Roads to Exhaustion

Since Superstorm Sandy, many of our New Jersey condominium associations clients and others are working closely with their brokers these days to review the terms of attachment for their excess insurance coverage policies. The current trend we see in the trigger language for excess insurance policies is designed to circumvent the established majority rule¹ first articulated in 1928 in Zeig v. Massachusetts Bonding & Insurance Company,² which allowed an insured to fill the gap between a settlement amount and an insurer’s policy limits.

In Zeig, the excess insurer argued that the trigger term “payment” meant actual, collected payment of the full amount of the underlying policy limits from the underlying insurer. The Second Circuit refused to accept that argument and reasoned that “[t]o require an absolute collection of the primary insurance to its full limit would in many, if not most, cases involve delay, promote litigation, and prevent an adjustment of disputes which is both convenient and commendable.”³ The court held that “[t]he plaintiff should [be] allowed to prove the amount of his loss, and if that loss [is] greater than the amount of the expressed limits of the primary insurance, he [is] entitled to recover the excess to the extent of the policy in suit.” For many years this rule has been the basis and foundation for insureds to quickly access the benefits of their excess policies to aid them in the prompt recovery for their insured losses.

In the years since Zeig, excess insurers have worked to narrow or lessen their exposure to liability through more precise trigger language in excess policies regarding the definition and terms of exhaustion. By 2007, a minority of jurisdictions adopted the rule established in Comerica Inc. v. Zurich American Insurance Company.⁴

In Comerica, the insured settled its disputed claim with its primary insurer for $14 million, less than the $20 million policy limits, and the parties entered into a settlement agreement that “the policy [Federal] shall be deemed fully exhausted and is null and void and has no force or effect whatsoever.”⁵

The Comerica court distinguished Zeig and its body of cases finding that “[t]he cases that follow Zeig generally rely on an ambiguity in the definition of ‘exhaustion’ or lack of specificity in the excess contracts as to how the primary insurance is to be discharged.”⁶ The Comerica court also departed from public policy and found that “[a] different result occurs when the policy language is more specific.” The Zurich excess policy stated:

In the event of the depletion of the limit(s) of liability of the ‘Underlying Insurance’ solely as a result of actual payment of loss thereunder by the applicable insurers. . .⁷

Many insurance brokers are very familiar with the new insurance forms and have become aware of the trend toward more precise contract language that often narrows the trigger of exhaustion of the underlying layer by removing the ambiguity defined by the courts. The excess policies are now drafted to define the terms of “payment” and “exhaustion” in ways not necessarily designed to protect the insurer from unfair exposure, but to add additional delay and constraints upon the insured, as the specific language often answers the questions: Does the underlying layer of insurance have to be actually “paid” to be exhausted? Are there situations when the underlying layer can be “deemed” exhausted, e.g., the claim exceeds the underlying policy limits? Can the insured and the primary insurer agree to “exhaustion” of the underlying through settlement?

But, the road does not end there. You can still reach exhaustion. And, you can still reach your excess coverage benefits. As with most policies drafted by the insurers to narrow coverage, the insurer also offers an option to purchase back the coverage through endorsements. Brokers are now seeking for their insureds endorsements for protection from the same risks now narrowed or excluded through re-drafted policy language, such as endorsements to allow “payment” by the “underlying insurer or insured” so the insured may absorb the gap in payment between the underlying insurer and the excess insurer to quickly resolve the underlying portion of the claim.

The two, or three, main take-aways here: 1). Know your policies and the terms of coverage; 2). Know a good coverage lawyer; and 3.) When you come to a fork in the road, Take it!⁸
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¹ See, e.g., Federal Ins. Co. v. Srivastava, 2 F.3d 98 (5th Cir. 1993); Stargatt v. Fidelity & Cas. Co. of New York, 67 F.R.D. 689 (D. Del. 1975), aff’d, 578 F.2d 1375 (3d Cir. 1978); Reliance Ins. Co. v. Transamerica Ins. Co., 826 So. 2d 998 (Fla. Ct. App. 2001).
² Zeig v. Massachusetts Bonding & Ins. Co., 23 F.2d 665 (2nd Cir. 1928).
³ Id. at 666.
⁴ Comerica Inc. v. Zurich American Ins. Co., 498 F. Supp.2d 1019, 1025-26 (E.D. Mich. 2007).
⁵ Comerica, at 1025-26.
⁶ Id. at 1030.
⁷ Id. at 1022.
⁸ Yogi Berra.