The Exhaustion of Primary Limits Issue
The Exhaustion of Primary Limits Issue01.05.2018
A few months ago, I had a discussion with an insurance intermediary about her client’s decision to not renew an excess liability policy based on what the client’s conclusion that its excess coverage was not needed as it was an additional insured on many other policies. Apparently, the client was relying on its perceived requirement to exhaust multiple primary insurance policies before its own excess policy would come into play. The broker was concerned that the client was going to leave itself open to potential excess exposure, and asked if I knew what his client was talking about. I was reminded of this discussion on what is known as the horizontal v. vertical exhaustion of a liability policy after reading that, last month, the California Supreme Court in Montrose Chemical Corporation v. Superior Court 14 Cal.App.5th 1017 (App. 4th Dist. 2017) agreed to hear arguments on this issue to trigger excess insurance.
Horizontal exhaustion requires that an insured party exhaust all applicable primary policy limits before coverage under an excess policy is triggered without regard to policy period. This theory is usually based on the language of “other insurance” clauses found in excess policies that such policies are excess “any other valid and collectible insurance”. In contrast, under vertical exhaustion, an excess policy coverage is invoked when the primary policy specifically listed or scheduled on the excess policy declarations page is exhausted. Courts have applied this vertical allocation method based on public policy considerations such as the efficient use and application of insurance, and not allowing an excess insurer to avoid coverage where other policies may be available but were not part of the excess insurer’s underwriting of the risk in question.
This exhaustion of primary limits issue arises when faced with (i) ongoing, continuous and/or multiple losses or injuries over multiple policy periods; or, (ii) when an insured has multiple primary polices (whether as a named insured or an additional insured) that could respond to an occurrence in a given policy year. While most states like Illinois, Florida, and New York apply the horizontal exhaustion approach, there are states such as Washington, Wisconsin and New Jersey that favor vertical exhaustion. An insured’s location could be a factor in deciding how much excess coverage to have. For example, if you are in a state that utilizes the horizontal exhaustion rule, and you are an additional insured on many policies (such as an general contractor or owner in a construction situation), all those polices may need to be exhausted before your excess policy is triggered.
Turning to the Montrose case, last month, the California Supreme Court agreed to review a California Appeals Court (2nd District) that applied horizontal exhaustion to determine when excess coverage is triggered on the basis that “other insurance” clauses requires a policyholder to exhaust every triggered underlying policy before any excess policy could come into play. This decision to do so by the California Supreme Court is to resolve a split in appellate districts as, is telling because, two months before the Montrose appellate decision, the California Court of Appeals (4th District) in State of California v. Continental Insurance Company held that vertical exhaustion applied, and the policyholder could access excess insurance as soon as the underlying limits for that particular coverage period were exhausted. The 4th District Court of Appeals based its decision on the basis that “other insurance” clauses are intended to apply between insurers in contribution actions between insurers and not coverage litigation between an insurer and an insured.
While the application of a horizontal or vertical exhaustion approach is unsettled but soon to be resolved in California, policyholders and insurance intermediaries alike need to be cognizant of which is utilized in the jurisdiction they reside to understand (i) whether the underlying policies on an excess policy are the ones that need to be exhausted before excess coverage is triggered; and, if not, (ii) what other polices could be triggered and need to be exhausted before excess coverage becomes applicable. Such an understanding provides information needed to assist in determining the amount of underlying and/or excess coverage a policyholder should carry.