Shaving of Limits Has Limits of Its Own

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1 Shaving of Limits Has Limits of Its Own May 2013 Lockton Companies When an underlying carrier does not pay its limit, the insured company may find itself at an impasse. After all, excess insurance does not trigger until the underlying limit is reached. That s where shaving of limits comes into play. It s a hot topic among risk managers and a rather tricky issue to navigate. This paper will help you make sense of it all. ERIC SILVERSTEIN Senior Vice President Risk Practices What Is Shaving of Limits? For companies that want to quickly settle a claim, protect their reputation and move on, the answer may be to shave the limits. In other words, they write a check to cover the amount not paid by the underlying carrier. Once that check is written and the limit is shaved, the excess insurance presumably becomes available. But that is not always what happens. For companies that want to quickly settle a claim, protect their reputation and move on, the answer may be to shave the limits. Different Interpretations, Different Expectations. The vast majority of excess policies do not recognize the reduction of an underlying limit unless the limit is exhausted through payment by the underlying insurer. For example, let s say there is a $25 million loss and your underlying insurer has a $5 million limit. Unless they pay every penny of that limit, the excess insurer does not have to pay. Several recent court cases have upheld this interpretation. L O C K T O N C O M P A N I E S

2 On the surface, this seems grossly unfair. If an insured company spends a few dollars to facilitate a settlement, should they not be rewarded? As you might expect, the answer to this is both yes and no. Insurers have a great deal of concern over the removal of clauses that require payment in full by the underlying insurer. In general, there is a disciplined process to excess settlement that leads to a more predictable pattern of payments. Insurers often follow the fortunes of the primary insurer for better or worse. If follow the fortunes is the linchpin of the excess industry, does removing that requirement threaten its very foundation? This logic may be a bit extreme, but some insurers view the issue this way. Most of the insurers who refuse to provide shaving of limits wording in their excess liability policies routinely include it in their directors and officers policies. In practice, large claims often include multiple claimants. Frequently, a settlement cannot be reached as a consequence of a single claimant s refusal to settle. On occasion, an insured may decide to settle, regardless of the insurer s position, in order to facilitate the most effective settlement for everyone involved. In these instances, a shaving of limits provision may very well be advantageous. When we address the shaving of limits issue with the insurance market, what we find is that the position of insurers varies based on the issue at hand. Virtually all insurers include wording that addresses the issue of insolvency of the underlying insurer. However, when the issue of partial payment of settlement arises, the field narrows. Removing all restriction is rare. Three Court Cases Illuminate the Issue Goodyear Tire & Rubber Co. v. Nat l Union Fire Insurance Company of Pittsburgh, PA, 694 F.3d 781 (6th Cir. 2012) This case involved a coverage dispute that led to a partial settlement by an underlying insurer. Although the claim was in excess of the attachment, the underlying insurer had settled with the insured for an amount lesser than the policy limit. As a consequence, the court ruled that excess coverage was not available. JP Morgan Chase & Co. v. Indian Harbor Ins. Co., 98 A.D. 3d 18 (1st Dep t 2012) When we address the shaving of limits issue with the insurance market, what we find is that the position of insurers varies based on the issue at hand. This is a complicated case where multiple claims were settled without clarification that could have matched policies to specific portions of the settlement. The result raised a question about whether the underlying limits had been exhausted. Preferred Construction, Inc., v. Illinois Nat. Ins. Co, No cv, 2012 WL (2d. Cir. Aug. 30, 2012) Exhaustion of underlying limits ruled a condition precedent if coverage is to apply. 2

3 How to Protect Yourself The first action is to review your excess policy. Chances are you will find the wording in one of four places: 1) Insuring Agreement, 2) Maintenance of Underlying Insurance, 3) When a Loss is Payable, or 4) Limits of Insurance. When the intent is clearly not to provide coverage, you are most likely to find an exception written in the insuring agreement. The example above is a common exception for insolvency of the underlying insurer. This type of clause is also often found in the bankruptcy or insolvency provision in the conditions section of many policies. 1) Insuring Agreements (examples)... If underlying insurance does not pay a loss for reasons other than the exhaustion of an aggregate limit of insurance, then we will not pay such loss. Ace Catastrophe Liability Plus Policy XSC (05/09)... If any underlying insurance does not pay damages, for reasons other than exhaustion of an aggregate limit of insurance, then we shall not pay such damages. Firemans Fund R The examples above suggest intent is to only pay upon exhaustion of underlying insurance by payment of the underlying insurer. 2) Maintenance of Underlying Insurance (example) If such underlying insurance is not maintained in full effect or if any limits of liability of underlying insurance are unavailable due to bankruptcy or insolvency of the underlying insurer, then the insurance afforded by this policy will apply in the same manner as if such underlying insurance and limits of liability had been in effect, available, so maintained or unchanged. Ace Catastrophe Liability Plus Policy XSC (05/09) 3) When a Loss is Payable (example) Coverage under this policy will not apply unless and until the insured or the insured s underlying insurance has paid or is obligated to pay the full amount of the total limits of all underlying insurance shown in item 6.B. of the declarations. Zurich Excess Policy U-EXS-100-CW (01/12) This example affirms that the insurer s intent is to consider shaving of limits via payment by the insured. In general, when affirmative coverage is provided, the terms by or on behalf of and insured or underlying insurer are used in conjunction with exhaustion of underlying limits. The insurer s intent is not always clear. In these cases, it is safe to assume that the insurer does not intend to provide an opportunity for shaving of limits. 3

4 4) Limits of Insurance (example) We will not make payment under this policy unless and until: The total applicable limits of scheduled underlying insurance have been exhausted by payment of loss to which this policy applies and any applicable, other insurance have been exhausted by payment of loss. Chartis Umbrella Prime Form (11/09) Although the above wording does not specifically require payment by the underlying insurer, AIG takes the position that this is implied and further supported by the definition of loss. What About a Retained Limits Form? If you have a retained limits form or endorsement, chances are that shaving of limits is less of an issue. Some insurers will volunteer retained limits wording options as a way to resolve the shaving of limits issue. However, keep in mind that retained limits wording in many cases stands on its own. This could create problems in consistency with coverage in underlying layers and possible issues with continuity in defense coverage. Endorsement Wording Most endorsements are manuscript and require a detailed review of the policy for continuity in terms. However, the basis of a well-written endorsement should: Modify the insuring agreement. Clearly include an obligation paid by or on behalf of the insured as eroding the underlying limit. Not include restrictions in addition to those previously included in the form. Shaving of limits wording can be an advantage; however, most issues are settled in good faith. Modifying the policy will serve to trigger the policy, but does not necessarily mean that the entire amount of the underlying claim will be covered. Be cautious about distinguishing between triggering coverage and where coverage attaches. The insurer may take the position that although the policy has been triggered, a portion of the underlying settlement is uncovered. Consequently, coverage could attach at a greater amount than you may have thought. Your Lockton excess casualty team has access to sample wording and is well-versed on the issues associated with shaving of limits. 4

5 Excess Casualty Practice Panel Members Practice Leader U.S. Tim DeSett Excess Casualty Practice Panel Members Practice Leader Tim DeSett Marjorie Hughes Nicole Lindstrom U.S Debbie Goldstine UK/BERMUDA Tony Hardy Jonathan Stokes Jason Riley Dirk vanheyst Mark Nieman Bruce Schneider Wendy Chen Paul Primavera (Claims) com Vince Gaffigan Nicole Holcomb Shawn Matthews Rex Cook Stephen Brown Stacy Seaberg Clay Brooks Greg Cohen Amanda Pocius g\unit_lewis\2013\excess casualty practice update draft march 2013.pptx\*** Lockton, Inc. All rights reserved. Images 2013 Thinkstock. All rights reserved.