Insurance/Reinsurance Report

December 2020 | Vol. 9
Where Advocacy Meets Business

Exhaustion of underlying policies vs. follow-the-settlements?  It comes down to policy language 

Reinsurer was bound by cedent’s settlement allocation based on pre-settlement exposure analysis.

Fireman’s Fund Ins. Co. v. OneBeacon Ins. Co., Case No. 1:14-cv-04718-PGG (S.D.N.Y. Oct. 19, 2020).

In its 2004 ruling in North River Ins. Co. v. ACE Am. Reins. Co., 361 F.3d 134, 139-40 (2d Cir. 2004), the Second Circuit held that a follow-the-settlements clause requires a reinsurer to follow not only the cedent’s settlement of a claim, but also its post-settlement allocation of a claim affecting multiple policies.  Specifically, the Second Circuit upheld the cedent’s use of a “rising bathtub” allocation, in which the settlement was allocated to lower layer policies before higher layer policies, despite a reinsurer’s contention that the allocation should have been in accordance with the cedent’s pre-settlement exposure analysis.

In Fireman’s Fund, these roles were reversed.  The cedent allocated a settlement in accordance with its exposure analysis, while the reinsurer argued, in effect, that the cedent should have used the rising bathtub method.  The court, however, held that follow-the-settlements applied, and that the allocation was therefore binding on the reinsurer.  The case presented issues including both (i) the effect of North River, and (ii) whether the cedent’s lower layer policies could be deemed to have been exhausted by the settlement.

The policyholder, ASARCO, was in the business of mining and processing asbestos.  It faced thousands of claims arising from injuries resulting from asbestos exposure.  ASARCO had several layers of insurance in several years during which the underlying claimants had been exposed to asbestos.  ASARCO turned to its insurers to cover its losses.

Fireman’s Fund had issued three excess liability insurance policies to ASARCO.  Policy 1 was effective  during the 1982 underwriting year, and Policies 2 and 3 were effective during the 1983 year.  Policies 1 and 2 covered $20M excess $30M, while Policy 3 covered the higher $20M excess $75M layer.

Fireman’s Fund’s pre-settlement exposure analysis indicated that its total potential exposure was $50.3 million.  This estimate meant that all three policies were exposed.

Fireman’s Fund eventually settled ASARCO’s coverage claims for $35 million.  It then allocated the settlement amount across its three policies, assigning each a percentage of the settlement amount commensurate with its estimated exposure.  This resulted in an allocation of $8.1 million to Policy 3.

OneBeacon was a facultative reinsurer of Policy 3.  It denied Fireman’s Fund’s billing on two main grounds, arguing that:  (1) the $35M settlement could not have exhausted the two lower layer policies, whose total limits were $40M; and (2) the Second Circuit’s North River decision required Fireman’s Fund to adopt a rising bathtub allocation.  Fireman’s Fund filed suit.

OneBeacon’s first argument was based on the Payment of Loss provision in Policy 3.  The provision stated that “the insurance afforded under this policy shall apply only after all the underlying insurance has been exhausted.”  OneBeacon contended that this language unambiguously required that the full limits of the underlying policies be paid to ASARCO before coverage under the reinsured Policy 3 was triggered.  Fireman’s Fund argued that the term “exhausted” did not clearly require actual payment of the full underlying limits to ASARCO, but rather allowed exhaustion by settlement.  Further, Fireman’s Fund argued that follow-the-settlements gave it the discretion adopt this reasonable interpretation of the policy.

The court agreed with Fireman’s Fund on this point.  Its review of the case law showed that cases requiring actual exhaustion of underlying policies explicitly required exhaustion ‘“as a result of payment of losses thereunder,’” which the court noted “is not present here.”  In contrast, it noted, the exhaustion language in Policy 3 “does not ‘require collection of the primary policies as a condition to the right to recover excess insurance.’”  Absent that explicit requirement, it was at least arguable that the underlying policies could be exhausted by settlement, and reasonable for Fireman’s Fund to read them that way.  As a result, follow-the-fortunes made this reading binding on OneBeacon.

The court also rejected OneBeacon’s suggestion that the North River decision required Fireman’s Fund to adopt a rising bathtub allocation.  The court ruled that the decision had held only that such an allocation is permissible, not that “the ‘rising bathtub’ approach was mandated.”  Accordingly, the court held that OneBeacon was bound by Fireman’s Fund’s allocation based on its exposure analysis, and granted summary judgment to Fireman’s Fund.

Full disclosure:  Chaffetz Lindsey represented Fireman’s Fund before the S.D.N.Y.

Read the court’s full decision here.

Eight or Sixteen Corners?  Court Can Look Outside The Language Of Complaint To Find No Duty To Defend

Undisputed facts outside complaint against insured demonstrated that claim fell within policy’s pollution exclusion.

BBG Design Build, LLC v. S. Owners Ins. Co., 820 F. App’x 962 (11th Cir. 2020).

A liability insurer’s duty to defend is ordinarily determined by looking solely at the language within the four corners of the complaint and comparing it against the four corners of the policy.  Courts sometimes refer to this rule of contract application as the “eight corners rule.”  If the complaint can be read to allege a potentially covered claim, the duty to defend is triggered.  However, in certain circumstances, the court may look outside the operative complaint when assessing the duty to defend.  BBG Design presented such a case.

The insured, BBG Design, was a general contractor.  Patricia Armor was an employee at a recreational facility on which BBG was performing work. Armor was exposed to construction debris, and she filed a complaint against BBG in Florida court.  Armor’s First Amended Complaint alleged only that she had sustained “bodily injury” from “construction debris” at the site.

However, prior to filing suit, Armor’s attorney sent a pre-suit demand package to BBG’s insurer, Southern Owners, which included a letter alleging that she had been injured after being “exposed to hazardous fumes and dust” due to BBG’s construction activities, and medical records indicating that Armor suffered from bronchitis after being exposed to fiberglass.  In her original complaint, Armor alleged that she suffered respiratory illness after BBG’s failure to implement proper controls caused “dust and airborne fiberglass” to be released into the air.

BBG sought a defense from Southern Owners under its commercial general liability policy.  Southern Owners denied any duty to defend BBG, relying on the policy’s pollution exclusion for bodily injury “which would not have occurred in whole or party but for the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of ‘pollutants’ at any time.”  The policy defined “pollutants” as “any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.”  BBG argued that the operative First Amended Complaint triggered Southern Owner’s duty to defend because it alleged only that Amber suffered bodily injury from construction debris, and therefore did not unequivocally plead facts that fit “solely and entirely” within the policy’s exclusion exception.

Southern Owners argued that that there was no coverage, applying an exception recognized by Florida courts to the general rule that the duty to defend depends only on the facts alleged in the four corners of the complaint.  Under this exception, the court may “consider extrinsic facts if those facts are undisputed, and, had they been pled in the complaint, they clearly would have placed the claims outside the scope of coverage.”  This is a judicially crafted “equitable remedy when it is manifestly obvious to all involved that the actual facts placed the claims outside the scope of coverage.”  The rule recognizes that “the right to an early resolution of a coverage issue should turn on the merits – on whether a policy exclusion applies and not on creative pleading.”

The district court agreed with Southern Owners and the Eleventh Circuit affirmed, holding that the undisputed facts set forth in Armor’s pre-suit demand package and her original complaint clearly demonstrated that the claim fell squarely within the unambiguous terms of the pollution exclusion, which “clearly encompasses the construction debris of the sort of which Armor complained.”  Accordingly, Armor’s First Amendment Complaint was “an attempt to plead into coverage despite the uncontroverted facts.”  Considering those undisputed facts, “Southern Owners did not breach its duty to defend BBG in the underlying lawsuit.”

Read the court’s full decision here.

Fifth Circuit Holds Insurer Had No Duty To Defend Criminal Complaint Against Insured For Environmental Contamination

Criminal complaint was not a “claim” under policy because it did not seek clean-up costs from insured.

Waste Mgmt., Inc. v. AIG Specialty Ins. Co., 974 F.3d 528 (5th Cir. 2020).

Following a series of heavy storms, a landfill in Hawaii owned by Waste Management, Inc. was flooded discharging contaminated water into the Pacific Ocean.  This resulted in two proceedings against Waste Management and related entities.  First, in January 2011, the EPA issued an Administrative Order on Consent (or AOC) requiring Waste Management to remediate the discharge.  Waste Management completed the remediation required by the Administrative Consent Order by August 2011.  Second, in 2014, two Waste Management employees and a subsidiary were indicted for criminal violations of the Clean Water Act.  The Waste Management parties entered into a plea and were sentenced to pay fines, restitution, and assessments.

AIG Specialty Insurance Company (ASIC) had issued a policy to Waste Management covering losses from “a Claim for Clean-Up Costs resulting from a Pollution Condition.”  The policy defined a “claim” as “a written demand … alleging liability or responsibility and seeking a remedy on the part of the Insured for Loss under” the clean-up cost coverage.  It also excluded “Claims or Loss . . . due to any criminal fines, criminal penalties or criminal assessment.”

Waste Management sought defense coverage for the criminal proceedings, arguing that the Administrative Consent Order constituted a clean-up claim that triggered ASIC’s duty to defend the related criminal proceedings.  Alternatively, Waste Management argued that the criminal indictment itself constitute a “claim” under the policy.  The Fifth Circuit affirmed the district court’s summary judgment in favor of ASIC, holding that, as a matter of law, ASIC owed no duty to defend.

First, the court found that, on their face, the Administrative Consent Order and the criminal complaints were independent.  The Administrative Consent Order issued months before the commencement of the grand jury proceedings, and Waste Management completed the required clean-up work nearly three years before the indictments were issued.  The court further held that the unambiguous policy language defeated Waste Management’s argument that the Administrative Consent Order and the criminal complaints were related based on federal enforcement guidelines.  The court pointed to the policy’s requirement that “[w]hen there is a claim for clean-up costs, ASIC has a duty to defend against ‘such claim,’” which it held was a “common-sense limit on ASIC’s duty to defend” to the specific claim for clean-up costs.  According to the court, accepting Waste Management’s argument “that the AOC, read in combination with the guidance documents, triggered a duty of ASIC to defend in all criminal or civil proceedings arising from the same pollution incidents, would effectively [read] this bargained-for restriction [on defense coverage] out of the contract.”  The court held it was “not at liberty to do so.”

In addition, the court held that the indictment itself did not meet the policy definition of a “claim,” because it did not seek a remedy from Waste Management.  The court rejected Waste Management’s argument that the lack of an explicit demand in the indictment introduced an ambiguity about whether there was a “claim,” because “clean-up costs were a potential outcome of the criminal proceedings.”  The court declined to “look outside the pleadings, or imagine factual scenarios that might trigger coverage.”  “Under the plain language of the contract,” “the indictment does not seek a remedy, so it did not trigger the duty to defend.”

Read the court’s full decision here.

In Case Of First Impression, California Law Rejects Tort Liability Of Reinsurer For Breach Of The Implied Covenant Of Good Faith

Reinsurance does not implicate the same policy concerns that warrant tort liability for certain direct insurers.

Cal. Capital Ins. Co. v. Maiden Reinsurance N. Am., Inc., Case 2:20-cv-01264-ODW-JPR (C.D. Cal. July 16, 2020)

In California Capital Insurance Company, the court resolved a question of first impression under California law – can a cedent recover tort damages for a reinsurer’s breach of the implied covenant of good faith and fair dealing?  The court predicted that the California Supreme Court would hold it could not.

From 2006 through 2016, Maiden Reinsurance North America, Inc. (MNRA) provided multi-line treaty reinsurance to California Capital Insurance and related entities (CIG).  CIG alleged that, after MNRA’s acquisition by a company in the business of purchasing failing reinsurance companies, MNRA “began fabricating reinsurance coverage disputes.”  CIG alleged that MNRA breached the implied covenant of good faith and fair dealing by, among other things, failing to pay previously accepted claims, failing to conduct appropriate investigations, seeking reimbursement for previously paid claims, and unreasonably delaying the payment of valid claims.  CIG sought tort damages for MNRA’s alleged bad faith, including attorneys’ fees and statutory penalties, arguing that reinsurance is a form of insurance, and therefore the same tort remedies available in some direct insurance cases should be available in the reinsurance context.

MRNA moved to dismiss CIG’s claim for breach of the implied covenant of good faith, arguing that reinsurers cannot be held liable in tort for breach of the implied covenant.  The court dismissed the claim to the extent it sought tort damages.

The court first found that, under California law, tort damages are generally not available for breach of contract.  While the California courts have recognized a narrow exception to this rule in certain insurance cases involving “elements of adhesion, public interest, and fiduciary responsibility,” that exception is itself narrow, as demonstrated by California decisions holding that tort damages are not even available in certain insurance contexts.

The court further held that reinsurance contracts do not implicate the same policy considerations applicable to certain direct insurance.  First, the district court determined that reinsurance contracts are not contracts of adhesion.  Second, because reinsurance contracts are intended to increase profits, rather than provide peace of mind or protect against calamity, reinsurance contracts do not implicate the same public interest concerns as some insurance contracts.  Finally, reinsurance contracts lack the elements of fiduciary responsibility present in some insurance contracts, such as liability policies that call upon insurers to defend third party claims on behalf of the insured.  Reinsurers “have no comparable duties to investigate or defend claims between third parties and the underlying liability insurers or their insureds, nor do they owe any duty of good faith and fair dealing to the original insureds, unless the reinsurance agreement somehow specifically so provides.”

Read the court’s full decision here.

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