Are your clients ready for California’s new insurance rules?

In Fox Paine & Company v. Twin City Fire Insurance Company, the California Supreme Court ruled that policyholders do not necessarily have to exhaust all underlying coverage before they pursue claims against excess insurers.

The case involves Fox Paine, a private equity management firm, which alleged that three excess insurance companies failed to reimburse the company for covered litigation expenses.

According to the insurers, the underlying coverage wasn’t exhausted yet, so their policies weren’t applicable.

Chief Justice Patricia Guerrero explained that a policyholder does not always have to wait until all underlying insurance is completely used up before asking a court to decide whether an excess policy may apply.

“In this case, the California Supreme Court ruled that policyholders can seek declaratory relief from their excess insurers and assert bad faith claims even where the underlying insurance has not yet been exhausted,” explained Scott Seaman, partner at Hinshaw & Culbertson.

While the Fox Paine decision may highlight the complexity of excess coverage disputes, it doesn’t change any rules. Instead, it clarifies that a policyholder could ask a court to decide whether excess coverage applies before fully exhausting any underlying policies.

For advisors with clients who have excess or layered insurance coverage, this case underscores the importance of understanding how primary and excess policies work together as well as where coverage gaps could arise.

What the ruling means for coverage disputes

Ultimately, the ruling clarifies when a coverage dispute is substantial enough for a court to determine an insurer’s obligations.

This is different from a breach-of-contract claim, which usually requires the policyholder to prove that the excess policy actually applies to the loss and that the insurance company failed to meet its obligations.

“In this context, a ‘reasonable likelihood’ may be sufficient enough to bring an issue before a court,” Seaman noted.

It could prevent policyholders from having to file separate lawsuits every time they transition from one layer of coverage to the next.

How excess insurers can respond

According to Seaman, excess insurers have several options available to them in the wake of this decision.

They can challenge whether the excess policy is reasonably likely to apply, ask the court to delay or limit the discovery phase where evidence and information is exchanged, or argue that the policy doesn’t offer coverage.

“When the excess policy is reasonably likely to be involved, the excess insurer may benefit from playing some role in the litigation process early on rather than sitting on the sidelines and waiting to be presented with a cake that is already baked,” Seaman said.

For insurance companies, this highlights the value of taking an active role.

The advisor takeaway

“Importantly, this is a pleading decision, not a merits decision,” Seaman explained.

Put simply, the ruling addresses what a policyholder must allege to bring a coverage dispute to court. It doesn’t establish that the excess insurance company breached the policy or actually owes coverage.

Advisors should use this case to realize that a client may be able to challenge a potential coverage issue before the excess policy is triggered. However, it’s up to them to prove that the loss could reach the policy’s coverage layers.

At the end of the day, advisors may be the resource clients need to understand how different layers of coverage interact. With the right support, clients are more likely to identify potential gaps and protect themselves, long before a large loss occurs.

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Anna Baluch is a finance reporter and writer with more than a decade of experience. Contact her at [email protected]