(Article from Insurance Law Alert, September 2020)
For more information, please visit the Insurance Law Alert Resource Center.
Reversing a district court decision, the Ninth Circuit dismissed an “improper exhaustion” claim, ruling that an excess insurer may not challenge the payment decisions of underlying insurers absent a showing of fraud or bad faith, or the reservation of such a right in the governing policy. AXIS Reinsurance Co. v. Northrop Grumman Corp., 2020 WL 5509743 (9th Cir. Sept. 14, 2020).
Two lawsuits were filed against Northrop alleging ERISA violations, one by the Department of Labor (“DOL” action) and the other on behalf of the ERISA plan (“Grabek” action). Northrop settled both actions and then sought coverage from insurers in its multi-layered program of insurance. AXIS provided secondary excess coverage that “dropped down” when the combined $30 million limit of the underlying policies was exhausted for “covered loss” under those policies. National Union, a primary insurer, and CNA, a first-level excess insurer, both determined that the DOL settlement fell within coverage of their policies and therefore indemnified the settlement payment. Because CNA’s partial payment did not fully exhaust its liability limit, AXIS was not required to pay any portion of the DOL settlement. However, because the DOL exhausted National Union’s primary coverage, CNA covered the Grabek settlement as primary insurer. That payment exhausted CNA’s liability limits. Therefore, AXIS was called upon to pay the remainder of the Grabek settlement–approximately $9.7 million.
AXIS did not contest coverage of the Grabek settlement under its policy, but sought reimbursement of the DOL settlement on the basis that the payments made for that settlement by National Union and CNA were not for “covered loss.” In particular, AXIS argued that the DOL settlement payment constituted disgorgement, which is uninsurable under California law and an “uncovered loss” under the underlying policies. AXIS filed a declaratory judgment action against Northrop, seeking reimbursement of its payment. A California district court ruled in AXIS’s favor, endorsing AXIS’s “improper erosion” theory of recovery.
The Ninth Circuit reversed, finding no basis in case law or policy language for the improper erosion theory. Further, the Ninth Circuit reasoned that allowing excess insurers to contest the soundness of underlying insurers’ payment decisions “would undermine the confidence of both insureds and insurers in the dependability of settlements” and “introduce a host of inefficiencies into the insurance industry.”
Importantly, the court noted that an excess insurer remains free to contest claims submitted to it during the claims adjustment process, even if an underlying carrier has determined that the same claim constitutes a “covered loss.” Additionally, excess carriers may dispute payments on the basis of alleged fraud or bad faith. However, absent a specific contractual provision, an excess insurer “may not second-guess other insurers’ payments of earlier claims without first showing that those payment were motivated by fraud or bad faith.”