When writing a newsletter with an aim to focus on unique cases, there is nothing better than a decision that states, in the first sentence, that the court will be addressing an issue of first impression. When this happens my eyes open wide and I begin to read with the anticipation of a child opening a box on Christmas morning. Unfortunately, sometimes the experience disappoints, like for the youngster who opens Aunt Mildred’s gift and finds a sweater. But usually the decision lives up to the pre-game hype.
This is what happened in Axis Reinsurance Co. v. Northrop Grumman Corp., No. 19-55135 (9th Cir. Sept. 14, 2020), where the court announced in its opening stanza that it was addressing an issue of first impression, at least in its circuit.
In simple terms, Northrop Grumman had a multi-layered Employee Benefit liability insurance program. National Union had the first $15 million. CNA had the next $15 million and AXIS had $15 million on top of that.
There was a settlement of two claims. The first was called the DOL Settlement. National Union determined that it was covered, paid a portion of it and its $15 million policy was now exhausted. CNA also believed that the settlement was covered and paid the remainder. AXIS had no involvement. The DOL Settlement did not reach its layer.
Next was the so-called Grabek Settlement. With National Union now exhausted, CNA paid part of it - $7 million -- with its remaining limits and was exhausted. AXIS was now up to the plate and called upon to pay the remainder of the Grabek Settlement -- $9.7 million.
Here’s the issue. AXIS did not dispute that the Grabek Settlement was covered and paid its portion. However, AXIS believed that the DOL settlement was not covered under the National Union and CNA policies, on the basis that it involved uncovered disgorgement. Therefore, as AXIS saw it, the erroneous decisions by National Union and CNA, to pay the DOL Settlement, resulted in the AXIS policy being prematurely triggered for the Grabek Settlement.
AXIS filed a coverage action against Northrup seeking reimbursement of the amount of its payment of the Grabek Settlement. The District Court found for AXIS, adopting its theory of “improper erosion.”
However, for various reasons, the Ninth Circuit reversed. To the appeals court, the insured should not have to bear “the risk that an excess insurer might disagree with payment decisions made by underlying insurers, and might withhold payment of valid claims it would otherwise cover to compensate itself for the exposure caused by those allegedly improper payments.” An exception exists, the court noted, if the exhaustion was motivated by fraud or bad faith. Not at issue here. Therefore, AXIS could not obtain reimbursement from Northrup of its payment for the Grabek Settlement.
Continuing its public policy-esque conclusion, the court stated: “We agree with Northrop that the district court’s alternative rule—that excess insurers generally may contest the soundness of underlying insurers’ payment decisions—would undermine the confidence of both insureds and insurers in the dependability of settlements, eliminating one of the primary incentives for obtaining insurance in the first place. Furthermore, such a rule would introduce a host of inefficiencies into the insurance industry, with no obvious countervailing benefits to insurers or policyholders.”
The case is certainly a win for policyholders, especially those insured under layered programs, with multiple claims, where the insurers in the tower may not agree with the coverage decisions made on certain ones. This is the scenario that can give rise to arguments, by higher layer insurers, that they were prematurely triggered.
I mention this scenario because the court noted that its rule did not apply where there was a dispute between insurers on a specific claim: “[A]n excess insurer remains free to contest claims submitted to it during the claims adjustment process, even when an underlying insurer has already determined that the same claim falls within the scope of coverage.”
But, despite the win here for insureds, the court also opened the door to insurers having the potential ability to contract for the right to argue improper erosion: “Of course,” the court observed, “excess insurers may contract around this general rule by including specific language in their policies reserving a right to challenge prior payments (so long as the provision is not prohibited by applicable law).”
On that last point, about the provision needing to not be prohibited by applicable law, the court made this observation: “We note that Northrop argued only that the inclusion of ‘improper erosion’ clauses in excess policies would be impractical and unwise, not that they would be per se illegal. Neither party has pointed to any public policy or provision of the California Insurance Code prohibiting such clauses as a matter of law, nor are we aware of any.”
Whether “improper erosion” clauses will be inserted in policies by excess insurers creates beaucoup issues, even if they are legally permissible. That’s an issue for down the road and well beyond the scope of discussion here. Until then, Northrup is an important win for policyholders that use certain types of layered insurance programs.
