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Excess carriers beware: no second-guessing underlying coverage decisions absent contractual right

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Home Publikationen Excess carriers beware: no second-guessing underlying coverage decisions absent contractual right
The Ninth Circuit recently confirmed that an excess carrier may not challenge the underlying insurers’ payment decisions on earlier claims absent proof that such decisions were motivated by fraud or bad faith, or unless the excess policy explicitly reserved the right to contest the underlying carriers’ prior payment decisions. AXIS Reinsurance Co. v. Northrop Grumman, No. 19-55135 (9th Cir. Sept. 14, 2020). The decision protected the policyholder’s reasonable expectation that the excess carrier would not use an “improper erosion” theory to avoid paying an unrelated subsequent claim that it admitted would otherwise fall within its coverage.

In 2016, Northrop Grumman Corp. faced two lawsuits, one involving an investigation by the Department of Labor (DOL) and the other a class action. Both claims alleged ERISA violations relating to alleged self-dealing and excessive fees arising out of Northrop’s pension plan administration. At the time, Northrop had a program of tiered employee benefit plan fiduciary liability insurance, including primary layer coverage of $15 million, first-layer excess coverage of $15 million, and second-layer excess coverage of $15 million written by AXIS Reinsurance Co.

Northrop settled both actions that same year. With the first settlement, the specific amount of which is confidential, Northrop’s primary carrier exhausted its liability limits, causing the primary excess carrier to drop down to cover the remaining loss. Upon the second settlement for $16.75 million, Northrop’s excess carrier exhausted its limits as well, thereby triggering coverage under the AXIS policy.

AXIS paid its share of the second settlement under protest, arguing that the prior DOL settlement was not a covered loss and should not have been paid by the underlying carriers. In November 2018, AXIS filed a complaint for declaratory judgment and damages against Northrup in the U.S. District Court for the Central District of California seeking reimbursement. AXIS later moved for summary judgment, arguing that AXIS’s coverage layer had been “improperly eroded” (i.e., prematurely exhausted) because the lower-level insurers had no obligation to cover Northrop’s “payment of disgorgement” – a category of risk that AXIS argued was uninsurable under California law and the applicable policies. The district court agreed, reasoning that, while bound by the terms of the primary policy, AXIS was free to reevaluate the underlying carriers’ coverage decisions on the prior claim.