PRIMARY AND EXCESS INSURERS:
What is "the deal" between them?
The Court of Appeal of Ontario has told us that the
obligations between primary and excess insurers, although not governed
by contract, should be subject to and governed by principles of
equity and good conscience. [See Broadhurst & Ball et al
v. American Home et al (1990) 1 O.R. (3d) 225 (C.A.)]
In the Broadhurst case, there was a single
primary policy at risk and a single excess policy issued by Guardian.
In its policy, Guardian had obligated itself to assume the defence
of any action against the insured and this obligation was not otherwise
qualified. A retention clause in the policy limited only the amount
to which Guardian was exposed to indemnify its insured but otherwise
did not diminish its duty to defend. The trial judge found that
the excess carrier had not had an obligation to participate in the
defence and the primary insurer bore the entire burden of the defence.
The primary limits had not, up until that point, been exhausted.
The Appellate Court found that it was manifest to all concerned
the potential judgment against the insured would substantially exceed
the limits of the underlying policy. Accordingly, it held that,
while an excess liability insurer was generally under no duty to
participate in the insured's defence until the primary coverage
was "exhausted", the excess carrier had an obligation
to defend the insured in these circumstances. The Appellant Court
was of the view that to hold otherwise would confer a win-fall on
the excess carrier by permitting it to have its defence obligation
discharged entirely by the primary carrier. It allocated the cost
of litigation equally. There was no real discussion about the supposed
windfall. In other words, the excess carrier lost the argument it
underwrote its excess coverage, as set out clearly in the policy,
on the basis that it was not required to defend the insured until
the underlying limits were, in fact, "exhausted" i.e.
paid out for indemnity.
In the now famous "cement" case, Alie
v. Bertrand & Frére Construction Co.,  O.J.
No. 1360 (Ont. Sup. Ct.), the Court was faced with circumstances
where there were a number of excess policies providing indemnity
coverage including defence of the insureds over various policy periods.
The plaintiffs were homeowners who had started experiencing problems
with foundations, which continually deteriorated over a number of
years. There were issues of allocation of damages over policy periods.
The Court found that the excess policies universally contained wording
by which coverage for defence costs was provided once the limits
of underlying insurance had been "exhausted".
In considering whether the excess insurers had a duty
to defend, the Court followed Broadhurst. It found that where
there was potential judgment against the insured that would substantially
exceed the amount of the limits of the underlying policy, the primary
policy "will be exhausted". Because the excess carrier
was plainly at risk, its duty to defend was triggered "upon
the reasonable perception that the claim could pierce into its layer".
It is suggested that excess carriers underwrite their policies on
the basis that they may well have a defence obligation, but only
where the primary policy limits are "exhausted" i.e. paid
out in full for indemnity thereby extinguishing the primary carrier's
duty to defend. To exhaust the underlying limits requires payment
of the underlying carrier's limits. It is the underlying carrier
that undertakes the conduct of a defence, which includes assessment
of policy coverage issues, and decides whether it is to tender its
policy limits in order to extinguish its policy obligations including
its duty to defend. The premium the excess carrier charges does
not contemplate it will conduct its own investigation to make such
a decision independently. The deal between these insurers is based
on the assumption the underlying carrier won't freely pay out its
full policy limits before it has satisfied itself the limits are
In complex cases where property damage has been occurring
over a number of years and there is are issues how to allocate this
to various policy years and where there are different excess carriers
with different policy limits at risk in any of these years, it is
usually not clear to an excess carrier whether claims will pierce
into its layer. It usually has no "reasonable perception"
until the underlying carrier pays its limits out. Although there
were a number of excess insurers and the damage occurred over a
number of policy years in Alie, the Court there adopted the
reasoning in Broadhurst where there were no such facts. It
is suggested that Alie did not address the "deal between
the insurers". There are virtually no decisions that do.
In Zeig v. Massachusetts Bonding 23 F. 2d 665
(2nd Cir.) 1928, the Court allowed an insured to proceed with an
action against its first party excess burglary insurer even though
the insured had settled its claim against its primary insurer for
less than the full underlying policy limits. The Court interpreted
the clause that provided the policy limits "be exhausted in
the payment of claims to the full amount of the expressed limits"
to require only that the underlying claims be satisfied. It was
not necessary that the full amount of the primary insurance be "collected".
As long as the insured only claimed from the excess carrier in excess
of the underlying policy limits, according to this Court, the defendant
excess insurer "had no rational interest whether the insured
in fact had collected the full amount of the primary policy or not".
In Zeig, there was no issue whether the "theft" was covered
under the primary policy. This case, therefore, does not address
the situation where there are concerns about policy coverage. In
addition, quantum was not in dispute. Quantum had been agreed to
by the insured and the carrier and as a fact, exceeded the primary
policy limit. There was no mention of any defence obligation, nor
any suggestion the excess carrier had some obligation to defend.
There was no discussion of the issues that are often at play between
primary and excess carriers. For these reasons, it is suggested
that Zeig should be limited to the particular facts of that case
and is not a precedent for the propositions for which it is often
cited. Unfortunately, the Zeig decision has been frequently followed
in the USA and it is cited there and in Canada for the proposition
that an insured may proceed against an excess carrier after settling
with the primary carrier for less than the primary limits as long
as the insured self-insures the gap created as a result of the settlement
with the primary carrier for less than its limits. The primary never
had to tender its limits as proof to the excess carrier of the true
risk the insured faced and it never had to conduct a complete investigation
and defend the insured for the benefit of the excess carrier either.
In circumstances where there are serious issues of liability and
quantum, which in turn give rise to issues whether or not insurance
coverage is afforded and, if so, whether the claims will exceed
policy limits, on what basis can it be said that an excess carrier
has underwritten an obligation to defend the insured or to be liable
for indemnification? The answer is "where the primary carrier
has, in fact, tendered its limits in full".
If the obligations between primary and excess insurers
are as set out by the Court in Broadhurst, "subject
to and governed by principles of equity in good conscience,"
it is suggested that excess insurers, in these cases, should not
have policy obligations prematurely imposed upon them by the Courts.
If a primary insurer forces the excess insurer to cover any part
of the primary insurers' exposure-for indemnity or defence-then
at the very least, the rate structure for the two types of insurance
should be adjusted. Since it is contemplated that the excess insurer
will not be directly involved in the investigation and defence of
any action, at least initially, it relies on the good faith obligation
of the primary carrier to do so thoroughly. The excess carrier has
written the excess liability coverage for a premium that is only
a fraction of that charged by the underlying carrier. This reflects
the good faith obligation by the primary carrier to conduct a proper
and complete investigation and defence or to tender its limits in
full. That is the only circumstance where it has agreed to do so.
The tendering of full policy limits is the proof of
good faith that is the "deal" between the carriers. The
excess carrier accepted the risk it may have exposure and will have
a defence obligation thereafter even where there may have been little
or no defence investigation. If the courts allow the primary carrier
to conclude a deal with the insured whereby it neither pays its
limits in full nor concludes a defence, the excess carrier has a
right to be suspicious it has been prejudiced. It hasn't had the
benefits of a full investigation and defence and it hasn't the benefit
of the payment of the full underlying limits either. And that was
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