Figuring Out The Insurance Exhaustion Rule In New York Is Exhausting

Although no New York state court has specifically addressed the issue, it has been the prevailing view among most insurance practitioners for decades that courts in New York would allow a policyholder to trigger excess coverage if it incurred losses sufficient to exhaust the limits of underlying coverage even if, for whatever reason, the underlying insurers did not actually pay the losses. This view was based on the Second Circuit's decision in Zeig v. Massachusetts Bonding & Ins. Co., 23 F.2d 665 (2d Cir. 1928). The Zeig court held that the insured could settle with the primary carrier for less than the primary limits and still trigger coverage under the excess policy, provided that the insured was responsible for the gap between the amount of the primary settlement and the excess policy's attachment point. While the Second Circuit held that actual payment by the underlying insurer was not necessary, it also stated, "It is doubtless true that the parties could impose such a condition precedent to liability upon the policy, if they chose to do so." Id. Thus, it remained unclear, following Zeig, whether an excess insurer could, as a condition to paying under its policy, require actual payment by the underlying insurers by including clear language imposing such a condition.

In a recent decision, Ali v. Federal Ins. Co., No. 11-5000-cv (2d Cir. June 4, 2013), the Second Circuit did little to clarify this issue. See http://www.ca2.uscourts.gov/decisions/isysquery/7e0c43c4-1c80-4f16-ada0-609c84774137/9/doc/11-5000_opn.pdf#xml=http://www.ca2.uscourts.gov/decisions/isysquery/7e0c43c4-1c80-4f16-ada0-609c84774137/9/hilite/. In a somewhat abstract decision, the Second Circuit held that if a policyholder merely incurs liabilities sufficient to exhaust underlying coverage—but does not actually pay them—it could not trigger its excess coverage. In Ali, the policyholders argued "that their liability must reach the attachment point in order to trigger excess coverage," while the excess insurers argued that "excess liability coverage is triggered only whenliability payments reach the attachment point" of the excess policies. Id., p. 2. The court did specifically address whether a policyholder can effectively exhaust underlying insurance by paying amounts sufficient to exhaust underlying coverage, but the decision leaves open the possibility that payment by the policyholder would be sufficient.

Ali involves the now-defunct Commodore International Limited...