Horizontal Allocation is Ninth Circuit Choice in Insolvent Gap Case; But Insured Not Required to Pay Share of Costs

Those west coast policyholders whose historical primary insurance carriers have since become insolvent may wish to take notice of a recent Ninth Circuit U.S. Circuit Court of Appeals decision styled California Ins. Co. v. Stimson Lumber Co., 2009 WL 1035238 (9th Cir. (Oregon) April 16, 2009). In Stimson, the appellate court was called on to reconsider district court rulings concerning how defense costs would be allocated in a situation where the policyholder’s primary insurer had become insolvent, but an umbrella policy had been purchased to overlay the risk for that particular policy period.

The lower court had ruled in effect that since the primary insurer had become insolvent, the policyholder was self-insured as to that policy period and should be required to pay its share in the pro-rata allocation of defense costs. This district court based this on its determination that the umbrella policy above the insolvent carrier’s policy did not “drop down” to provide primary coverage.

The Ninth Circuit reversed the district court’s ruling in part on equitable considerations, saying in its opinion that the insolvency of the primary insurer did not cause the policyholder to take on non-insured status and it would be “unreasonable to treat Stimson as a self-insured, when it sought to limit its liability by purchasing primary insurance.” The allocation of defense costs for the gap period would be among the primary insurers for the non-gap periods.

As for the issue of the “drop down” of the umbrella policy, the Ninth Circuit upheld the district court’s ruling, reasoning that since the “applicable limits” of the underlying policy remain in force after the primary insurer’s insolvency, the umbrella policy does not drop down to provide primary coverage. Like the district court, the appellate court reasoned that Stimson would have to exhaust the limits of all underlying insurance before the umbrella could drop down. The court said that the “other insurances” clause in the umbrella policy showed that the policy was designed as excess over scheduled as well as unscheduled policies.