9th Circuit: ‘Improper Erosion’ of Policy Limits No Grounds for Denial by Excess Insurer

Unless fraud or bad faith is involved, no policyholder should be expected to justify its reasons for making payments to settle litigation as a condition for making a claim under an excess insurance policy, the 9th Circuit Court of Appeals ruled Monday.

The appellate panel rejected Axis Reinsurance’s arguments that Northrop Grumman Corp. “improperly eroded” its policy limits when settling a retirement plan dispute. The court said it was the first time it had ruled on the question, and reversed a decision by the U.S. District Court in Pasadena, California.

“We begin our analysis by noting that no circuit precedent adopts the ‘improper erosion’ theory of recovery asserted by Axis and relied upon by the district court in its summary judgment order,” the panel opinion, written by Circuit Judge Consuelo M. Callahan, says.

The U.S. Department of Labor and administrators of a savings plan set up on behalf of Northrup-Grumman employees filed two lawsuits against the defense contractor alleging violations of the Employee Retirement Income Security Act. Northrop reached a confidential settlement in the Labor Department lawsuit. It also settled the second lawsuit by the savings plan for $16,750,000.

National Union Fire Insurance Co. paid the first settlement, which exhausted the $15 million policy limit in Northrop’s employee benefit plan fiduciary liability insurance policy. Continental Casualty Co. paid the remainder of the Department of Labor settlement and also contributed $7,043,762 toward the second settlement, which exhausted the $15 million limit of Northrop’s excess insurance policy.

Northrop asked Axis to step in to pay the remaining amount of the second settlement that wasn’t covered by CNA: $9,706,238. Northrup’s secondary excess policy with Axis also had a $15 million policy limit.

Axis paid claim, but notified Northrop that it intended to seek reimbursement for the Department of Labor settlement. It argued that the amounts paid by National Union and CNA were “not for a covered loss.”

The carrier filed a lawsuit seeking declaratory relief and damages from Northop. Axis argued that the settlement constituted a “disgorgement” that is “uninsurable under California law.”

District Court Judge André Birotte Jr. agreed and granted summary judgment in Axis’ favor. Northrop appealed.

The appellate panel said case law holds that excess insurers generally may not avoid or reduce their own liability by contesting payments made at prior levels of insurance, unless there is an indication that the payments were motivated by fraud or bad faith. Insurers can place language in their policies to exclude coverage for any unapproved settlements if they want to, but no such provision was in Northop’s policy with Axis.

In a 2019 case, titled Costco Wholesale v. Arrowood Indem. Co., the district court held that excess insurers may not “second-guess the coverage determinations of the underlying insurers” unless they have a specific contractual right to do so.

The appellate panel said it found the findings in the Costco case persuasive.

“We agree with Northrop that the district court’s alternative rule—that excess insurers generally may contest the soundness of underlying insurers’ payment decisions—’would undermine the confidence of both insureds and insurers in the dependability of settlements,’ eliminating one of the primary incentives for obtaining insurance in the first place,” the opinion says. “Furthermore, such a rule would introduce a host of inefficiencies into the insurance industry, with no obvious countervailing benefits to insurers or policyholders.”