High anxiety: does the Wisconsin Supreme Court's opinion in Johnson Controls create a new "drop down" exposure for excess insurers?

• Author: Aylward, Michael F.

This article originally appeared in the January 2011 Insurance and Reinsurance Committee Newsletter.

During the 1980s, excess carriers were surprised to learn that their policies might be triggered by the insolvency of underlying insurance. Now a new opinion from the Wisconsin Supreme Court has suggested that "drop down" exposures may also exist in cases where the underlying insurance is solvent but coverage is deemed to be "unavailable" due to the primary or umbrella carrier's refusal to accept coverage.

Excess insurers can offer policies with high limits for significantly less premium than primary policies for two reasons. First, there is a limited statistical risk that the insured will suffer losses of sufficient magnitude to exhaust the underlying limits of coverage. Second, excess policies generally do not contain "duty to defend" provisions. Rather, they cover defense costs, if at all, as part of the overall insured "loss." While umbrella carriers may occasionally face a direct defense obligation in cases where a loss is not covered by the primary policy, such cases are relatively rare. Otherwise, courts have nearly universally ruled that an excess insurer's duty to pay defense costs do not arise until the underlying limits are exhausted and are not triggered by the primary insurer's "tender" of its limits or the mere prospect that the insured's liability is so severe that the excess insurer will have to pay some share of a settlement or judgment eventually. This is to be contrasted with the unhappy plight of primary insurers, who frequently end up paying total defense costs that are many multiple limits of their "occurrence" limits before a case is finally disposed of.

Nevertheless, higher layer excess insurers may feel less secure about being "remote from the action" in the wake of the Wisconsin Supreme Court's recent opinion in Johnson Controls v. London Market. (1)

The case in question involves an insurance dispute that was originally filed in 1989 and has already resulted in a landmark Supreme Court decision in 2003 finding coverage for the cost of cleaning up hazardous waste site. In late 2005, Johnson Controls moved for summary judgment against Wausau contending that, as it had failed to provide a defense, its breach of the defense obligation warranted the imposition of liability for the full amount of its claimed damages. Soon thereafter, Johnson Controls settled with Wausau for an undisclosed amount.

Having resolved the issue of its primary insurance coverage, Johnson Controls turned its attention to its excess insurers and moved for summary judgment against Allstate, an umbrella carrier, arguing that it too breached its duty to defend by failing to step down and defend Johnson Controls after Wausau refused to. After Allstate settled, Johnson Controls pressed forward against the London Market, which had issued excess umbrella insurance between 1973 and 1976. These policies followed form to underlying Travelers umbrella policies, which were in turn excess of the Wausau primaries.

In 2007, the Circuit Court ruled not only that the London Market policies incorporated duty to defend provisions but that this duty arose immediately upon the refusal of the lower layer insurers to defend. London appealed.

In Johnson Controls v. London Market, (2) the Court of Appeals chose not to resolve the issue and instead certified two issues to the Supreme Court: (1) should a duty to defend be imported from an underlying umbrella policy where the higher layer policies state that they follow form to the underlying policy...