Chapter 14, G. The Drop-Down Requirement

• Jurisdiction: United States

G. The Drop-Down Requirement

Typically, an excess carrier is not required to pay until the primary coverage has been exhausted. "Drop-down" coverage is an exception to this general rule. If an insured files for bankruptcy and maintains an SIR, or an underlying carrier goes into liquidation, the excess carrier may be concerned about the possibility it may have to drop down and provide coverage for those underlying layers. Drop-down coverage occurs when an insurer at a higher level of coverage is required to provide coverage for amounts due within the limits of an underlying insurer. For example, if the insured has a $2 million SIR (per policy period) or maintains underlying coverage in the amount of $2 million, and either the insured files for bankruptcy or the underlying carrier goes into receivership, will the excess carrier be responsible for any amounts in the $2 million layer?

Most courts will not require excess insurers to "drop down" without explicit, unambiguous language in the policy that states it will drop down in the event of the insolvency of a lower layer of insurance. Courts are cognizant of the fact that the purpose of a liability policy is to cover the insured's exposure to third-party liability, not to the solvency of another insurer.³⁷⁹ If there is a fixed monetary amount that defines the point at which the liability of the excess carrier arises, generally courts will not require the excess carrier to drop down. One court noted that to require an excess insurer to drop down and provide coverage when the primary insurer is insolvent "would, in effect, transmogrify the [excess] policy into one guaranteeing the solvency of whatever primary insurer the insured might choose. An excess liability insurer obviously does not anticipate this heavy onus."³⁸⁰ In the above example, the excess carrier would not have to pay for any judgments or settlements until the aggregate amount due exceeded $2 million. If a party had a judgment for $2.2 million, it could only seek payment of $200,000 from the excess carrier.

Where a first-tier excess carrier was insolvent, the court looked to the legal effect of the contractual language of the excess insurance policy and determined that the policy contained unambiguous language. The plain meaning demonstrated that the policy was to protect against excess liability claims, not to protect against the underlying carrier's insolvency. The excess insurer was not required to drop down and provide coverage for the...