A feature of most corporate liability insurance programs is the tower system of coverage: a primary policy with several overlying excess policies stacked atop one another collectively providing coverage up to a desired (or available) limit of liability. Depending on the size and liability exposures of a policyholder, a tower can consist of dozens of policies providing limits totaling hundreds of millions of dollars. Adding to this complexity, excess policies often share layers of coverage in quota share arrangements, sometimes subscribing to the same policy but more often issuing separate policies for a stated percentage of the quota share whole. To avoid as much as possible an impenetrable web of conflicting coverage terms, excess policies often “follow form” to the underlying coverage (usually to the primary policy) providing the insurer certainty and providing the policyholder a consistent tower of coverage. It is not always possible, though, to obtain clarity and certainty in tower placements. Insurance companies issuing excess coverage may not wish to agree to all the terms included in the underlying policies, and so may offer additional or differing terms, creating inconsistencies in an otherwise monolithic tower. For example, a primary insurer may refuse to cover punitive damages whereas an excess insurer may agree to do so, or vice versa.
More pernicious than the problems created by a lone inconsistency, follow form language in higher-layer excess policies can create surprises—for the policyholder, the insurer, or both. If an overlying policy tower names a specific policy by policy number as the followed policy, or states that it follows the policy in a specific layer (such as the first umbrella or immediately underlying layer) then most confusion is averted. Problems arise when a higher-level policy refers vaguely to “the underlying insurance” as the controlling insurance, made even more confusing if the underlying insurance is comprised of several quota share policies with differing terms. Inconsistency among policy provisions by layer can have significant impacts on the availability of follow form coverage: i.e., exclusionary clauses, a duty to defend or to reimburse defense costs, retroactive dates, choice of law provisions, suit limitation periods, the application of aggregate limits, and the definition of “insured.”
In the claims context, when an excess follow form policy is vague as to which policy(ies) it follows form to and there are conflicting terms in the underlying policies, policyholders should argue there is ambiguity, because the coverage provided by the following form policy is uncertain. General principles of insurance policy construction dictate that insurers must clearly state exclusions and limitations to coverage in their policies, and where the terms of an insurance policy are ambiguous, the policy must be interpreted against the insurer and in favor of coverage (the doctrine of contra proferentem). Therefore, an excess policy that does not explicitly contain an exclusion and follows form to policies that both do and do not contain an exclusion should be ruled ambiguous. The insurer should bear the risk as to such ambiguity.
As might be expected, insurers do not agree with this conclusion. Insurers sometimes argue, for example, that a follow form wording that adopts the terms, conditions and exclusions of “the underlying insurance” provides them the benefit of the most restrictive terms found in any underlying policy even if other underlying insurance policies are inconsistent. Relatedly, Insurers sometimes argue that where one underlying policy excludes or limits coverage but another is silent on that particular issue, there is no conflict and no ambiguity. The caselaw does not support such insurer arguments but it is muddy. Some courts have recognized that such conflicts create ambiguity, while others have not. There have been cases in New Mexico and Virginia that have accepted insurer arguments that where one underlying policy includes a limiting provision on an issue for which a second underlying policy is silent, the following form policy is unambiguous, there is no conflict, and the limiting provision is incorporated into the excess policy.
From the policyholder’s perspective, where one underlying policy contains an exclusion (e.g., for punitive damages) and another does not, a higher-layer excess policy that follows form to both is ambiguous. This creates a clear conflict between two underlying policies and an excess policy that follows form to both therefore is ambiguous. When facing this situation, the contra proferentem argument is a strong one for policyholders. Notably, certain excess insurance policies expressly state that they follow form to the most restrictive terms found in any underlying policies. In other words, insurers are well aware of how to solve this problem. Most restrictive term wording has been available to insurers for decades. If an excess policy does not include this language, an insurer should be at risk and should be required to provide coverage according to the broadest terms found in the underlying policies.
Importantly, a policyholder can take steps to avoid stumbling blindly behind errant follow form wording at the time of a claim. Renewal of large towers of insurance often focus on the terms of the primary policies. The terms of the excess are often an afterthought or assumed to be in line with the primary layer. Being attentive to the excess policy terms can go a long way toward preventing disputes, or at a minimum advising senior management, for example, that one excess policy may require the application of New York law and another English law, one excess policy may require arbitration of a claim while another permits litigation of the same claim. A policyholder should review excess policy proposals with the help of its broker and qualified coverage counsel, focusing both on inconsistent terms in the excess and non-specific follow form language that can amplify one policy’s divergence into a much larger negation of coverage up the tower. By catching such problems before binding a policyholder can put pressure on insurers to bring excess terms into line with the primary or develop a Plan B solution with the broker if insurers refuse to put their ducks in a row.