EXCESS INSURANCE NOT TRIGGERED WHEN UNDERLYING INSURANCE LIMIT NOT EXHAUSTED BY PAYMENT

EXCESS INSURANCE NOT TRIGGERED WHEN UNDERLYING INSURANCE LIMIT NOT EXHAUSTED BY PAYMENT

The Fifth Circuit, applying Texas law, recently held that where an insured accepts a compromise payment from its primary insurer for less than the primary limits, the excess insurers’ payment obligations are not triggered. Citigroup, Inc. v. Federal Insurance Co., et al., Case No. 10-20445, United States Court of Appeals for the Fifth Circuit (August 5, 2011).

Associates First Capital Corporation purchased $200 million in coverage in three layers. The first layer included a $50 million policy issued by Lloyd’s. Citigroup subsequently purchased Associates and later sought coverage from the insurers in connection with a $243 million settlement of two Associates matters. Citigroup entered into the settlement without the consent of the insurers, resulting in an initial coverage denial. Citigroup ultimately entered into a settlement with Lloyd’s pursuant to which Lloyd’s paid only $15 million of its $50 million layer. The excess insurers refused to pay, and Citigroup filed suit.

Citigroup then settled with the insurers in the second layer, and continued litigating the coverage dispute against the insurers in the third layer. The district court granted summary judgment in favor of the insurers, holding that their obligations to Citigroup did not attach until the primary insurer had paid its full limits. The excess policies at issue required that the “full amount,”“total,” or “all” of the underlying insurers’ limits of liability be exhausted before the excess limits attached.

On appeal, Citigroup attempted to rely on the seminal case of Zeig v. Massachusetts Bonding & Insurance Co., 23 F.2d 225 (2d Cir. 1928), arguing that where an excess insurance policy ambiguously defines “exhaustion,” settlement with an underlying insurer constitutes a "functional" or "constructive" exhaustion of the underlying policy for purposes of determining when the excess limits attach. The Fifth Circuit declined to follow the “Zeig rule,” stating that “we conclude that the plain language of the policies dictate that the primary insurer pays the full amount of its limits of liability before the excess coverage is triggered.”

The Fifth Circuit in Citigroup joins a growing list of recent judicial decisions rejecting the Zeig rule and requiring exhaustion of underlying insurance through actual payment of loss before an excess insurer is required to pay. In each of the decisions rejecting the Zeig rule, the excess policy language required complete exhaustion of the underlying policies, and the courts found that language to be unambiguous.