Chapter Fourteen

• Jurisdiction: New York

Chapter Fourteen

Excess and Extended Coverages and Excess Coverage Issues

Michael C. Cannata, Esq. Frank Misiti, Esq.*

* The authors would like to thank William M. Savino, Esq., partner at Rivkin Radler LLP, for his efforts in preparing the first edition of this chapter and, more importantly, serving as a mentor to the authors.

I. Introduction

The relationship between primary and excess insurers can at times be uncertain and complex. Excess insurance is written to apply to an insured’s loss after the primary policy obtained by an insured is exhausted. The limits of liability of the excess policy only cover a loss after the limits of the primary policy have been paid, either to settle the loss or to indemnify the insured as a result of an adverse judgment. Thus, the policies—primary and excess—are interrelated. The language of each policy will control the outcome in a wide variety of contested issues between primary and excess insurers. This chapter will discuss various issues in the excess insurance arena.

II. Excess Coverage and The Exhaustion Requirement

Excess insurers write their coverages and charge premiums based on an important consideration, namely, that their coverage will be implicated only after all applicable primary and/or underlying coverages are exhausted. Excess insurance policy language differs and can vary greatly from policy to policy. The common principle, however, is that excess insurance coverages cannot be reached until the limits of the underlying insurance are exhausted, either to settle the loss or indemnify the insured as a result of an adverse judgment.

A. When Does Exhaustion Occur?

1. The Effect of Settlement by the Primary Insurer for an Amount Less Than the Primary Limits as Triggering Excess Coverage

a. Jurisdictions Where Settlement for Less Than the Primary Limits Is Deemed Exhaustion

In New York, there is precedent establishing that an excess insurer’s policy may be triggered by a settlement between the primary insurer and the insured for an amount less than the amount of the limits of the primary insurance. In other words, the primary policy can be exhausted by a settlement for less than the primary limits.¹⁵⁸⁰

In Zeig¹⁵⁸¹ the insured had three burglary insurance policies providing a total of $15,000 in primary coverage. The excess insurer’s policy provided coverage in the amount of $5,000 as excess, not contributing, insurance to apply and cover only after all other insurance therein referred to had been “‘exhausted in the payment of claims to the full amount of the expressed limits’” of such other insurance.¹⁵⁸² The insured settled its burglary claims against its primary insurers for $6,000 and presumably released them for the full amounts of their policies. The excess insurer argued that it was not required to contribute to the insured’s loss because, in order for the primary insurance to be exhausted, the insured must actually collect the full amount of the policy limits. The court ruled that the primary policies were exhausted, and the excess insurer would be required to contribute to the insured’s loss in excess of $15,000, the limits of the primary policies, not the amount of the loss in excess of the cash settlement.¹⁵⁸³ In so holding, the court reasoned that the particular contract language at issue provided only “that it be ‘exhausted in the payment of the claims to the full amount of the expressed limits.’ The claims are paid to the full amount of the policies, if they are settled and discharged, and the primary insurance is thereby exhausted.”¹⁵⁸⁴

Other jurisdictions have followed Zeig and concluded that settlement by a primary insurer for less than its primary limits can exhaust the primary limits. Further, these jurisdictions have extended the Zeig holding to situations involving liability insurance contracts and third-party liability cases.¹⁵⁸⁵

b. Jurisdictions Where Settlement for Less Than the Primary Limits Is Not Deemed Exhaustion of the Primary Policies

In United States Fire Insurance Co. v. Lay,¹⁵⁸⁶ the Seventh Circuit held that a settlement for less than the primary limits does not exhaust the primary policy. Thus, the court ruled that an excess insurer’s coverage will not be triggered unless the primary insurer has actually paid the amount of its limits. In so holding the court stated:

[w]e can conceive of good reasons for an excess carrier to be unwilling to accept liability unless the amount of the primary policy has actually been paid. A settlement for less than the primary limit that imposed liability on the excess carrier would remove the incentive of the primary insurer to defend in good faith or to discharge its duty . . . to represent the interests of the excess carrier. ¹⁵⁸⁷

2. The Trigger of Excess Coverage as a Result of the Exhaustion of Primary Coverage by Year or by Layer

Certain courts have addressed issues of vertical exhaustion or horizontal exhaustion (exhaustion by year or by layer, respectively). In Associated International Insurance Co. v. St. Paul Fire & Marine Insurance Co.,¹⁵⁸⁸ for example, an insured who produced industrial safety equipment, including masks and respiratory systems used by construction workers for sandblasting, was sued by numerous workers who alleged they acquired silicosis as a result of using the insured’s defective products over an extended period of time. Between 1952 and 1983, the insured had successive primary, first-level and second-level excess liability coverage and sought coverage for the numerous claims against it. Associated, who had provided second-level excess coverage for one year, argued that all the primary insurance contracts, implicated by the claims asserted by the insured, must be exhausted before excess coverage for any year could be triggered. The court disagreed, holding that “neither an excess nor a primary insurer should be required to pay for the portion of injury attributable to a period outside the defined limits of its own coverage.”¹⁵⁸⁹ Therefore, there is “no reason why an excess insurer should not be required to contribute for that portion of a continuous injury that occurs during its policy year” once the primary policy for that period is exhausted.¹⁵⁹⁰

In contrast, in Stonewall Insurance Co. v. City of Palos Verdes Estates,¹⁵⁹¹ the insured, the city, was sued by a resident for damages caused by the city’s actions over an extended period of time. The city sued its primary and excess insurers to recover the amount it paid to the resident in the underlying case. One of the city’s excess insurers also commenced suit to recover from the city and the primary insurers the amount it contributed to the judgment against the city in the underlying case. The court found that “if . . . the aggregate of the policy amounts of the primary policies in effect . . . is adequate to cover the [insured’s] obligation to [claimant], then no excess carrier is liable for any of that obligation.”¹⁵⁹²

B. Does an Excess Insurer Have a Duty to “Drop Down” and Provide Primary Coverage in the Event of a Primary Insurer’s Insolvency?

Insurer insolvency was relatively uncommon until the early 1980s. However, insurer insolvency increased dramatically in the eighties, and, as it became more common, insureds attempted to remedy the resulting gaps in their insurance by looking to their excess coverages. Thus, insureds began to argue that an excess insurer must “drop down” below the intended triggering amount that was specified in order for excess coverage to be implicated, to provide primary coverage to the insured when the primary insurer is insolvent. In other words, insureds may argue that when a primary insurer is insolvent, that policy should be deemed exhausted, requiring the excess insurer to “fill the gap.” Various cases across the country have decided this precise issue. Most of the decisions focus on the specific contract language at issue and, thus, have produced different outcomes.

In New York, when a primary insurer becomes insolvent, the excess insurer is not obligated to “drop down” and provide coverage below its intended layer to the insured.¹⁵⁹³ In Ambassador, both the trial court and the First Department concluded that the specific policy language was unambiguous and clearly set forth the point at which excess insurance coverage would be provided.¹⁵⁹⁴ At issue in Ambassador was policy language providing that

[t]he . . . Company agrees to pay on behalf of the Insured the Ultimate Net Loss in excess of the Underlying Insurance as shown in Item 4 of the Declarations [which list[ed] the Mission Insurance policy], but only up to an amount not exceeding the company’s Limit of Liability as shown in Item 3 of the Declarations [i.e., $15,000,000]. ¹⁵⁹⁵

Ultimate net loss was defined as the following: “[T]he amount payable in settlement of the liability of the Insured after making deductions for all recoveries and for other valid and collectible insurance, excepting however the policy(ies) of the Underlying Insurer(s).”¹⁵⁹⁶

The court rejected the insured’s arguments that the policy was ambiguous. In so holding, the court ruled that the

excess insurer first becomes liable when the limits of the underlying insurance have been exceeded; its coverage is only activated when the loss exceeds the amount specified in the underlying policies. . . . Were the courts to impose upon excess insurers the risk of an underlying insurer’s insolvency, it would, in effect, “transmogrify the policy into one guaranteeing the solvency of whatever primary insurer the insured might choose.” ¹⁵⁹⁷

This holding was consistent with a line of New York authority which held that an excess insurer is not required to drop down to the primary limits and provide coverage in the event the primary insurer becomes insolvent.¹⁵⁹⁸ In Pergament Distributors, Inc. v. Old Republic Insurance Co., the policy was quoted as providing the following:

“The Company hereon shall only be liable for the ultimate net loss the excess of either

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