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The Balance Between Conservative And Common Sense Policy Interpretation

Daily Journal

The summer of 2010 has been a busy time for the courts with a smattering of insurance cases published by the California Courts of Appeal. The published decisions are not generally ground breaking and usually involve re-affirmation of long held concepts to specific factual circumstances. However, they do hint at the continuing balance of a precise and conservative reading of policy provisions with a common sense treatment of the competing interests of insured and insurer. One of the more complex opinions published this summer reviewed a multitude of insurance concepts, including the duty to defend as opposed to the duty to indemnify in a policy, which contained aspects of excess, umbrella and primary insurance.

Exercising its discretion in Legacy Vulcan Corp. v. Superior Court (2010) 185 Cal App 4th 677, the 2nd Appellate District granted a petition by Legacy, the insured, for a writ of mandate. In doing so the court reviewed a trial court decision determining that Transport Insurance Co., was an excess/umbrella insurer, but that it's duty to defend was limited to that of an excess insurer, arising only if Vulcan could show that underlying policies were exhausted and only if there was actual coverage. The appellate court disagreed with these conclusions.

Justice H. Walter Croskey, one of the authors of the "Rutter California Practice Guide on Insurance Litigation," authored the opinion and in so doing reviewed and clarified the basic distinctions between "excess" and "umbrella" coverage, and how a "self insured retention" provision works in regard to the insurer's duty to defend. Most significantly the court determined that an umbrella insurer is a primary insurer and a self insured retention provision in a policy providing primary coverage (like an umbrella policy) relieves the insurer of the duty to provide first dollar immediate defense "only if the policy expressly so provides."

Vulcan had been sued by the city of Modesto and others in three lawsuits alleging that the use of chemicals manufactured by Vulcan by the dry cleaning industry resulted in environmental contamination. Vulcan tendered the lawsuits but none of its insurers defended. Vulcan defended itself and settled the cases. It then to its insurers. Transport filed the declaratory relief action alleging that it agreed to defend only as to losses that were actually covered under its policy and only after Vulcan established its right of indemnity. Other insurers filed their own declaratory relief actions, which were consolidated.

As is common in Judge Carl J. West's courtroom, Transport and Vulcan agreed to have the court address the key legal questions: the meaning of "within the terms of coverage of this insurance" (the trial court determined Vulcan had to show "actual coverage" in the Transport policy to get a defense);the meaning of "underlying insurance" (the trial court determined the term included not just the policies listed in Schedule A, but all possible underlying policies); and principles of horizontal exhaustion with respect to Transport's duty to defend (he trial court determined Vulcan must exhaust all applicable underlying insurance before it may look to Transport, not just those policies listed in Schedule A.)

Vulcan successfully challenged the trial court's answers to the three questions. The Croskey court addressed the issues by first re-stating the general rules of policy interpretation and then noting the distinction between primary, excess and umbrella coverage.

Primary insurance provides coverage immediately upon the occurrence of a loss giving rise to liability while excess insurance provides coverage only upon exhaustion of specified primary policies. An umbrella policy however, "drops down" to provide primary coverage in those circumstances where the underlying insurance does not cover a claim, but the umbrella policy does. Transport's policy was both an excess and an umbrella policy.

Justice Croskey noted the insuring agreement provided that Transport's indemnity obligation is not triggered until the underlying policies are exhausted and the self insured retention is met. However, if the umbrella aspects of the policy come into play, where the claim is not covered in the underlying policies but may be in the Transport policy, the rules change.

The court described two circumstances where Transport may be called upon to defend. One is where the claims are covered in the underlying policies, and those policies are exhausted (the "excess" coverage). The second is where the claims are not covered in the underlying policies but are covered in the Transport policy (the "umbrella" coverage). Where the facts support the umbrella provisions, as an umbrella insurer, Transport was a primary insurer. So under the standard set of principles applicable to primary insurance, Vulcan need only establish the possibility that the claims would be potentially covered in the Transport policy, but are not covered in the underlying policies. There is no necessity to show actual coverage in the Transport umbrella policy as the trial court had determined.

The opinion also found the term "underlying insurance" was not defined and was ambiguous. Thus, applying the "objectively reasonable expectations of the insured" standard, Justice Croskey determined that the phrase only refers to those policies actually listed in Schedule A.

The balance of the opinion explained why the "retained limit" provisions did not limit Transport's duty to defend, starting with the point that there is no general rule in every policy with a self insured retention that until the insured incurs amounts in excess of the retention, there is no duty to defend. Rather it all depends on the language in the policy. Significantly, a self insured retention is a limitation on coverage and thus must be "stated precisely and understandably, in words that are part of the working vocabulary of the average lay person."

This court rejected the application of two prior cases, City of Oxnard v. Twin City Fire Ins. Co. (1995) 37 Cal App 4th 1072 and General Star Indemnity Co. v. Superior Court (1996) 47 Cal App 4th 1586. Each was based on precise policy language and found that the insurer had no duty to defend until the self insured retention was paid. Instead, this Court looked to Montgomery Ward & Co. v. Imperial Casualty & Indemnity Co. (2000) 81 Cal App 4th 356, which found horizontal exhaustion principles did not apply to certain SIR policies. The Montgomery Ward decision determined that not all the SIR's in successively applicable policies need exhaust before there was a duty to defend in connection with considering the horizontal exhaustion rule. That court found that the policies at issue were not excess, nor were the retentions primary insurance, thus there was an immediate duty to defend.

Turning to Transport's policy, the Transport umbrella/excess policy does recite that Transport will defend those claims not covered in the underlying insurance, but covered in the Transport policy, it had a duty to defend like a primary policy if the circumstances pertain. Thus the Croskey court determined that the rules of horizontal exhaustion do not apply to the defense of claims under the umbrella coverage, nor is payment of the self insured retention required before Transport's duty to defend is triggered. This is because while Transport's policy expressly limited the indemnity duty to amounts in excess of the retained limit, it did not recite the defense duty was so limited.

In this single opinion, Justice Croskey reviewed the extensive law of what constitutes a primary versus an excess policy and when an umbrella policy may be considered. He also deftly reconciled previous apparently contradictory decisions regarding the working of self insured retentions and notions of horizontal exhaustion. Applying common sense interpretation of the specific words of the insurance policy by using the rules of construction laid down in the common law, one can actually ascertain the scope of the coverage in order to carry out the objectives of the insurance. This decision is a significant addition to insurance coverage common law.

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