Law firm partner predicts ‘more and more coverage disputes’ for excess layer insurance

Coverage disputes involving excess layer insurance look likely to increase, which could draw brokers into the “argy-bargy” between primary insurers and excess layer insurers, according to Fenchurch Law partner Jonathan Corman.

Speaking at the law firm’s Virtual Coverage Symposium event on Tuesday 8 December, Corman explained: “In an ever increasing hard market, there are fewer insurers willing to write excess layer insurance and I suspect there will be more and more coverage disputes in relation to excess layer policies as time goes on.

“By contrast with more disputes, there’s very little law in this country about excess layer insurance. There’s probably only two or three cases bang on point to do with excess layer insurance and there’s a few brokers’ [errors and omissions] cover negligence cases, which have excess layer insurance as their underlying context.”

Also known as excess of loss cover, excess layer insurance is a top-up liability product designed for businesses, which provides increased liability limits over the firm’s primary insurance cover. It can be written on a per claim or aggregated basis and will issue cover after the primary layer of insurance has paid out.

The main culprit for coverage disputes in this area – and where brokers can get caught in the middle – is when primary insurers and excess layer insurers disagree on coverage decisions.

“The point to emphasise here is that although the excess layer policy may well be written on a so called ‘follow form’, that does not mean anything equivalent to the excess follows the coverage decisions of the primary layer. And what it means is that the excess layer is therefore able to take policy points that the primary layer has chosen, irrevocably and irreversibly, not to take,” Corman explained.

Broker impact

An example of this, said Corman, is the Ocean Finance v Oval Broking case where “the policyholder Ocean Finance sued its producing and placing brokers for their combined failure to make the block [notification]”.

He explained: “That was a broker E&O case. The case was mainly about the broker’s failure to make a block notification or a blanket notification to what I’ll call policy year one and the broker failed to make a block notification to either the primary or the excess layer in year one, but they did say some things to the primary. The primary knew more about the problem than did the excess layer.

“Year one therefore expired without a block having occurred. Year two of the policy came into existence, again with the same primary layer and Hiscox writing the excess layer, and the problem got worse for the insured during the year.

“At the end of the year, the broker made their block notification to both the primary and the excess. The primary accepted the block and it mainly accepted the block because it had known more about the problem than had the excess [insurer], and therefore it felt it would be unfair or churlish or uncommercial to complain about the position.

“By contrast, the excess layer insurer, Hiscox, which hadn’t been given as much information on the renewal about the problem, decided it was going to stand on its strict legal rights and said that it didn’t need to deal with the problem under year two despite the block because it could instead rely upon a pre-existing exclusion. Hiscox took that point which the primary hadn’t.

“The result was that in the end, the policyholder Ocean Finance sued its producing and placing brokers for their combined failure to make the block during year one.”

Primary and excess layer insurers also came to blows in Friends Provident v Sirius. Corman continued: “Although the primary layer had accepted the validity of a circumstance, the excess layer sought to argue that the primary layer shouldn’t have done that and the notification wasn’t, in fact, effected.

“In practice, you may well see situations where there’s lots of argy-bargy between the broker and the policyholder on the one hand and the primary on the other, where the primary is or isn’t accepting notification and the brokers are urging the primary to say whether they’ll accept it or not.

“Even if the primary has accepted the notification, that doesn’t necessarily bind the excess layer by any means.”

This debate can lead to another potential problem in deciding which insurer is due to pay the claim.

Corman added: “The interests of the primary layer and the excess layer are in fact adverse to one another because it suits the primary layer for the claims to aggregate and penetrate upwards through the excess layer tower, whereas it suits excess layer insurers for the claims not to aggregate but instead to stack sideways and to hit the primary layer again and again.

“As long as the tower is big enough, there is cover for the claims, the only question is who should be paying them?”

Although primary and excess layer insurers may try to settle the matter of claims payment between them, this doesn’t always work – especially as there is no formal contract between the two insurers themselves.

If the policy wordings have dispute resolution clauses, the policyholder may have to resort to suing their insurers simply to get an answer on aggregation, Corman said. If these clauses aren’t included, however, the parties have to adopt an arbitration route, which could lead to the “nightmare” situation of contradictory results for each layer of insurance.

‘Nasty’ policy wordings

Corman added that in terms of notifications, there are “nice” and “nasty” excess layer policy wordings.

As an example, he cited a “nasty” clause from a TMHCC policy. This read:

“As conditions precedent to their right to be indemnified under this [policy], the insured shall inform the insurer as soon as practicable, provided always that such notification is received by the insurer before the expiry of the period of insurance, of the receipt, awareness and discovery of:

• Any claim made against them.
• Any notice of intention to make a claim against them.
• Any circumstance.

“Where the maximum potential liability from any such claim or circumstance exceeds 50% of the underlying insurance limits.”

Corman added that “there are two traps” here.

He continued: “First of all, this is a condition precedent and secondly, notification to be effective has to be made before expiry of the excess layer policy. And what that means, it seems to me, is that in the situation where the insured has got a problem which is being dealt with under the primary policy, and the problem doesn’t seem particularly large and doesn’t look like it’s going to be more than 50% of the underlying, you can’t effectively notify the excess layer then.

“If that remains the situation up until the policy expires, it’s always too late to notify them. If the problem then becomes much more serious two years later, there’s nothing you can do about it and the policy is useless.

“I would have thought it is a very risky thing to try and have a policy with this type of clause, unless you’ve warned your clients that this policy might be of very limited utility.”