For nearly 80 years, courts throughout the country have been split over interpretation of conditions in excess insurance policies that require complete exhaustion of underlying insurance. While many courts enforced excess policies as written and held that exhaustion requires actual payments by the underlying insurers, other courts —following the ancient decision in Zeig v. Massachusetts Bonding & Ins. Co., 23 F2d 663 (2d Cir. 1928) — declined to enforce such provisions, citing public policy that encourages settlement of claims. Those courts allowed that primary insurance layers can be exhausted by settlement with the insured.
Over the past five years, the tide has changed. Overcoming public policy concerns and strictly enforcing excess policies as written, courts throughout the country have rejected Zeig and held that the condition in excess policies requiring exhaustion of underlying limits can be satisfied only through actual payments by the underlying insurers. See, Intel Corp. v. American Guarantee & Liability Ins. Co., 2012 Del. LEXIS 480 (Del. 2012); JP Morgan Chase v. Indian Harbor Ins. Co., 947 N.Y.S.2d 17 (N.Y. App.Div. 2012); Citigroup, Inc. v. Federal Ins. Co., 649 F.3d 367 (5th Cir. 2011); Qualcomm, Inc. v. Certain Underwriters at Lloyd’s London, 73 Cal.Rptr.3d 770 (Cal.App. 2008)
The recent Illinois decision in Great American v. Arnoff, 2010 U.S. Dist. LEXIS 61553 (N.D. Ill. 2010), highlights the mutiny against Zeig. The facts underlying the case mirror Zeig. The insureds, Bally Total Fitness and its officers, agreed to settle claims under the primary policy for less than the limit of liability and sought a judicial declaration of coverage under two excess insurance policies. The excess insurers denied liability, arguing coverage under their excess policies applied: “(1) only in excess of all Underlying Insurance, (2) only after all Underlying Insurance has been exhausted by payment of the total underlying limit of insurance and (3) only if each and every Underlying Insurance Policy has responded by payment of loss as a result of any wrongful act.”
Clinging to the Zeig principles, the insureds argued their settlements with the primary carrier had effectively exhausted the primary insurance. The policyholders reasoned that the settlements did not increase the excess insurers’ liability and that requiring the primary insurers to pay the full limits of their layer, as a condition of coverage under the excess policies, served only to discourage settlement. Following the axiom that a policy must be enforced as written, the Arnoff court held the insureds were bound by the contract they purchased, notwithstanding competing public policy considerations. The court explained that:
The policy defines the method of exhaustion as actual payment by the "insurers of the Underlying Policies." The policy defines the "Underlying Policies" as the Primary Policy and the First and Second Layer Excess Policies. The payment amount is "the full amount of the Underlying Limit" and is specifically defined as the combined aggregate of the underlying policy limits (i.e. $30 million). Unlike the policy language in Zeig, the Third Layer Excess Policy's plain language is not ambiguous regarding the manner in which the underlying insurance policies must be exhausted. Thus, this Court, in accordance with well-established Illinois law, must enforce the plain language as written. Id. at (17-18.)
The court held that, because the insureds settled with the primary carrier for less than the policy limits, the insureds had not exhausted the limits of those policies and, therefore, the insureds had not met a necessary condition of coverage under the excess policies.
This, as well as other cases cited above, demonstrate that policy language, not public policy considerations, should govern policy interpretation and an insured that settles with a primary carrier for less than that primary insurer was required to pay under the primary policy, does so at its own peril.