The relationship between excess insurers and primary insurers is a complex one. There typically is no contractual relationship between them. Instead, both have contractually agreed to provide insurance coverage to a policyholder. Based on those contractual obligations, many states hold that each insurer owes the policyholder a duty of good faith and fair dealing to evaluate claims and settle them within limits if it is reasonable to do so.1 And yet, the actions of the primary insurer and the excess insurer in fulfilling those duties can prejudice the other depending on the circumstances.
For example, an excess insurer may sue a primary insurer for failing to undertake obligations that the primary insurer owes the policyholder, typically via a claim for equitable subrogation. The excess insurer essentially steps into the policyholder's shoes and argues that the primary insurer's failures in its duties to the policyholder have damaged the excess carrier's rights or, more specifically, its pocketbook2 . This can happen if the primary insurer fails to defend a policyholder when it should, leaving this obligation to the excess carrier. It more commonly occurs when the primary carrier has an opportunity and obligation to settle a claim within its limits to avoid exposing the policyholder or excess carrier to a judgment in excess of the primary limits but fails to do so.3
Conversely, the excess carrier may owe duties to the primary carrier. For example, some states provide that if a claim is likely to invade the excess layer, the excess carrier should participate financially and in a prorated fashion in the policyholder's defense.4 Also, if the excess carrier has the opportunity and obligation to settle a claim within its limits and fails to do so, the excess carrier may be liable to the primary carrier defending the claim, which should be settled. In such an instance, the primary carrier is expending resources defending a lawsuit that should be settled,5 and therefore, the actions of the excess carrier have prejudiced the primary carrier.
The recent case of Westport Ins. Corp. v. Penn National Mutual Cas. Ins. Co., 6 decided by the U.S. Court of Appeals for the Fifth Circuit in September 2024, provides an interesting case study for the mutual rights and obligations between excess and primary carriers. In that case, an insurance broker was sued by a marina owner client for failing to procure insurance to cover a marina. The marina was badly damaged in a storm, and the owner sued the broker for breach of contract. During the litigation, the primary carrier for the broker received but refused to pay five different settlement demands within the primary carrier's policy limits. The case went to trial, resulting in a judgment against the broker for substantially more than the primary policy limits.
Interestingly, the primary carrier initially sued the excess carrier for breach of the excess policy via equitable subrogation. Because the judgment was more than the primary limits, and a bond was required to prevent the garnishment of the broker's assets, the primary carrier ultimately put up the bond for amounts well above its policy limit with the understanding that the excess carrier would pay its portion of any judgment. However, the excess carrier refused to pay the amount exceeding the primary carrier's limit, asserting that the primary carrier improperly handled settlement negotiations prior to the trial.
The excess carrier then counter-sued the primary carrier (again, via equitable subrogation) for breaching the primary policy by failing to settle the case within the primary limits when the primary carrier had several opportunities to do so. In its cross-claim, the excess carrier sought an additional sum it had paid beyond the amount paid by the primary carrier after the underlying judgment became final, with all appeals exhausted. Following a Texas jury trial on the coverage dispute, the jury found in favor of the excess carrier based on the primary carrier's failure to settle within its limits.
On appeal, the main issue was whether the failure of the primary carrier to pay the settlement demands within its limits was a "defense" to the excess carrier's failure to pay the judgment in excess of the primary carrier's limit of liability. The district court, on summary judgment, determined that the excess carrier breached its duties to pay, and the excess carrier did not contest this finding on appeal. Instead, the excess carrier's position was that its breaches of the excess policy did not damage the policyholder because the primary carrier had already breached its obligation to pay the settlement demands, which the excess carrier argued was a "policy defense" to its obligation to reimburse the primary carrier for the amounts it paid in excess of its limits. The district court agreed.
However, the appellate court disagreed with the excess carrier's position and the district court's decision. The appellate court held that once it was determined that the excess carrier had breached its policy, the district court should have ordered the excess carrier to reimburse the primary carrier. The appellate court also found, however, that the error was "harmless" because once the jury found that the settlement demands should have been paid by the primary carrier, the primary carrier would have had to return the funds to the excess carrier. Thus, the appellate court effectively determined that the excess carrier could not assert the primary carrier's breach of the primary policy as a defense to its failure to honor its obligations under the excess policy.
The Westport case is a stark reminder that although primary and excess carriers act concurrently in their duties to the policyholder, those duties translate into duties to each other. Ultimately, the primary carrier's duty to pay reasonable settlements when afforded the opportunity to do so may trump any duties breached by the excess carrier in the same claim.
The Westport case is a stark reminder that although primary and excess carriers act concurrently in their duties to the policyholder, those duties translate into duties to each other. Ultimately, the primary carrier's duty to pay reasonable settlements when afforded the opportunity to do so may trump any duties breached by the excess carrier in the same claim.
Footnotes
1. See, e.g., Edwards v. Prudential Property & Cas. Co., 357 N.J. Super. 196 (2003) ("Such duty is grounded on the fundamental principle that in every contract there is an implied covenant that neither party shall commit any act which shall destroy or injury [sic] the rights of the other party to enjoy the fruits of the contract."); Smith v. Citadel Ins. Co., 285 So. 3d 1062 (La. 2019) ("The insurer's duty to act in good faith includes the duty to deal fairly in handling claims."); Woodie v. Berkshire Hathaway Homestate Ins. Co., 806 Fed. Appx. 658 (10th Cir. 2020) (duty of good faith "emanates from the special relationship of the parties to the insurance contract.").
2. See, e.g., Scottsdale Ins. Co. v. Addison Ins. Co., 448 S.W.3d 818 (Mo. 2014) ("a right of subrogation belongs to one, not a volunteer, who pay's [sic] another's debt, to recover the amount paid, which in good conscience should be paid by the one primarily responsible for the loss.").
3. Id. ("An insurer's duty to act in good faith in settling third-party claims arises from the insurer's reservation in the policy of the exclusive right to contest and settle third-party claims. An action for the breach of that duty, while a tort, arises from a contract of insurance, which is not of a purely personal nature. Therefore, a bad faith refusal to settle action falls within the category of assignable torts.").
4. Columbia Cas. Co. v. U.S. Fid. & Guar. Co., 870 .2d 1200 (Ariz App. 1994) (equity required that primary and excess share defense costs when it was apparent at the outset of the litigation that primary limits would not resolve the claim); Pallotta v. Aetna Ins. Co., 322 N.Y.S. 2d 92 (1971) (same); Celina Mut. Ins. Co. v. Citizens Ins. Co. of Am., 349 N.W.2d 547 (Mich. App. 1984) (primary and excess required to split defense on a pro rata basis based upon amount of settlement); Am. Motorists Ins. Co. v. Trane Co., 544 F. Supp. 668 (W.D. Wisc. 1982) (finding that excess duty to defend is activated along with primary if the claim exceeds primary limit); Teleflex Medical Incorporated v. National Union Fire Insurance Company of Pittsburgh PA, 851 F.3d 976 (9th Cir. March 21, 2017) ("In Diamond Heights Homeowners Association v. National American Insurance Co., 227 Cal. App. 3d 563 (1991), a California appellate court ruled that an excess liability insurer has three options when presented with a proposed settlement of a covered claim that has met the approval of the insured and the primary insurer. The excess insurer must (1) approve the proposed settlement, (2) reject it and take over the defense, or (3) reject it, decline to take over the defense, and face a potential lawsuit by the insured seeking contribution toward the settlement. Id. at 580–81. Under Diamond Heights, the insured is entitled to reimbursement if the excess insurer was given a reasonable opportunity to evaluate the proposed settlement, and the settlement was reasonable and not the product of collusion.")
5. Am. Alternative Ins. Corp. v. Hudson Specialty Ins. Co., 938 F.Supp.2d 908 (C.D. Cal. 2013) ("California law allows primary and excess insurers to recover from one another for their bad faith refusal to accept a reasonable settlement offer under the theory of equitable subrogation"); Diamond Heights Homeowners Assn. v. National Am. Ins. Co., 227 Cal. App. 3d 563 (1991) (the court found that the primary insurer could proceed on an equitable subrogation theory where the excess insurer arbitrarily vetoed a reasonable settlement and forced the primary insurer to proceed to trial and bear the full costs of the defense).
6. Westport Ins v. Penn Natl Mutual, No. 23-2082 (U.S. Court of Appeals, Fifth Cir. Sept. 18, 2024)
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