Other Insurance and Allocation in Construction Defect Claims
Joseph Junfola | October 23, 2020
This is the second in a series of articles addressing construction defect (CD) claim fundamentals. The first, "Coverage Triggers for Construction Defect Claims," addressed the triggering of coverage. This article naturally flows from the first—when multiple occurrence-based commercial general liability (CGL) policies are triggered, how is the property damage (PD) allocated to the entire triggered period?
Allocation in continuous damage claims, like CD claims, refers to the process of allocating indemnity and defense costs to more than one "period" of time, generally corresponding to primary and excess policy periods, and uninsured periods. Calculating equitable allocation depends on the jurisdiction, policy language and type, damage characteristics, and causation. Defense allocation can differ from indemnity allocation in the same claim primarily due to the different obligations underlying each duty.
Concurrent versus Continuous Other Insurance
Our subject is the allocation of defense and indemnity payments to multiple periods involving multiple policies and uninsured periods if any—a continuous other insurance approach. In focus is the availability of more than one policy to a loss involving PD occurring during more than one policy period. Equitable considerations come into play.
In contrast, a concurrent other insurance scenario refers to the availability of more than one policy in the same policy period. Allocation depends on the policies' other insurance clauses that contain specific rules and formulas.
Various allocation methods and hybrids are in use, and determining the appropriate allocation is fact- and jurisdiction-sensitive. We will focus on major approaches.
Underlying Concepts
Before delving into law and methodology, a brief review of underlying concepts is useful.
Duty To Defend versus Duty To Indemnify
The duty to defend is broader than the duty to indemnify. If there is a reasonable potential for coverage, there is a duty to defend a suit. The duty to indemnify, on the other hand, requires more than just a potential for coverage. It must be demonstrated that the loss is actually covered. Allocation of defense and indemnity may be treated differently.
Trigger of Coverage
A discussion of allocation in continuous damage claims would be unnecessary if only one policy was activated. In the CGL occurrence-based form, PD must occur during the policy period. In CD claims, the defects and damage are initially latent and characterized by a continuous and progressive process. To complicate matters, distinct defects could contribute to the same damage. Various trigger theories address such claims, including manifestation or discovery, exposure, continuous, and injury-in-fact.
In a continuing/progressive damage dynamic, when does the triggered period begin? When does it end—when the defect and/or PD manifests or is discovered, when the first complaints are documented, or when a suit is filed?
The California Supreme Court in Montrose Chemical Corp. v. Admiral Ins. Co., 10 Cal. 4th 645 (Cal. 1995), provided an answer. While the underlying case involved environmental contamination, the ruling also specifically impacted CD claims. The court determined, in addition to nullifying the manifestation trigger, that a loss is insurable until legal liability is established (i.e., when a verdict is rendered).
Number of Occurrences
Given the nature of latent, progressive, and cumulative damage, within the context of the occurrence definition, it is challenging to determine how many occurrences there are in a continuous damage loss.
This is important because the limits of liability, excess coverage, and deductibles or self-insured retentions are impacted. More than one occurrence can complicate an already-challenging allocation calculation.
Most jurisdictions look to the cause to determine the number of occurrences. What constitutes a particular cause is impacted by other relevant variables that are highly fact-specific. Are the effects (e.g., PD) the result of the same or substantially the same conditions? Is the exposure of the property to these conditions repeated or continuous and not unbroken by an intervening or superseding cause(s)? Are the exposures, while substantially similar, separated by time or distance to such an extent that to conclude that there is one occurrence pushes the envelope of reason?
Allocation Law and Methodology
How are indemnity and defense allocated among insurers and insured in continuous damage claims? The following are key questions.
- What trigger theory applies?
- When does the triggered period begin and end? Date(s) of work through manifestation, lawsuit, or verdict?
- The number of occurrences? Is cause or effect determinative? If cause, are there intervening or superseding causes? Other factors?
- Does allocation differ between defense and indemnity?
- Does the amount allocated to a policy depend on its position in the coverage continuum? Does a policy at the beginning of the continuum have more exposure than a policy at the end? It is well established that PD beginning during a policy and that progresses/continues after expiration does not relieve the insurer, at the time the damage begins, of responsibility for the entire loss. But should the policy later in the continuum be responsible for damage that begins prior to inception?
- How are indemnity and/or defense allocated to policies participating on a named insured and an additional insured basis?
- Is the other insurance clause the basis to calculate allocation, or is allocation a matter of equity? Is there a different basis of allocation between a continuous loss and a concurrent loss?
- Does allocation depend on the amount of primary and excess coverage available in a particular period?
- How does vertical and horizontal exhaustion fit in? Does an excess policy participate when the direct underlying policy exhausts (vertical) or only when all underlying insurance in every period exhausts (horizontal)?
- How are deductibles handled? SIRs?
- Does the insured participate in bare years? Does the reason for the lack of insurance matter? Is the insured's participation different as between indemnity and defense cost-sharing?
The Approaches
Joint and Several (Also Known as All Sums)
An insurer's obligation is joint and several if its policy is triggered. The original "all sums" language in the insuring agreement obligates the insurer to respond in full. This language has since been replaced by "those sums."
Pro Rata
This approach recognizes that the insurer should only be responsible for the PD occurring during its policy period.
Methodology
Generally, the approach (i.e., pro rata or joint and several) will determine which calculation method is used and whether the insured will participate in bare years.
Equal Shares
The joint and several approaches are conducive to an equal share allocation among policies triggered, without any contribution from the insured in bare years. Some practitioners interpret equal shares to mean that each insurer must share equally regardless of the number of policies in play. For example, Insurer A has nine policies, and Insurer B has one. Each insurer shares on a 50 percent basis (i.e., two insurers, two shares). An alternate interpretation is that each policy participates equally (e.g., Insurer A pays 9X and Insurer B pays 1X) each of the 10 policies sharing equally.
Time on Risk
In a pro rata approach, the specific policy period is compared to the total triggered period, and the loss is then shared based on the proportion of the specified period compared to the total period. The insured is responsible for bare years depending on the reason for lack of insurance (i.e., voluntary or involuntary) and whether the jurisdiction permits it. Furthermore, defense and indemnity may be treated differently.
Time-on-Risk Times Limits
Limits of liability are factored in, the premise is that there is a greater assumption of liability by the policy with higher limits. While justifiable in a concurrent loss situation (provided for in the other insurance condition), in a continuous loss case, such an approach fails to recognize the fundamental premise that it is PD, and the amount of such PD, occurring during the policy period that is covered for which the insurer should pay. The limits are relevant only to the extent that the amount of covered PD is finite. To include limits in a pro rata calculation creates the inequitable result of one insurer paying more than another when their time on risk is the same, and the PD is assumed to have occurred equally over a specified period of time.
Other Methods
Among other methods, "flexible" or "weighted" pro rata allocation recognizes that other factors may require a nonlinear approach to when PD occurs. Facts may indicate that PD occurred in different amounts at different times.
The tier approach, often used in CD claims, allocates defense and indemnity based on the extent to which a particular trade has contributed to the loss.
Other Issues
How Are Deductibles Handled?
The insured will only want to pay one deductible. A joint and several approaches would support this position. If multiple deductibles are applicable, it can get complicated. Not every triggered policy deductible may be the same (i.e., per claim or per occurrence, indemnity only, expense included, etc.).
Should the Insured Contribute to Defense?
The insurer's duty to defend is complete. If there is potential for coverage, then the lawsuit must be defended by the insurer in total, notwithstanding the inclusion of uncovered allegations. (Some jurisdictions permit the insurer to seek reimbursement of payments for losses not potentially covered.)
When Does Excess Insurance Participate?
It depends. The second Montrose case, cited later, is relevant.
The following exhibit illustrates the approaches to other insurance and allocation.
Selected Case Law
Owens-Illinois and Carter-Wallace—New Jersey
These two New Jersey cases are complementary.
Owens-Illinois, Inc. v. United Ins. Co., 650 A. 2d 974 (NJ 1994), held that the continuous trigger applies and that allocation should be based on time-on-risk and the degree of risk assumed (i.e., limits of coverage), including uninsured periods. It left the question of how excess insurance applied for another day. "Another day" arrived over 3 years later in Carter-Wallace, Inc. v. Admiral Ins. Co., 712 A.2d 1116 (NJ 1998).
Owens-Illinois pointed out that the other insurance clauses contained in the policies did not adequately resolve how the allocation is to be determined because they address concurrent losses, not continuous losses. Furthermore, the insured should share in the risk if the decision was made to go bare.
In Carter-Wallace, the court reiterated its ruling in Owens-Illinois and then determined how excess insurance figured into the calculations. Horizontal exhaustion was not necessary. Owens-Illinois provided for an allocation based on the extent of risk assumed by each insurer in each year, primary and excess. Carter-Wallace affirmed that the allocation in each year would require that the primary and excess policies would pay the allocated share. There is no requirement to horizontally exhaust all primary policies before accessing the excess insurer in that specific year.
Montrose v. Superior Court, Case No. S244737
Another case involving Montrose addressed horizontal and vertical exhaustion when determining the applicability of different layers of excess coverage.
Montrose manufactured the insecticide DDT at its Torrance, California, facility from 1947 to 1982. Sued by the United States and California for contamination due to the operation of this facility, millions were expended in cleanup costs. Montrose was insured on a primary and excess (multiple layers) basis from 1961 to 1985.
The question before the California Supreme Court was whether vertical or horizontal exhaustion applied to upper-level excess policies once directly underlying excess policies were exhausted. Montrose argued that it was entitled to coverage under the upper-level excess policy once it exhausted the directly underlying excess policies for the same policy period (vertical exhaustion). Conversely, the insurers argued that all underlying excess policies had to be exhausted before the upper-level excess policy applied (horizontal exhaustion).
Siding with Montrose, the court affirmed that the approach depends on the other insurance clauses in the excess policies, notwithstanding the fact that most other courts have found that such clauses are not applicable in continuous damage claims as opposed to concurrent claims. The excess policies, when read in their entirety, "strongly suggest that the exhaustion requirements were meant to apply to directly underlying insurance and not to insurance purchased for other policy periods." Vertical exhaustion is appropriate. Montrose is entitled to access coverage from an upper layer excess policy once the directly underlying excess policies were exhausted.
Takeaways
When calculating allocation in continuous damage claims, do the following.
- Differentiate concurrent from continuous losses.
- Distinguish the duty to defend from the duty to indemnify.
- Determine the appropriate trigger of coverage.
- Determine when the trigger period begins and ends.
- Determine the number of occurrences.
- Determine the appropriate allocation methodology.
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