Two recent New York State cases involving high layer excess liability insurance programs, Union Carbide Corp. v. Affiliated FM Ins.Co., 16 NY3d 419 (2011) and JPMorgan Chase v. Indian Harbor Ins. Co., 31 Misc 3d 1240(A), 2011 NY Slip Op. 51055(U), 2011 WL 2320087 (NY Sup. Ct. May 26, 2011), highlight the importance of using care when structuring an excess program, particularly when drafting language with respect to limits of liability and exhaustion of limits.

The pro-policyholder Union Carbide decision of New York’s highest court, the Court of Appeals, held that the aggregate limit of liability stated in a three-year umbrella excess insurance policy purchased by Union Carbide was “annualized,” that is, the limit renewed for each year of the policy. This decision could significantly impact the coverage responsibilities of insurance carriers under “follow form” excess liability insurance policies.

In Indian Harbor, the New York trial court, applying Illinois law, dismissed a coverage suit against five excess carriers, ruling that the excess policies could not attach when the policyholder had compromised the limits of an underlying excess policy.  The court found that the policyholder’s conduct in settling with another excess insurer for less than the total amount of the carrier’s policies violated the other excess carrier’s policies requiring exhaustion of the underlying limits. The rationale behind the decision demonstrates the importance of how excess policies are worded and how settlements with underlying insurers are structured.

The Union Carbide Decision

For policyholders that purchase high limits on a multiyear basis, the February 22, 2011 decision of the New York Court of Appeals is instructive. The Court unanimously held that the aggregate limit of a multiyear excess policy would renew annually in the same fashion as the primary policy, where the excess policy “followed the form” of the primary policy and the primary policy clearly provided annual limits on a multiyear basis. In Union Carbide, plaintiff Union Carbide Corporation (UCC) purchased several layers of liability insurance coverage for asbestos-related losses. Coverage on the primary (or bottom) layer was provided under a policy that was issued for a three-year period (the Primary Policy). The Primary Policy covered UCC for the first $5 million of loss, except for a “retained” amount for which UCC was self-insured. The Primary Policy clearly stated that the $5 million limit renewed annually, such that the Primary Policy provided a $5 million aggregate limit in each of the three years of the policy period, as opposed to a single $5 million aggregate limit spread across all three years. This annual $5 million limit was referred to in the Primary Policy declarations as an “annual aggregate.”   The higher layers of coverage, however, did not clearly address whether the limits renewed annually.

The fifth layer of excess coverage covered losses exceeding $70 million and up to $100 million (total of $30 million of coverage). The fifth layer excess coverage was divided equally among six carriers, $5 million each. Under this arrangement, any covered loss above $70 million would be apportioned equally among the six carriers until the carriers’ respective $5 million limits were reached, i.e., until the covered losses exceeded $100 million. The fifth layer excess coverage was issued pursuant to a $30 million “brief ‘subscription form policy’” (the Excess Policy) that would “follow all the terms, insuring agreements, definitions, conditions and exclusions” of the Primary Policy, “subject to the declarations” of the Excess Policy. The declarations of the Excess Policy stated, in part, that the Excess Policy’s limit of liability was “$30,000,000 each occurrence and in the aggregate excess of $70,000,000.”

Two of the fifth layer excess carriers, Continental Casualty Company (Continental) and Argonaut Insurance Company (Argonaut), claimed that since the Excess Policy declarations only mentioned an “aggregate” limit” (as opposed to the “annual aggregate” limit referenced in the Primary Policy) the maximum amount that UCC could be paid during the entire three-year period of the Excess Policy was $30 million, $5 million per carrier. By contrast, UCC argued that the “follow the form” language of the Excess Policy incorporated all terms and conditions of the Primary Policy, one of which provided for the annual renewal of the aggregate primary limit. Thus, according to UCC, the maximum amount that UCC could be paid during the period of the Excess Policy was $90 million ($30 million per year), $15 million per carrier ($5 million per year).

After reviewing the relevant policy wording, the Court of Appeals held in favor of UCC, agreeing with its argument that “under the follow-the-form clause, the conditions of the [Primary Policy] are part of the [Excess Policy], and that one of those conditions is that the ‘aggregate’ limit shall be annualized.” Union Carbide Corp., 16 NY3d at 424. The Court found that “[w]hile the reading Continental and Argonaut give to the word ‘aggregate’ might be plausible in many contexts, here the follow-the-form clause should prevail.” Id. The Court reasoned that such “follow-the-form” clauses are important because they allow an insured dealing with multiple carriers on the same risk to know the nature and extent of its coverage, without conducting a policy-by-policy analysis. The Court also found it implausible that an insured with as large and complicated an insurance program as UCC would have purchased primary and excess policies that differed with respect to the time over which the policy limits were spread. As noted by the Court, Argonaut and Continental’s interpretation of the Primary and Excess Policies could have produced an undesirable result in which UCC reached the second and third years of its excess policies with the full limit of its primary coverage in place, but with its fifth-layer excess coverage exhausted.

The Court noted that its interpretation of the Excess Policy was reinforced by the fact that the Excess Policy’s declarations provided for a limit of liability of “$30,000,000 each occurrence and in the aggregate.” “If $30 million was the most that could be paid on the entire policy why, UCC asks, did the parties bother to specify a per occurrence limit in an equal amount? Continental and Argonaut offer no answer.” Id.1

The Indian Harbor Decision

In a case that provides a clear warning that all settlements of major coverage disputes necessitate an analysis of coverage under all excess layers, the New York Supreme Court, New York County, applying Illinois law, dismissed a coverage suit as to five excess insurers, holding that their excess policies could not attach when the policyholder had compromised the limits of an underlying excess policy in the settlement agreement.  In JPMorgan Chase, certain JPMorgan Chase entities (collectively, JPMorgan), successor to several Bank One entities (collectively, Bank One), sought money damages from defendant excess insurers, arguing that the insurers wrongfully failed to indemnify them for monies paid to defend and settle claims asserted against Bank One in 2002 for its role as indenture trustee for a medical finance company.

Ten insurers underwrote $175 million of primary and excess coverage for the 2002 to 2003 policy year.  JPMorgan sued all 10 insurers, but settled with the third and eighth excess insurers shortly after filing its complaint.  The settlement with the third excess insurer compromised coverage claims under both the 2002 to 2003 insurance policy and an earlier policy for $17 million dollars, an amount greater than the $15 million limit for the 2002 to 2003 excess policy but less than the total amount of both policies.

Defendant Twin City Fire Insurance Company (Twin City), the fourth excess insurer, joined by the excess insurers above it, moved to dismiss the coverage action against it because its policy contained a condition precedent requiring it to pay losses only after each carrier beneath it both admitted liability for the losses and paid the full amount of its liability under its policy. Thus, while JPMorgan argued that the full limits of the insurers’ coverage were owed to indemnify it for covered losses, Twin City argued that because JPMorgan’s settlement with the third excess insurer did not allocate the $17 million settlement between the two policies, JPMorgan could not prove that the third excess policy was exhausted.

The court found that the Twin City policy was not ambiguous and that JPMorgan had failed to set forth a reasonable alternative interpretation of a contractual provision requiring the underlying excess insurers to have “admitted liability” and “paid the full amount” of their liability before Twin City's liability attached. Thus, Twin City’s motion to dismiss was granted. Id. at *10.

The court noted that the settlement required the third excess insurer to pay $17 million to settle $28 million worth of claims under two policies, and that JPMorgan “deliberately chose not to allocate those payments between different policies involved in different underlying lawsuits.” Id. at *6. The court further rejected JPMorgan’s argument that it could fill the gap in the 2002 to 2003 insurance tower with its own funds because the unambiguous policy language required exhaustion of underlying limits and did not allow the policyholder to fill the gap. 

Noting that while the court “certainly favors and encourages settlements of cases whenever possible, it cannot do so in contravention of the clear language of the policy” Indian Harbor, 2011 WL 2320087 at *13. The court, thus, granted Twin City’s motion to dismiss.  The court likewise granted the motions of the four additional excess insurers higher in the tower based on similar language in their policies. Although the specific language in each of the moving insurers’ excess policies varied slightly, each required that the underlying policy limits be paid by the underlying insurers before the policy would be triggered. The ruling resulted in dismissal of approximately $95 million in claimed Bankers Professional Liability and Securities Claim insurance coverage for the underlying suits filed against Bank One.

Analysis and Guidance

Both of the above cases address typical wording in excess policies and provide valuable guidance in structuring an excess program.  

The Union Carbide decision will guide other courts confronting the issue of annualization of multiyear policies in the context of a following form program, as well as insurers structuring multiyear excess programs. Insurers will consider the impact of the New York Court of Appeals’ decision in evaluating the nature and extent of coverage for policy limits as between primary and excess layers of coverage, and policyholders must do so as well. In large and complicated insurance programs, the parties will need to adequately express the extent of limits purchased.   

The Indian Harbor case is significant in that it upholds the clear excess policy requirements that underlying policies be exhausted by actual payments, and in following a recent trend in the law finding no exhaustion absent payment of full underlying limits.  When excess policies contain this fairly standard requirement, insureds will be precluded from seeking excess coverage after settling in a piecemeal fashion with underlying insurers for less than full policy limits and, thus, must settle each carrier dispute with an eye on all other carriers in the tower.