Maximus Opinion Permits Functional Exhaustion Of Underlying Insurance

Excess insurers should carefully note both trends in the law, and particular policy language, that may potentially influence whether their policyholders can exhaust underlying policies without actually receiving payment of the full underlying limits. In its recent opinion in Maximus, Inc. v. Twin City Fire Insurance Company, No. 11-CV-1231, the U.S. District Court for the Western District of Virginia determined that an ambiguously worded follow-form excess policy permitted this result.

Policyholders seeking their full insurance limit from one or more underlying insurers for an expensive loss may decide to avoid risk, by entering into below-limits settlements with those insurers. After "filling the gap," by paying the difference between the below-limit settlement amount and the full underlying policy limit toward the loss, the policyholder may then call on its excess insurer and claim "functional exhaustion" of the underlying layer(s).

The Maximus court ruled that ambiguous language appearing in the third-excess professional liability insurance policy issued by Axis Reinsurance Company (Axis) permitted the insured (Maximus, Inc.) to exhaust the policy limits of all three underlying policies below Axis by (1) settling its coverage claims with each underlying insurer and (2) "filling the gap" by paying the difference between what each underlying insurer paid and the insurer's policy limit.

Maximus was involved in an underlying breach of contract lawsuit, arising from its provision of health and human services programs in the State of Texas. Maximus claimed coverage for total damages of $78.3 million based on the underlying settlement agreement.1 Addressing the terms of Axis's excess coverage for damages in the $60 to $70 million range, the court found that Maximus had satisfied the Axis policy's underlying-exhaustion requirement.

The Maximus court applied Virginia law to conclude that the Axis policy's exhaustion provision was ambiguous and relied on the "public policy favoring settlements" as articulated in the 1928 2nd Circuit case Zeig v. Massachusetts Bonding & Ins. Co., 23 F.2d 665 (2nd Cir. 1928).

According to the Maximus court, Zeig had concluded that it made no practical difference to an excess insurer whether its exhaustion point was reached by full collection of the underlying policy limits, so long as the excess insurer was only called upon to pay the portion of loss in excess of the underlying limits. And Zeig further commented...