March 2014 Excess Insurance and Umbrella Coverage: When Is the Defense Duty Triggered?

By Diane Polscer

Pure Excess and Umbrella liability insurance are often confused for the same thing, and the terms routinely are used interchangeably.  In fact, umbrella coverage is often just a type of excess insurance that provides coverage different than pure excess insurance. Usually, an umbrella policy may provide pure excess insurance under one coverage form and drop-down umbrella coverage under a separate coverage form.  Under pure excess coverage, a defense obligation may be triggered only when the underlying insurance is exhausted by payment of settlements or judgments.  By contrast, under umbrella coverage,a defense obligation under the latter may be triggered on a primary basis due to gaps in coverage.

This distinction has been addressed by the Washington Court of Appeals in a series of cases.  In Christal v. Farmers Ins. Co. of Washington, 133 Wn. App. 186, 135 P.3d 479 (2006), the Court stated: “whereas excess policies provide coverage over and above that available through an underlying policy, an umbrella policy may provide primary coverage in areas not otherwise covered.” As the Court explained in Diaz v. Nat’l Car Rental Sys., Inc., 143 Wn.2d 57, 64, 17 P.3d 603 (2001),“[t]he name given the policy however is not the controlling factor as to whether the policy is excess, primary or umbrellas.”For the insurer, the difference between a pure excess policy and an umbrella policy can mean the difference between owing a duty to defend the insured and not.  Two recent cases illustrate this distinction.

In a recent decision, the Washington State Court of Appeals confirmed that an excess insurer has no obligation to defend or indemnify until after underlying insurance coverage is exhausted. QuellosGrp. LLC v. Fed.Ins. Co., 312 P.3d 734, 2013 WL 5989370 (Wash. Ct. App. Nov. 12, 2013) (published).TheQuellosdecision involved an insured that purchased several tiers of excess insurance totaling approximately $30 million in excess coverage.  The underlying insurer carried a $10 million policy and paid approximately $5 million of the $10 million to settle certain claims on behalf of the insured, Quellos. Quellos then paid the remaining $5 million out of its own pocket in an attempt to trigger the $30 million in excess tiers.   The Court, however, found that the excess insurance was only triggered by exhaustion of the underlying insurance through payments by the underlying insurer.  The Court relied on the plain language of the excess policies in rejecting the insured’s attempt to self-exhaust the underlying limits. Notably, the Court also rejected the insured’s argument that the exhaustion of the underlying limits was a “condition” of the excess policy for which the insurer must show prejudice, finding that the use of the terms “only after” “reflects the distinguishing characteristic and function of an excess insurance policy” and was not a condition of the policy. Quellos,2013 WL 5989370 at *16.

Conversely, in National Fire & Marine Ins. Co. v. Certain Underwriters at Lloyd’s London, 169 Wn. App. 1016, Not Reported in P.3d (2012), the Washington Court of Appeals held that under an umbrella policy an insurer is required to defend against claims that trigger a gap in underlying policy coverage.  The Court found that an “umbrella policy provided coverage for amounts exceeding the limits of the underlying or primary policy and protects against gaps in that underlying policy” and “umbrella insurers typically agree to provide not only excess coverage on claims within the ambit of the insured’s primary policy, but also primary coverage for those claims not included in the insured’s basic primary coverage.”  The Court deemed this umbrella coverage to apply on a primary basis as “gap-filling” coverage.

As a result, the Court in National Fire held that “when gaps in a primary policy’s coverage trigger the gap-filling provisions in an umbrella policy, Washington courts treat the umbrella policy as a primary policy for purposes of duty to defend and duty to indemnify analysis.”  Thus, an umbrella insurer may have a duty to defend even though there is a primary insurer that has already picked up the defense.  In National Fire,the Court found that the umbrella policy provided gap-filling coverage in at least four different ways:(1) the underlying policy’s “your product” exclusion contained no real estate exception like the umbrella policy;(2) while the underlying policy had a fiduciary exclusion provision, the umbrella policy did not, and the complaint contained allegations of breach of fiduciary duty;(3) the umbrella policy contained no alienated premises exclusion similar to the underlying policy; and (4) the umbrella policy was issued over different years than the primary policy and therefore provided gaps in policy years.

The National Fire Court ultimately determined that the umbrella insurer owed a defense obligation despite the fact that other primary insurers had picked up the defense. The Court also provided some guidance on how to determine whether the policy provides drop down or pure excess defense obligation, stating that, had the umbrella insurer intended to bind itself to defend only if no other insurer had a duty to defend, it should have used that language.  Even though the umbrella policy in National Fire provided a defense only where the underlying policy did not provide “coverage,” the Court observed that “coverage” is different than “defense.”

These two cases highlight an important distinction in pure excess and gap-filling umbrella coverage when it comes to an insurer’s obligation to defend. Thus, it is important to recognize the differences in the policies and not assume that there is no defense obligation simply because there is an excess policy issued, especially in Washington, where a wrongful denial of a defense obligation can have dire consequences, including waiver of coverage defenses and policy limits. Safeco v. Butler, 118 Wn.2d 383, 823 P.2d 499 (1992).The Quellosand National Fire decisions illustrate how important it is to look at the language actually used in the policy in determining what type of coverage is afforded and not simply relying on the name of the policy or general description in the declaration page.