Settling With Underlying Insurers For Less Than Policy Limits -- The Good, The Decent And The Ugly

When a policyholder resolves or settles an insurance claim that implicates multiple layers of insurance, and not every layer is settled at once, trouble is bound to ensue. Unfortunately, for many policyholders, this issue is first considered on the eve of settling a large claim implicating multiple coverage layers. As a result, policyholder after policyholder has unwittingly forfeited their right to excess insurance coverage, because they failed to understand what the law required of them, and failed to see how to use the law to their advantage in settling with their underlying insurers.

The Problem

This primary-excess settlement issue is almost ubiquitous. It lurks behind settlement of most any claim that triggers more than one layer of coverage. The situation typically arises when a lower-level insurer will settle a claim, but still wants some "credit" - however small - for all of those coverage defenses that its lawyers have raised. That "credit" commonly comes in the form of settling for an amount less than policy limits.

All the while, the excess insurers sit, confidently asserting the same defenses as the primary insurer, hoping that the policyholder makes a mistake in settlement that arms them with an additional coverage defense. Excess insurers have the luxury of sitting on their doubtful defenses, with little-to-no incentive to engage in good faith settlement discussions, because they stand a chance that the policyholder will make a critical mistake and relieve them from liability.

Thus, a question arises - can the policyholder settle with the underlying insurer for less than policy limits, then itself "fill the gap" between the settlement amount and the policy's limits of liability? Perhaps not surprisingly, the answer to that question comes from the excess policies themselves.

The Good, The Decent, and The Ugly

Exhaustion language in excess policies varies but generally falls into one of three categories: (1) the good, (2) the decent, and (3) the ugly.

1. The Good

   First, the "good" exhaustion language. A well-negotiated excess policy will clearly and unambiguously state that the policy is triggered after exhaustion of the underlying limits through payments by the underlying insurer, the insured or others on behalf of the insured. For instance, a good example of this exhaustion language reads:

   This Policy shall provide insurance excess of the Underlying Insurance. Liability shall attach to the Insurer only after (i) the insurers of...