Non-Covered Claims May Exhaust Primary Limits, Trigger Umbrella

A recent ruling from the Fifth Circuit Court of Appeals clarified that an umbrella policy may be triggered even when the underlying insurance is exhausted by claims that would not be covered by the umbrella policy itself. The case bears importantly on the relationship between excess and primary policies, highlighting the need for clarity in policy language and reminding insurers not to make assumptions about the mechanics of the policies, as the contract language will control the parties’ obligations.

In Indem. Ins. Co. v. W&T Offshore, Inc., 2014 U.S. App. LEXIS 11775 (5th Cir. June 23, 2014), an energy company turned to its insurers for recovery after Hurricane Ike damaged the company’s offshore operations in the Gulf of Mexico. The company had numerous layers of insurance including primary insurance with coverage limits up to $150 million, and a secondary layer of umbrella coverage to cover losses in excess of the primary coverage. While the primary policy covered a broad set of losses, the umbrella coverage was restricted to a much narrower set of losses and notably excluded coverage for property damage.

The company exhausted the $150 million limits of its underlying insurance with property damage claims and then sought coverage from its umbrella insurer for an additional $50 million in separate losses from removal of debris expenses.

The umbrella insurer sought a declaratory judgment that its policy did not cover the company’s claims, arguing that the policy took effect only if the primary insurance was exhausted by claims that would be covered by the umbrella policy itself. Because the underlying limits were exhausted by property damage claims, which were covered by the primary insurance but not by the excess insurance, the umbrella insurer asserted that the retained limit had not been exhausted for the purpose of triggering the umbrella coverage for removal of debris expenses.

The company argued, however, that the plain language of the umbrella policy obligated the umbrella insurer to respond when the underlying limits were exhausted, “without regard to the nature of the costs that resulted in the depletion.”

Specifically, the policy granted coverage for “those sums in excess of the Retained Limit that the Insured becomes legally obligated to pay,” and defined Retained Limit, in pertinent part, as the total of the limits of the underlying primary policies. A subsequent section provided: “If the applicable limits of insurance of [the underlying policies] are reduced or exhausted by payment of one or more claims that would be insured by our policy we will… pay in excess of the reduced underlying limits… or… continue in force as underlying insurance.” The umbrella insurer pointed to this section as restricting the exhaustion of the Retained Limit to claims covered by the umbrella policy itself. The trial court agreed with this interpretation of the policy and cited to Westchester Fire Ins. Co. v. Stewart & Stevenson Services, Inc., 31 S.W.3d 654 (Tex. App. Houston 1st Div. 2000), which stated, “Allowing a non-covered claim to erode the underlying limits would accelerate the excess carrier’s obligations and effectively make it ‘primary’ on claims which its policy does not otherwise cover, thereby undercutting the excess nature of the policy.”

But on appeal, the Fifth Circuit took a different view and reversed the trial court’s ruling. The Fifth Circuit said the subsequent provision relied upon by the umbrella insurer did not qualify how the insured could satisfy the Retained Limit, but rather outlined additional obligations for the insurer in the event that the claims both exhausted the Retained Limit and were covered by the umbrella policy itself. “[The policy] merely outlines what will happen if the underlying insurance is entirely exhausted by claims covered under the policy” and “says nothing about what will happen if the Retained Limit is exhausted by non-covered claims” and “makes no claims about the breadth of coverage or requirements for exhausting the Retained Limit.”

In addition, the Fifth Circuit distinguished the policy at issue in Westchester. Rather than finding the case and the policy analogous, the court noted that the policy in Westchester explicitly stated that the underlying insurance would not be considered exhausted unless it was exhausted by claims covered under the excess policy. However, the umbrella insurer in W&T included no such limitation and the policy only stated what would occur if the Retained Limit was exhausted by covered claims. The court observed that if the umbrella insurer truly wanted to restrict the manner in which the Retained Limit could be satisfied, it could have added language like that in Westchester, rather than relying on the assumption—and logical fallacy, as the court underscored—that its provision impliedly restricted coverage because “one provision is the converse of the other.” The court concluded that the policy did not restrict the manner in which the Retained Limit could be exhausted and therefore the umbrella coverage applied.

Parties need to pay attention to the plain language and basic mechanics of their policies. Insurance policies are contracts and their words control the rights and obligations of the parties. As the Fifth Circuit highlighted, insurers should explicitly outline their expectations within the terms of the agreement and ensure that the provisions work together to represent the intentions of the parties. While certain rules may govern the relationship between primary and excess policies, courts will not presume the mechanics of the policies and coverage will depend on the stated language of the agreement, not implied assumptions.