Effect of Insolvency on Exhaustion Clauses
and "Drop Down" Coverage
the U.S. has impacted the practice of
insurance law in many ways, not the least
of which has been the effect of massive
insolvency on insurance coverage issues.
Many self-insured companies and
primary insurers fell into bankruptcy
during this time creating insurance
coverage issues for their excess carriers.
While in bankruptcy, of course, self-
insured companies and insurers were
largely protected from tort claims by the
automatic stay, including catastrophic
claims. Often times during bankruptcy,
many claimants who have been left
without recovery or even unsatisfied
judgments, sought redress outside of
the bankruptcy court. They pursued
the excess carrier by way of declaratory
judgment for "drop down" coverage to
cover unsatisfied claims from dollar
one. Because of the recent increases
in insolvencies, this issue has again
come to the forefront in insurance policy
policies vary considerably and courts
rely on different policy provisions in
reaching different results on this issue in
various jurisdictions around the country.
The requirements and formulas that
determine exhaustion of the coverage
limits or retentions in the primary layer
are often what determine the rights
and obligations of an excess carrier in
those cases. Generally, the insured's
primary coverage must be exhausted
by actual payment of the policy limit
amount. In some cases, however, the
policyholder can settle for less than
the underlying policy limit, absorb the
gap between the settlement and the
primary limit, and then seek coverage
from the excess insurer for the balance.
The scenarios can vary significantly,
and both decisional law as well as
policy construction will ultimately
determine the excess carrier's duties and
obligations under each circumstance. In
addition, it is important to understand
carrier's obligation to pay under the
excess policy following the exhaustion
of the primary limits with the limits of
liability section of the policy, which is
what courts should rely on to determine
if there is "drop down" coverage to
begin with.
The Second Circuit's decision
in Zeig v. Massachusetts Bonding &
Insurance Co. is an interesting decision
often cited for the proposition described
above, 23 F.2d 665 (2nd Circuit 1928).
The Court in Zeig found that construing
the excess policy's exhaustion clause
to mean that the plaintiff in the
underlying tort claim actually had
to collect the full policy limit was
"unnecessarily stringent." Id. at 666.
The court reasoned that the defendant,
the excess insurer, had "no rational
interest in whether the insured collected
the full amount of the primary policies,
Law Firm. He has represented national and regional motor
carriers, trucking companies, third party administrators and
insurers, including primary, excess and reinsurers, in the fields
of transportation and insurance law. He handles all aspects of
transportation and insurance litigation including personal injury,
product liability, coverage and regulatory.
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