Excess Insurance and Umbrella Coverage New

Appleman on Insurance Law Library Edition, Chapter 24

By Douglas R. Richmond, Senior Vice President, Aon Risk Services

Businesses and individuals seeking liability protection have varying insurance coverage
needs. One concern is the amount of coverage required to shield against potential
losses. Some insureds may see the breadth of coverage as a concern. In other cases,
the cost of insuring against potentially severe losses may be a factor. Insureds may
address all of these concerns through tiered insurance programs that combine primary
liability insurance policies with excess insurance or umbrella policies.
This chapter examines critical excess insurance and umbrella coverage issues. It
begins in Section 24.02 by characterizing liability insurance in three essential
ways: primary, excess and umbrella.
A primary policy provides the first layer of insurance coverage. Primary coverage
attaches immediately upon the happening of an occurrence, or as soon as a claim is
made. The primary insurer is first responsible for defending and indemnifying the
insured in the event of a covered or potentially covered occurrence or claim.
An excess policy provides specific coverage above an underlying limit of primary
insurance. A true excess policy does not broaden the underlying coverage. While an
excess policy increases the amount of coverage available to compensate for a loss, it
does not increase the scope of coverage. Excess coverage generally is not triggered
until the underlying primary limits are exhausted by way of judgments or
settlements. An excess policy may be written on either a stand alone or following
form basis. A stand-alone policy relies exclusively on its own insuring agreement,
conditions, definitions and exclusions to grant and limit coverage. A following form
policy, on the other hand, incorporates by reference the terms, conditions and
exclusions of the underlying policy.
An umbrella policy is like an excess policy in that it is written in addition to a primary
policy to protect the insured against liability for catastrophic losses that would exceed

the limits of affordable primary coverage. An umbrella policy differs from an excess
policy in a critical aspect: an umbrella policy typically insures against certain risks that a
concurrent primary policy does not cover. An umbrella policy is thus a gap filler; by
design it provides first dollar coverage where a primary policy and an excess policy do
not. For example, an umbrella policy may insure against personal injury when a
primary policy only insures against bodily injury and property damage. By dropping
down to provide primary coverage, or by filling a gap in primary coverage, an umbrella
policy broadens the insureds primary coverage where an excess policy does not. The
terms excess policy and umbrella policy are not synonymous.
Section 24.03 addresses notice of loss as a condition precedent to coverage. Excess
and umbrella policies, like primary policies, contain notice requirements. An insureds
obligation to give notice of a loss to an excess or umbrella insurer exists separate and
apart from the insureds duty to give notice of a loss to a primary insurer. Giving notice
of a loss to either a primary or excess insurer does not relieve the insured of the
obligation to give notice to the other.
The insured is normally obligated to notify its insurer notice of a loss. This is a simple
proposition, since the insured is a party to the contract imposing the notice requirement,
and a policy expressly assigns the obligation to the insured. Notice requirements in
excess and umbrella policies are a valid condition precedent to coverage; they are not
just fluff that an insured can ignore or act on at its convenience. An excess or umbrella
insurer often has a huge financial stake in litigation. It may want to involve itself in the
insureds defense even if it is not obligated to do so. Timely notice allows an excess or
umbrella insurer to inject itself into settlement negotiations at a point when its
contributions, whether strategic or financial, can be most meaningful.
What of the mechanics of notice to an excess or umbrella insurer? Does a primary
insurer have a role in notice to an excess or umbrella insurer? The majority position
holds that the insured, not the primary insurer, is obligated to give an excess or umbrella
insurer notice of a loss that implicates the excess or umbrella carriers policy. This is
consistent with the language of the excess or umbrella policy, which imposes the notice
obligation on the insured. The primary insurer and excess or umbrella insurer, on the
other hand, have no contractual relationship on which a duty to notify might be

premised. The same principle operates by extension in a multi-level insurance program

in which there are several excess or umbrella insurers. There, notice remains the
insureds obligation and is not owed by a lower-level excess or umbrella insurer to a
higher-level excess or umbrella insurer.
Occasionally a court will impose on a primary insurer a direct duty to notify an excess or
umbrella insurer of a loss based on the dependent relationship between the excess and
primary insurer. This is a minority position. A more sensible construction of the minority
position, however, is that a primary insurers duty to notify an excess carrier of a loss
potentially affecting the excess carriers limits supplements the insureds duty to give
notice to the excess carrier but does not supplant it. This approach gives meaning to
the notice language in the excess policywhich clearly requires the insured to notify the
excess insurer of a losswhile still recognizing the unique relationship between the
primary and excess insurer that is at the heart of the minority rule.
Section 24.04 analyses excess and umbrella insurers defense obligations. As a rule, it
is a primary insurers duty to defend an insured against a claim or suit. An excess
insurer typically has no duty to defend its insured until the limits of the underlying
coverage are exhausted. This is true even where the amount of third-partys claim
against the insured exceeds the primary policy limits, such that any judgment might
implicate the excess or umbrella insurers duty to indemnify the insured. An excess
insurer may, however, elect to participate in its insureds defense where its policy limits
are implicated.
Because an excess insurer has no duty to defend, it cannot later be estopped from
raising coverage defenses, or be said to have waived those defenses, if it fails to
reserve its rights when notified of a claim or suit potentially implicating its coverage. It
is, after all, an insurers duty to defend which compels it to reserve its rights, and without
a duty to defend an excess insurer has no obligation to issue a reservation of rights
letter. These same principles apply where an umbrella policy affords excess
coverage. An excess insurer may assume a duty to issue a reservation of rights letter if
it is the insurers custom to do so. That custom, however, must relate to the particular
insured arguing for coverage based on estoppel or waiver; what the excess insurer
does or does not do vis--vis other insureds is irrelevant.

Some excess policies provide that in certain circumstances the insurer may be
obligated to reimburse the insured for its defense costs. The duty to reimburse defense
costs and the duty to defend are not equivalents. An excess insurer may incur a duty to
reimburse defense costs without assuming a duty to defend. Indeed, a policy provision
granting an excess insurer the option to participate in its insureds defense contradicts
any possible duty to do so. Similarly, excess policies often give the insurer the option to
associate in the defense of covered suits. The mere fact that this option exists,
however, does not mean that an excess insurer can be compelled to pay for some or all
of the insureds defense before any underlying primary coverage is exhausted. An
excess insurer that chooses to associate in the insureds defense to protect its interests
while the primary insurer is still defending does not through that association terminate
the primary insurers defense obligation. Rather, the excess insurer is responsible for
paying the lawyers that it hires and it typically agrees to bear some portion of other
defense expenses, such as court reporter fees, expert witness fees, and the like.
There are cases in which the insureds potential exposure clearly exceeds the primary
insurers policy limits, but the primary carrier cannot avoid what will surely be an
expensive defense because the plaintiff will not settle and the excess carrier will not
accept the primary carriers tender of the defense. In such cases the primary insurer is
forced to defend for the excess insurers benefit. Should not the excess carrier be
required to bear some portion of the defense costs on equitable grounds? The answer
to this question may depend on the language of the excess policy. If the excess policy
is a following form policy, or includes language that arguably suggests a duty to defend,
the excess insurer may be required to share in the defense costs on some pro rata
basis. The forced sharing of defense costs by an excess insurer absent exhaustion of
the primary insurers policy limits is a minority position, however, as it should be.
Unlike true excess policies, umbrella policies typically provide that the umbrella policy
will afford primary coverage for certain claims or occurrences that are not within the
ambit of the insureds primary policy. With primary coverage come a primary insurers
duties. Thus, an umbrella insurer may have a duty to defend its insured where a true
excess carrier would not. Of course, there must be a potential for coverage under the
umbrella policy in order for the umbrella carrier to have a duty to defend.

Section 24.05 discusses insurers duty of good faith and fair dealing in the excess and
umbrella context. Excess insurance policies, including those that provide only for
indemnity, impose a duty of good faith on the insurer. An excess insurers duty of good
faith exists throughout the term of the policy. If the carrier breaches this duty, of course,
an insured may sue the carrier for bad faith.
While it generally makes sense to limit an insurers duty of good faith to its insured,
excess insurance presents a special need. A primary insurer may decline to settle a
claim within its policy limits secure in the knowledge that it cannot be held liable for bad
faith to its insured because any judgment that exceeds its limits will be paid by the
excess carrier. Here the primary insurer is gambling with the excess insurers money
instead of the insureds. A primary insurers failure to settle a case within its policy limits
when the facts should require it to do so, thereby exposing its insured to personal
liability, is the essence of third-party bad faith. A primary insurers wrongful failure to
settle a case within it policy limits is no less offensive when an excess insurer must bear
liability for the resulting judgment above the primary carriers limits. Allowing excess
insurers to sue primary insurers for bad faith encourages reasonable settlements,
prevents primary insurers from obstructing settlement, prevents unfair distribution of
losses among primary and excess insurers, and reduces the cost of excess insurance.
The theory on which an excess or umbrella carrier pursues a primary insurer for bad
faith may be pivotal. For example, courts typically reject equitable contribution in this
context because excess and primary policies do not cover the same risk. A few courts
hold that a primary insurer owes an excess insurer a direct duty of good faith and fair
dealing. These courts reason that when a primary insurer refuses to settle in bad faith,
the excess insurer is in the same position as an insured. Fairness dictates the
imposition of a direct duty of good faith on the primary insurer, inasmuch as the excess
carrier relies on the primary carrier to discharge claims handling and defense
obligations.
Most courts reject the direct duty theory. Under the majority rule, the duty to settle that
a primary insurer owes an excess insurer derives from the primary insurers duty to the
insured, such that an aggrieved excess insurer may sue on an equitable subrogation
theory. Generally, the measure of damages in an equitable subrogation action is the

difference between the amount the excess insurer would have contributed to the
settlement that the primary insurer unreasonably refused, if anything, and the amount
the excess insurer ultimately paid to satisfy the judgment. As between direct duty
theory and the equitable subrogation approach, the latter represents better contract law
and insurance law.
Some courts decline to recognize a cause of action for excess insurers against primary
insurers, whether by way of equitable subrogation or pursuant to a direct duty theory,
even where the primary insurers conduct clearly is blameworthy. These courts reason
that excess insurers that are forced to indemnify their insureds for judgments greater
than their primary policy limits have suffered no injury. Rather, the excess judgments
about which they complain are exactly the risk for which they bargained and collected
premiums. This approach is misguided. Certainly, excess insurers bargain for the risk
they accept above the limits of underlying primary insurance and they collect premiums
for the risk they assume. But their willingness to assume risk and to price it reasonably
is at least to some extent predicated on rational behavior by their underlying primary
insurers.
Section 24.06 analyses the key excess insurance concept of exhaustion. Generally, for
an excess insurer to have any obligation to its insured, the primary insurer must pay its
policy limits toward the satisfaction or settlement of the claim or judgment against the
insured. A primary insurer that properly pays its policy limits is said to have exhausted
its limits.
Most problems arise in cases involving continuous or progressive injuries or losses
spanning several policy periods. A loss that spans years may trigger multiple
insurance policies. Triggering occurs when a loss implicates a policys coverage,
subject to the policys terms and exclusions, and any other coverage defenses the
insurer may raise. Courts can pick from several coverage triggers. Most courts now
employ the continuous trigger or triple trigger. Under this approach, any policy on
the risk at any time during the continuing loss is triggered, meaning that the issuing
insurer must be prepared to defend or pay up to its policy limits as the case may be.
One of the most hotly contested issues in continuous loss cases is whether an insured
is obligated to exhaust its liability coverage vertically or horizontally. This issue

arises when several primary policies or lower level excess policies are triggered, and a
court must determine whether the limits of the underlying policies for one year
(vertical) or all years (horizontal) must be exhausted before a particular excess policy
must pay. Special problems may arise when an underlying insurer becomes insolvent,
or an excess insurer is otherwise required to drop down to provide a level of coverage
lower than that for which it bargained.
Vertical exhaustion allows an insured to pick and choose policy periods triggered by a
continuous loss. Under vertical exhaustion theory, first-in-time primary and excess
policies are exhausted before the next-in-time primary and excess policies are
tapped. Horizontal exhaustion means that the primary insurance must be exhausted
across all of the triggered policy periods before the next layer of coverage, whether
excess or umbrella, must respond to a continuous loss. Horizontal exhaustion best
comports with the continuous trigger theories favored in many jurisdictions.
Whether a court will apply vertical or horizontal exhaustion principles in a continuing
loss case is a question that is sometimes answered by looking at the language of the
excess policy (or policies) at issue. A court will typically require vertical exhaustion
when the limits of a specifically scheduled primary policy are exhausted and the excess
policy provides that it shall be excess only to that specific underlying policy. Where
excess policies are not so specific, horizontal exhaustion is preferred.
Unfortunately, primary insurers sometimes become insolvent. In such a case, may an
excess insurer be forced to drop down and fill the coverage gap created by the
underlying insurers insolvency? The answers to drop down questions typically are
answered by the terms of the subject excess policy. The majority rule, however, is that
absent obligatory policy language, an excess insurer is not required to drop down and
cover that portion of a loss once within an insolvent primary insurers coverage, nor
must it drop down to provide the defense that an insolvent primary insurer was to
fund. Excess insurers simply are not guarantors of the solvency of underlying insurers.
Section 24.07 examines the allocation of losses among multiple excess or umbrella
insurance policies. Insurers contend that allocation is mandated by the terms of their
policies, which specify coverage periods. Thus, in the case of a continuing loss, an
insurer should be allowed to limit its indemnity obligation to damage occurring during its

policy period. Insureds argue strenuously against allocation, fearing that their SIR
obligations and other gaps in coverage will leave them responsible for portions of a
continuing loss (so-called orphan shares).
Insureds generally make two arguments against allocation. The first is tied to standard
language in most primary policies by which the insurer promises to pay all sums the
insured becomes obligated to pay as damages by reason of specified liabilities, or
those sums that the insured becomes legally obligated to pay as damages. Insureds
argue that because standard policies do not specify that they will pay all sums or
those sums attributable to damage caused during the policy period, if any portion of a
loss is covered the insurer must pay the entire loss up to the limits of its coverage.
Policyholders second argument against allocation is cloaked in terms of joint and
several liability. This argument has two variations. First, because each of several
consecutive insurers provides coverage at relevant times, each has an independent
obligation to insure the entire loss. Second, an insured may argue that because it faces
joint and several tort liability for the loss for which coverage is sought (as in
environmental cases), its insurers liability is also joint and several.
The all sums and joint and several approaches make little sense. Among other
things, they require an incorrect presumption that all damage occurred in one policy
period. Insurers are wrongly held liable for damages occurring outside their policy
periods, while insureds, who purposely reduce their insurance costs at different times by
way of SIRs and varying limits, receive coverage for which they did not bargain. Pro
rata allocation makes far more sense because it confines insurers obligations to losses
occurring during their policy periods.
Because of the scientific complexities that characterize many continuing losses, as well
as the extended period of time that damages may go undiscovered and the many
parties potentially involved, it often is impractical to hold each insurer responsible only
for those damages occurring during its policy period. Some courts therefore allocate
losses based on insurers time on the risk. Under the time on the risk method, a loss
is allocated in proportion to the amount of time that an insurers policies were in effect
(the numerator) as a percentage of the total months or years during which the loss
occurred (the denominator).

Other insurance clauses in competing insurance policies sometimes factor into

allocation controversies, although they rarely are determinative. Other insurance
refers only to two or more policies insuring the same risk and the same interest, for the
benefit of the same person, during the same period. Other insurance clauses in
policies only operate when there is concurrent coverage. Consecutive policies cannot
constitute other insurance because while they many insure the same type of risk, they
do not insure the same risk.
Liability insurance policies may contain any one of several other insurance clauses,
one of which is an excess clause. An excess other insurance clause provides that
the insurers liability is limited to the amount of the loss exceeding all other valid and
collectible insurance, up to the insurers policy limits. When two policies both contain an
excess other insurance clause, most courts treat the excess clauses as mutually
repugnant and prorate the loss between the competing insurers. But excess and
umbrella policies clearly differ in purpose from primary policies containing excess other
insurance clauses. Excess and umbrella policies are therefore regarded as true
excess coverage over and above all primary policies, including those with excess other
insurance clauses. The presence of an excess other insurance clause in a primary
policy does not transform that policy into an excess policy vis-a-vis a second carrier
providing true excess or umbrella coverage.
Finally, Section 24.08 discusses malpractice claims by excess and umbrella insurers
against the defense lawyers engaged by primary insurers. In some ways malpractice
claims by excess insurers against defense counsel make little sense. An excess insurer
typically does not share an attorney-client relationship with the defense attorneys that a
primary carrier hires. To avoid the strict privity rule common the legal malpractice
doctrine, courts that allow an excess insurer to sue defense counsel hired by a primary
insurer for malpractice typically hold that the excess insurer is equitably subrogated to
the insureds rights against the attorneys. Other courts have declined to allow excess
insurers to sue defense counsel for malpractice even on an equitable subrogation
theory. This is not surprising, for a number of courts have generally rejected equitable
subrogation in the legal malpractice context. These courts tend to view equitable
subrogation as the assignment of a legal malpractice claim and such assignments are
generally impermissible.

The development of excess insurers rights against defense attorneys hired by primary
carriers is far from complete. The law in many states is uncertain, and there are good
arguments both for and against recognizing excess insurers right to sue defense
attorneys they did not hire for malpractice.
In conclusion, there is no questioning the importance of excess insurance and umbrella
coverage. Such policies protect insureds against catastrophic loss at prices that most
businesses and individuals can comfortably afford. Excess and umbrella coverage is in
fact quite common, and these policies spawn numerous and varied controversies and
questions. Unfortunately, many lawyers and courts do not fully appreciate or understand
excess and umbrella insurers differing obligations. But that understanding must come
because litigation involving excess and umbrella insurers is now common.