Triggering Excess Insurer Duties Without Full Payments by Primary Insurers

During recent years, insureds have faced a wide range of claims with potential liability exceeding the limits of their primary insurance policies. In such a setting, excess insurers typically argue that their duties are not triggered unless and until the primary policy has paid its limits. Such arguments should not be readily accepted. Excess insurers owe duties even before primary policies have exhausted. And, when a primary insurer settles with its insured, excess insurers may be obligated to pay under their policies even if the settlement was for less than the primary policy's limits.

Courts have repeatedly rejected any notion that an excess insurer owes no duties to its insured until a primary policy is exhausted. For example, California courts have recognized the wide range of duties that an excess insurer owes its insured before a primary policy exhausts. See, e.g., Kelley v. British Commercial Ins. Co., Ltd., 221 Cal. App. 2d 554, 562, 34 Cal. Rptr. 564 (1963) (duty to participate in settlement discussions when potential settlement may invade limits of liability); Armstrong World Indus., Inc. v. Aetna Cas. & Sur. Co., 45 Cal. App. 4th 1, 85, 52 Cal. Rptr. 2d 690 (1996) (duty to accept reasonable settlement); Schwartz v. State Farm Fire & Cas. Co., 88 Cal. App. 4th 1329, 1338, 108 Cal. Rptr. 2d 523 (2001).

Likewise, it is clear in most jurisdictions that an excess insurer must contribute to a settlement that reaches its limits even if the primary policy has not paid its full limits. In fact, this principle was established more than 75 years ago. In Zeig v. Massachusetts Bonding & Insurance Co., 23 F.2d 665 (2d Cir. 1928), an excess insurer argued that an insured could not collect from it unless it first actually collected the full amount of the primary policy limits. The Second Circuit disagreed, stating:

[T]he [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. To require an absolute collection of the primary insurance to its full limit would in many, if not most, cases involve delay, promote litigation, and prevent an adjustment of disputes which is both convenient and commendable. Id. at 666.

The court also observed that a clause requiring a policy to be “exhausted in the payment of claims” does not require “interpreting the word 'payment' as only relating to payment in cash.” Id. As the court explained, “It often is used as meaning the satisfaction of a claim by compromise, or in other ways.” Id.

Many other courts have reached similar conclusions. See, e.g., Koppers Co. v. Aetna Cas. & Sur. Co., 98 F.3d 1440, 1454 (3d Cir. 1996) (“[T]he widely-followed rule [is] that the policyholder may recover on the excess policy for a proven loss to the extent it exceeds the primary policy's limits.”); Denny's, Inc. v. Chicago Ins. Co., 234 Cal. App. 3d 1786, 1794, 286 Cal. Rptr. 507 (1991) (when “the insured's liability exceed[s] the underlying insurance limits … liability attaches to the excess insurer, whether or not the underlying insurer has actually paid out the policy limit); Pacific Employers Ins. Co. v. Servco Pacific Inc., 273 F. Supp. 2d 1149, 1154, 2003 U.S. Dist. LEXIS 20997 (D. Haw. June 19, 2003) (“The Court is unconvinced by PEIC's argument that its duty to defend, as an excess carrier, is not triggered unless and until the primary carrier pays its limits by either a judgment or settlement of the underlying claim. … The plain terms of PEIC's policy provide that its duty to defend arises when 'the limits of liability of the underlying insurance are exhausted because of … property damage' ' not when the limits are exhausted by payments of judgments or settlements of the underlying claim.”). Thus, it is clear that in most circumstances, an excess insurer cannot refuse to contribute to a settlement (or assume a duty to defend) simply because a primary insurer has not paid its limits.

It also is clear that an excess insurer cannot refuse to contribute to a settlement even when a primary insurer resolves its indemnity duty by paying less than its policy limits. In that circumstance, the excess insurer must still pay, at least to the extent that the settlement or judgment exceeds the limits of the primary policy. As the Koppers court explained:

[S]ettlement with the primary insurer functionally 'exhausts' primary coverage and therefore triggers the excess policy – though by settling the policyholder loses any right to coverage of the difference between the settlement amount and the primary policy's limits. 98 F.3d at 1454.

See Archer Daniels Midland Co. v. Aon Risk Servs., 356 F.3d 850, 853 (8th Cir. 2004) (excess duty to pay when insured settled with underlying policies “for a partial sum and absorb[ed] the balance”); Drake v. Ryan, 514 N.W.2d 785, 789 (Minn. 1994) (“[The insurer] is not prejudiced because it is only being asked to fulfill its contractual obligations to its insured ' to provide coverage in excess of that provided by the primary … policy.”).

Furthermore, an excess policy may be obligated to respond below its attachment point if the insured and a primary insurer enter into a good faith settlement for less than the primary insurance policy limits. The leading case is Phoenix Insurance Co. v. United States Fire Insurance Co., 189 Cal. App. 3d 1511, 235 Cal. Rptr. 185 (1987). In Phoenix, insurers disputed their respective duties to fund a settlement. An excess insurer contended that it could be called upon to indemnify the insureds for a settlement “only after the insureds exhausted the coverage of their primary carriers. … ” Id. at 1529. The excess insurer argued that because the primary insurers had paid less than their full limits toward a settlement of a suit against the insured, it did not have to pay. The court rejected this argument. Instead, it held that “the primary coverage was 'exhausted' when [the primary insurers] paid their share of the settlement and were dismissed from the declaratory relief action.” Id. The court noted that had the excess insurer “wanted to raise this issue, it could simply have named [the primary insurers] as defendants in its cross-complaint thereby assuring that all the parties were before the court when the reapportionment was determined.” Id. at 1529-30.

Another court reached a similar conclusion. In E.R. Squibb & Sons, Inc. v. Accident & Casualty Insurance Co., 853 F. Supp. 98 (S.D.N.Y. 1994), the excess insurers argued that they had no duty to indemnify their insured after it settled with its primary insurers for less than full policy limits. The federal court rejected this argument, applying a similar rationale to that used by the Phoenix court:

Absent collusive arrangements to defraud an excess carrier … a carrier which has issued a policy containing … language [stating that the policy covers sums that the insured becomes 'legally obligated to pay through adjudication or compromise' or similar language] must pay amounts due the insured which are unpaid for any reason, including a compromise reached by a first-tier carrier through an arm's length settlement. To rule otherwise in the face of clear language to that effect would be contrary to the public interest: it would undermine the reliability of contracts, and it would discourage settlements. Id. at 101.

A somewhat different approach was taken in County of Santa Clara v. United States Fidelity & Guaranty Co., 868 F. Supp. 274 (N.D. Cal. 1994). In this case, an excess insurer disputed whether a settlement between the insured and the primary insurer was in good faith and triggered its duties. The primary insurer had agreed to a settlement whereby it would deposit its limits into an escrow account for the insured. The escrow instructions provided that the money would be released if the court determined that the primary insurer's agreement to fund the escrow exhausted its policy limits. The escrow agreement was reached in order to fund the amount that the insured could be ordered to pay pursuant to the terms of a remediation plan to clean up contamination at a site owned by the insured.

The excess insurer argued that the primary insurer's tender of its policy limits was conditional and collusive and constituted an “artificial exhaustion.” The court agreed that the deposit of money into the escrow account did not, by itself, constitute an exhaustion of the primary insurer's duties, thereby triggering the excess insurer's duty to defend. In so holding, the court first noted the general rule in California:

Under California law, it is clear that '[all] primary insurance must be exhausted before liability attaches under a secondary policy.' … This means that an excess insurer has no duty to defend or contribute to defense costs until primary limits are exhausted in resolution of third party claims against the insured. … Moreover, the primary insurer cannot extinguish its defense obligation simply by tendering its indemnity limits to the insured and walking away from the fray ' a tempting maneuver when it appears that defense costs will exceed indemnity limits. Id. at 277.

However, the court ultimately rejected the excess insurer's arguments. It held:

[T]he [insured] will incur indemnity sufficient to validly exhaust primary coverage when [the state agency] approves a remediation plan for the Site which requires the [insured] to incur response costs in excess of the … primary indemnity limits. … Primary coverage cannot be exhausted until a remediation plan is approved which clearly establishes that the costs of remediation will exceed the primary indemnity limits. At that point [the primary insurer] can tender its policy limits to the [insured] and thereby extinguish its duty to defend. [The excess insurer] will then be obligated to provide a defense to the [insured]. Id. at 279-80.

Thus, the court recognized that even if the primary insurer had not yet paid all of its funds, its commitment to do so would constitute an exhaustion of its limits.

Phoenix was followed in Fuller-Austin Insulation Co. v. Fireman's Fund Ins. Co., No. BC 116835, Statement of Decision as to Phase IB, Issues 2-7 and 9 (Los Angeles County Super. Ct. Feb. 26, 2002). There, the court stated:

Phoenix stands for the proposition that when the policyholder settles and dismisses an insurance company from a coverage action without the non-settling insurance companies filing cross-claims for contribution, subrogation, or other equitable relief against the settling insurance company, the settling insurance company's policies will be deemed exhausted. Id. at 23.

The court also stated the governing principles:

[A]n insurance company is liable for, and its obligation to pay is triggered by, that portion of a liability that exceeds its attachment point, irrespective of whether the policyholder or the underlying insurance company has paid the underlying limits or anything at all. …

Actual payment in cash by underlying insurance companies is not a condition precedent to an umbrella or excess insurance company's obligation. …

Exhaustion by payment is not a prerequisite to triggering an umbrella or excess insurance company's obligation, as opposed to the transfer of the duty to defend. Such an obligation is triggered by a liability that exceeds underlying coverage. …

[I]nstallment payments by settling insurance companies constitute exhaustion of coverage where such payments are made for liabilities that exceed the settling insurance company's policy limits. The timing of these payments negotiated through settlement does not inure to the benefit of the non-settling and remaining [insurers]. The fact that an underlying insurance company may have been able to secure a beneficial payment schedule has no effect on the relevant inquiry ' whether the liability in question triggers the excess insurance coverage. …

Where the policyholder and the insurance company contest exhaustion, the burden is on the insurance company to prove exhaustion. … However, if the dispute is resolved, and the insurance company is dismissed without a cross-claim asserted by a non-settling insurance company, the inquiry is complete and the settled insurance company's insurance limits are deemed exhausted. Id. at 17 & 21-22.

Given these decisions, an excess insurer cannot refuse to pay simply because a primary insurer has not yet paid its full policy limits. An excess insurer should be obligated to pay whenever the liability exceeds primary limits, regardless of whether the primary insurer has paid its limits in full, agreed to pay over time, agreed to make conditional payments, or agreed to settle a coverage dispute by paying less than its limits. And, if a primary insurer settles a coverage dispute by paying less than its limits, that settlement may constitute an “exhaustion” of the primary policy. As a result, an excess insurer may be obligated to pay, including amounts that otherwise would have been payable under the primary policy had the primary insurer not settled with the insured.

During recent years, insureds have faced a wide range of claims with potential liability exceeding the limits of their primary insurance policies. In such a setting, excess insurers typically argue that their duties are not triggered unless and until the primary policy has paid its limits. Such arguments should not be readily accepted. Excess insurers owe duties even before primary policies have exhausted. And, when a primary insurer settles with its insured, excess insurers may be obligated to pay under their policies even if the settlement was for less than the primary policy's limits.

Courts have repeatedly rejected any notion that an excess insurer owes no duties to its insured until a primary policy is exhausted. For example, California courts have recognized the wide range of duties that an excess insurer owes its insured before a primary policy exhausts. See, e.g., Kelley v. British Commercial Ins. Co., Ltd., 221 Cal. App. 2d 554, 562, 34 Cal. Rptr. 564 (1963) (duty to participate in settlement discussions when potential settlement may invade limits of liability); Armstrong World Indus., Inc. v. Aetna Cas. & Sur. Co., 45 Cal. App. 4th 1, 85, 52 Cal. Rptr. 2d 690 (1996) (duty to accept reasonable settlement); Schwartz v. State Farm Fire & Cas. Co., 88 Cal. App. 4th 1329, 1338, 108 Cal. Rptr. 2d 523 (2001).

Likewise, it is clear in most jurisdictions that an excess insurer must contribute to a settlement that reaches its limits even if the primary policy has not paid its full limits. In fact, this principle was established more than 75 years ago. In Zeig v. Massachusetts Bonding & Insurance Co., 23 F.2d 665 (2d Cir. 1928), an excess insurer argued that an insured could not collect from it unless it first actually collected the full amount of the primary policy limits. The Second Circuit disagreed, stating:

[T]he [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. To require an absolute collection of the primary insurance to its full limit would in many, if not most, cases involve delay, promote litigation, and prevent an adjustment of disputes which is both convenient and commendable. Id. at 666.

The court also observed that a clause requiring a policy to be “exhausted in the payment of claims” does not require “interpreting the word 'payment' as only relating to payment in cash.” Id. As the court explained, “It often is used as meaning the satisfaction of a claim by compromise, or in other ways.” Id.

Many other courts have reached similar conclusions. See, e.g., Koppers Co. v. Aetna Cas. & Sur. Co., 98 F.3d 1440, 1454 (3d Cir. 1996) (“[T]he widely-followed rule [is] that the policyholder may recover on the excess policy for a proven loss to the extent it exceeds the primary policy's limits.”); Denny's, Inc. v. Chicago Ins. Co., 234 Cal. App. 3d 1786, 1794, 286 Cal. Rptr. 507 (1991) (when “the insured's liability exceed[s] the underlying insurance limits … liability attaches to the excess insurer, whether or not the underlying insurer has actually paid out the policy limit); Pacific Employers Ins. Co. v. Servco Pacific Inc., 273 F. Supp. 2d 1149, 1154, 2003 U.S. Dist. LEXIS 20997 (D. Haw. June 19, 2003) (“The Court is unconvinced by PEIC's argument that its duty to defend, as an excess carrier, is not triggered unless and until the primary carrier pays its limits by either a judgment or settlement of the underlying claim. … The plain terms of PEIC's policy provide that its duty to defend arises when 'the limits of liability of the underlying insurance are exhausted because of … property damage' ' not when the limits are exhausted by payments of judgments or settlements of the underlying claim.”). Thus, it is clear that in most circumstances, an excess insurer cannot refuse to contribute to a settlement (or assume a duty to defend) simply because a primary insurer has not paid its limits.

It also is clear that an excess insurer cannot refuse to contribute to a settlement even when a primary insurer resolves its indemnity duty by paying less than its policy limits. In that circumstance, the excess insurer must still pay, at least to the extent that the settlement or judgment exceeds the limits of the primary policy. As the Koppers court explained:

[S]ettlement with the primary insurer functionally 'exhausts' primary coverage and therefore triggers the excess policy – though by settling the policyholder loses any right to coverage of the difference between the settlement amount and the primary policy's limits. 98 F.3d at 1454.

See Archer Daniels Midland Co. v. Aon Risk Servs., 356 F.3d 850, 853 (8th Cir. 2004) (excess duty to pay when insured settled with underlying policies “for a partial sum and absorb[ed] the balance”); Drake v. Ryan , 514 N.W.2d 785, 789 (Minn. 1994) (“[The insurer] is not prejudiced because it is only being asked to fulfill its contractual obligations to its insured ' to provide coverage in excess of that provided by the primary … policy.”).

Furthermore, an excess policy may be obligated to respond below its attachment point if the insured and a primary insurer enter into a good faith settlement for less than the primary insurance policy limits. The leading case is Phoenix Insurance Co. v. United States Fire Insurance Co., 189 Cal. App. 3d 1511, 235 Cal. Rptr. 185 (1987). In Phoenix, insurers disputed their respective duties to fund a settlement. An excess insurer contended that it could be called upon to indemnify the insureds for a settlement “only after the insureds exhausted the coverage of their primary carriers. … ” Id. at 1529. The excess insurer argued that because the primary insurers had paid less than their full limits toward a settlement of a suit against the insured, it did not have to pay. The court rejected this argument. Instead, it held that “the primary coverage was 'exhausted' when [the primary insurers] paid their share of the settlement and were dismissed from the declaratory relief action.” Id. The court noted that had the excess insurer “wanted to raise this issue, it could simply have named [the primary insurers] as defendants in its cross-complaint thereby assuring that all the parties were before the court when the reapportionment was determined.” Id. at 1529-30.

Another court reached a similar conclusion. In E.R. Squibb & Sons, Inc. v. Accident & Casualty Insurance Co. , 853 F. Supp. 98 (S.D.N.Y. 1994), the excess insurers argued that they had no duty to indemnify their insured after it settled with its primary insurers for less than full policy limits. The federal court rejected this argument, applying a similar rationale to that used by the Phoenix court:

Absent collusive arrangements to defraud an excess carrier … a carrier which has issued a policy containing … language [stating that the policy covers sums that the insured becomes 'legally obligated to pay through adjudication or compromise' or similar language] must pay amounts due the insured which are unpaid for any reason, including a compromise reached by a first-tier carrier through an arm's length settlement. To rule otherwise in the face of clear language to that effect would be contrary to the public interest: it would undermine the reliability of contracts, and it would discourage settlements. Id. at 101.

A somewhat different approach was taken in County of Santa Clara v. United States Fidelity & Guaranty Co., 868 F. Supp. 274 (N.D. Cal. 1994). In this case, an excess insurer disputed whether a settlement between the insured and the primary insurer was in good faith and triggered its duties. The primary insurer had agreed to a settlement whereby it would deposit its limits into an escrow account for the insured. The escrow instructions provided that the money would be released if the court determined that the primary insurer's agreement to fund the escrow exhausted its policy limits. The escrow agreement was reached in order to fund the amount that the insured could be ordered to pay pursuant to the terms of a remediation plan to clean up contamination at a site owned by the insured.

The excess insurer argued that the primary insurer's tender of its policy limits was conditional and collusive and constituted an “artificial exhaustion.” The court agreed that the deposit of money into the escrow account did not, by itself, constitute an exhaustion of the primary insurer's duties, thereby triggering the excess insurer's duty to defend. In so holding, the court first noted the general rule in California:

Under California law, it is clear that '[all] primary insurance must be exhausted before liability attaches under a secondary policy.' … This means that an excess insurer has no duty to defend or contribute to defense costs until primary limits are exhausted in resolution of third party claims against the insured. … Moreover, the primary insurer cannot extinguish its defense obligation simply by tendering its indemnity limits to the insured and walking away from the fray ' a tempting maneuver when it appears that defense costs will exceed indemnity limits. Id. at 277.

However, the court ultimately rejected the excess insurer's arguments. It held:

[T]he [insured] will incur indemnity sufficient to validly exhaust primary coverage when [the state agency] approves a remediation plan for the Site which requires the [insured] to incur response costs in excess of the … primary indemnity limits. … Primary coverage cannot be exhausted until a remediation plan is approved which clearly establishes that the costs of remediation will exceed the primary indemnity limits. At that point [the primary insurer] can tender its policy limits to the [insured] and thereby extinguish its duty to defend. [The excess insurer] will then be obligated to provide a defense to the [insured]. Id. at 279-80.

Thus, the court recognized that even if the primary insurer had not yet paid all of its funds, its commitment to do so would constitute an exhaustion of its limits.

Phoenix was followed in Fuller-Austin Insulation Co. v. Fireman's Fund Ins. Co., No. BC 116835, Statement of Decision as to Phase IB, Issues 2-7 and 9 (Los Angeles County Super. Ct. Feb. 26, 2002). There, the court stated:

Phoenix stands for the proposition that when the policyholder settles and dismisses an insurance company from a coverage action without the non-settling insurance companies filing cross-claims for contribution, subrogation, or other equitable relief against the settling insurance company, the settling insurance company's policies will be deemed exhausted. Id. at 23.

The court also stated the governing principles:

[A]n insurance company is liable for, and its obligation to pay is triggered by, that portion of a liability that exceeds its attachment point, irrespective of whether the policyholder or the underlying insurance company has paid the underlying limits or anything at all. …

Actual payment in cash by underlying insurance companies is not a condition precedent to an umbrella or excess insurance company's obligation. …

Exhaustion by payment is not a prerequisite to triggering an umbrella or excess insurance company's obligation, as opposed to the transfer of the duty to defend. Such an obligation is triggered by a liability that exceeds underlying coverage. …

[I]nstallment payments by settling insurance companies constitute exhaustion of coverage where such payments are made for liabilities that exceed the settling insurance company's policy limits. The timing of these payments negotiated through settlement does not inure to the benefit of the non-settling and remaining [insurers]. The fact that an underlying insurance company may have been able to secure a beneficial payment schedule has no effect on the relevant inquiry ' whether the liability in question triggers the excess insurance coverage. …

Where the policyholder and the insurance company contest exhaustion, the burden is on the insurance company to prove exhaustion. … However, if the dispute is resolved, and the insurance company is dismissed without a cross-claim asserted by a non-settling insurance company, the inquiry is complete and the settled insurance company's insurance limits are deemed exhausted. Id. at 17 & 21-22.

Given these decisions, an excess insurer cannot refuse to pay simply because a primary insurer has not yet paid its full policy limits. An excess insurer should be obligated to pay whenever the liability exceeds primary limits, regardless of whether the primary insurer has paid its limits in full, agreed to pay over time, agreed to make conditional payments, or agreed to settle a coverage dispute by paying less than its limits. And, if a primary insurer settles a coverage dispute by paying less than its limits, that settlement may constitute an “exhaustion” of the primary policy. As a result, an excess insurer may be obligated to pay, including amounts that otherwise would have been payable under the primary policy had the primary insurer not settled with the insured.