HNRK Coverage Corner

Excess policies frequently “follow form” to—that is, incorporate the terms of—the underlying primary policy.  Nevertheless, an excess policy is a separate insurance contract, and the excess insurer is typically not bound by the primary insurer’s coverage decisions. 

After the primary insurer pays out its policy limits, can the excess insurer challenge the propriety of the primary insurer’s coverage determination, and on that basis argue that the  the excess policy is not triggered because the followed policy wasn’t properly exhausted? 

Judge Cooper of the United States District Court for the District of Columbia addressed this question—evidently an issue of first impression under Virginia law—in Federal Home Loan Mort. Corp. v. Twin City Fire Ins. Co., Case No. 23-cv-1758-CRC.  In a decision issued on November 8, 2024, Judge Cooper held that “excess insurers cannot avoid their obligations by arguing that the underlying coverage was improperly eroded,” explaining:

The limited caselaw that has addressed this issue . . . has consistently held that excess insurers generally may not avoid or reduce their own liability by contesting payments made at prior levels of insurance, unless there is an indication that the payments were motivated by fraud or bad faith or there is specific language in the policies reserving a right to challenge prior payments. . . .

This rule promotes finality and settlement.  It also makes sense given the nature of a layered insurance structure, within which each insurer is independent.

The excess insurers argued that a different rule should apply in this case because the primary insurer had “likely made an unallocated compromise payment” that the insured “then applied to fees and costs that do not constitute covered loss and thus do not erode the underlying insurance.”  Therefore, the insurers argued they, were not “second-guessing” the primary insurer’s payment decision; the primary insurer had, in fact, “never made a specific determination to cover certain costs.”  But Judge Cooper rejected this argument, finding that “the same policy justifications bear on that situation as where an underlying insurer designates a specific purpose for a payment, so the same prohibition on excess-insurer challenges to such payments should also apply.  In both instances, allowing higher-layer excess carriers to challenge these payments would encourage litigation, delay the resolution of claims, and undermine the discretion of lower-layer carriers to settle claims within their limits.”