale LLP in Kansas City, Missouri (1989-2004), where he had a national trial and appellate practice. In 1998, he was named the nation’s top defense lawyer in an insurance industry poll as reported in the publications Inside Litigation and Of Counsel. He is a member of the American Law Institute (ALI), the American Board of Trial Advocates (ABOTA), the International Association of Defense Counsel (IADC), and the Federation of Defense and Corporate Counsel (FDCC). Mr. Richmond has also been selected to The Best Lawyers in America in the areas of legal malpractice, personal injury litigation, and railroad law. In 2003, the Euromoney Legal Media Group named him one of the nation’s top insurance and reinsurance lawyers. He is the co-author of a leading treatise, Understanding Insurance Law (4th ed. 2007), published by LexisNexis. Additionally, Mr. Richmond has published roughly 50 articles in university law reviews, and many more articles in other scholarly and professional journals. He teaches Legal Ethics at the Northwestern University School of Law and he is a regular National Institute of Trial Advocacy (NITA) faculty member. He previously taught Trial Advocacy and Insurance Law at the University of Kansas School of Law, and Insurance Law and a seminar on Damages at the University of Missouri School of Law. Mr. Richmond earned his J.D. at the University of Kansas.