Companies that wish to have higher limits of insurance than their primary (or umbrella) insurance companies are willing to provide usually can purchase excess insurance policies. Excess policies respond to losses above the limits of the primary layer of coverage. A company may purchase multiple layers of excess coverage from different insurance companies, creating a tower of coverage, with the primary layer at the bottom, and one or more excess layers at the top.
Many excess insurance policies are written as “follow-form” coverage. That is, rather than containing a full set of terms and conditions themselves, the excess policies “follow form” to, or incorporate by reference, the terms and conditions of a policy in a lower layer. Follow-form excess policies therefore tend to be shorter than policies that need to set out all of their own terms. The general idea behind follow-form excess coverage is to provide a seamless tower of coverage to the policyholder to respond to large losses.Despite their brevity, the mechanics of follow-form excess policies do not always work as smoothly as intended. This post sets out a number of traps for the unwary that sometimes are hidden within excess insurance policies. As described below, most of these can be avoided if policyholders and their advisors are vigilant when purchasing excess policies, and stay away from those with language that could lead to unintended results.
Could a Settlement With an Underlying Layer Forfeit of All Excess Insurance?
A policyholder facing a large loss may find itself in a coverage dispute with multiple layers of its tower of insurance. Like any party facing a contract dispute, the policyholder may desire to reach a settlement with one or more of the insurance companies, accepting less than the full limits of a layer as a compromise of the parties’ dispute over coverage. Policyholders who make such settlements with lower layers of coverage, however, increasingly are facing arguments from their excess insurance companies that such a settlement does not properly exhaust the lower layer of coverage, even if the policyholder is willing to make up the difference by itself bearing the remaining amount of loss within the settled layer. The excess insurance companies argue that, as a result of the alleged failure to exhaust the underlying layer of coverage properly, their excess policies are excused from any obligation to pay, even if the loss unquestionably is covered, and undeniably is large enough to reach into the excess layer.
While many courts reject such arguments, several have accepted it and held that a policyholder’s settlement with an underlying layer releases the excess coverage from any liability, under certain variations of excess policy language. See, e.g., Michael T. Sharkey, “Settlements With Underlying Layers Satisfy Exhaustion Conditions in Excess Policies,” 2013 LexisNexis Emerging Issues Analysis 7108 (Nov. 2013) (discussing cases). In light of this risk, policyholders should make sure the excess insurance policies they purchase contain language that makes it unmistakably clear that the excess insurance company does not receive a windfall from a below-limits settlement by an underlying insurance company. This could be as simple as purchasing an excess policy that defines exhaustion of the underlying limits in terms of “the actual payment of loss by the applicable Insurer or the Insured,” rather than only in terms of payment by the underlying insurer.
Which Underlying Policy Is Followed?
In many cases, an excess policy is precise in identifying the policy that is follows form to, usually the underlying primary or umbrella policy, or the excess policy in the immediately underlying layer. Other excess policies are not as clear. Some may be issued with a placeholder, such as “To Be Determined,” which is never updated. Others may refer to the “immediately underlying layer” of coverage, but that layer may be shared among a number of insurance companies, each with its own slightly different policy form.
Additional complications could arise if the excess policy’s policy period is not precisely concurrent with that of the primary. In such a situation, it may not be clear which underlying policy the excess is referring.
Most of these sources of confusion can be cleared up with careful attention to the excess policy’s references to the underlying coverage. In the event ambiguities remain, however, courts often will construe the excess policy as following form to the underlying policy most favorable to the policyholder.
Which Language Is Followed?
There is no such thing as an excess policy that completely follows form to another policy. If nothing else, an excess policy will need its own clauses setting out the identity of the insurance company, the limits of liability, and other details particular to the policy. In addition, most follow-form excess policies contain at least a few clauses of their own. The follow-form provision generally states that the excess policy follows form to the underlying coverage “except as otherwise provided herein.”
Application of this language is not always clear. For example, if an excess policy states that it does not follow form to the “limits” of the underlying policy, does that mean just the numerical limits of liability, or also the clauses addressing the mechanics of how those limits apply? If the excess policy contains a version of an exclusion similar to that found in the underlying policy, but narrower in scope, is the broader scope of the underlying exclusion followed by the excess?
Serious problems can arise if the excess policy form purports to follow form to underlying coverage, but its own clauses are dramatically inconsistent with that underlying policy. For example, if an excess policy form designed to sit above an occurrence-based liability policy is used instead with an underlying claims-made liability policy, it may be difficult to determine what coverage actually was intended.
Do Cooperation and Consent Clauses Apply Only to Claims Likely to Reach the Excess Layer?
Insurance policies, particularly liability insurance policies, impose several obligations on a policyholder in connection with a pending claim. A policyholder generally must permit the excess insurance company to associate in the defense of an underlying liability claim against the policyholder, and the policyholder often cannot settle a claim without the consent of the insurance company.
In many excess policies, the clauses setting forth these obligations apply only when the loss is likely to reach the layer of the excess policy. That is, an insurance company with an excess liability policy high up in the tower will have no interest in participating in the defense or settlement of a claim that is resolved well below its layer of coverage.
Nevertheless, in some excess policies the relevant clauses are not expressly made applicable only to losses likely to reach the excess layer. If the policyholder failed to involve the excess insurance company in even the smallest claim, and to obtain its consent even for settlements well below the excess layer, an excess insurance company with that language may argue there is no coverage if the loss later reaches the excess layer, on the grounds that the earlier settlements without its consent violated the terms of the policy.
Policyholders should review their proposed excess policies to determine which obligations they impose, and whether they impose them on all claims, or only those that are likely to reach the excess layer.
Will the Dispute Resolution Clauses Add Cost and Complexity?
An excess policy may contain its own arbitration, choice-of-forum, or choice-of-law clauses. In many contracts, these types of clauses related to dispute resolution are intended to help streamline disputes. In the context of excess insurance, however, they may have the opposite effect.
A key factor here is that any insurance coverage dispute reaching the excess layers of insurance is likely to involve the lower layers of coverage as well. Particularly in a situation where the excess follows form to the lower layers of coverage, any policy language in dispute between the excess insurance company and the policyholder is likely to be in dispute between the policyholder and lower layers as well. In normal situations, a policyholder could bring a single insurance coverage lawsuit against the entire tower of implicated insurance policies, in order to resolve the overlapping issues in one proceeding binding on all of the insurance companies.
If, however, the layers of insurance have mandatory arbitration clauses, or inconsistent forum selection clauses, the policyholder may not be able to join all of the insurance companies in a single action. As a result, the policyholder may be required to litigate disputes involving the same issues against different layers of coverage in separate but duplicative arbitrations or litigations. In such a situation, the arbitration or forum-selection clauses have the effect of multiplying, rather than reducing, the dispute resolution costs and burdens. In addition, the policyholder is put at risk of inconsistent decisions on the same issues for different layers of coverage.
Inconsistent choice-of-law provisions in different layers of coverage also increase the risk that a policyholder will face inconsistent decisions about the rights and obligations of the parties under the different layers.
Many excess insurance companies may be unwilling to remove the mandatory arbitration clauses from their policy forms: there is a perception among many insurance law practitioners that arbitration is more favorable to insurance companies than regular litigation. Regardless of whether that perception is correct, policyholders should bear in mind the potential for such clauses to add to the complexity and cost of dispute resolution, when evaluating proposed excess insurance policies that contain these clauses.
The issues discussed in this post are just a sampling of the issues that can lead to disputes in connection with the operation of excess insurance policies. Despite the relative brevity of follow form excess policies, policyholders and their advisors should review them carefully, to avoid unpleasant surprises. And the time to do such review is before the policyholder needs to make a claim under the policies, so that troublesome or unclear policy language can be corrected before a dispute arises.