David Adelstein | Florida Construction Legal Updates
Recently, I participated in a webinar involving the horizontal and vertical exhaustion of insurance coverage. Say what?
This pertains to the PRIORITY of liability insurance coverage and the interface between a general contractor’s (or upstream party’s) primary insurance and the subcontractor’s (or downstream party’s) excess insurance, particularly when the general contractor is required to be indemnified by the subcontractor and named as an additional insured under the subcontractor’s liability policies.
For instance, let’s assume the general contractor has a $2M primary policy and a $5M excess policy. Its subcontractor has a $1M primary and a $5M excess policy. The general contractor is an additional insured under the subcontractor’s policies and the subcontractor is required to contractually indemnify the general contractor. An issue occurs caused by the subcontractor’s negligence resulting in a $5M judgment against the general contractor and the subcontractor.
A. Horizontal Exhaustion
Under the horizontal exhaustion approach, the court will look primarily to the “other insurance” provision in the policies–specifically, the subcontractor’s excess policy–which will take precedence over the contractual indemnification language. Since the “other insurance” provision in excess policies typically state it is excess over the exhaustion of primary policies, under the horizontal exhaustion approach, the policies would be exhausted as follows relative to the $5M judgment:
1) $1M from subcontractor’s primary policy;
2) $2M from general contractor’s primary policy; and
3) $1M from the general contractor’s excess policy and $1M from the subcontractor’s excess policy, as the excess policies share in coverage after the primary coverage is exhausted.
The general contractor and its insurers do not perceive this to be equitable as it dilutes the indemnification and additional insured requirement. Further, it results in the general contractor’s carriers subrogating to the rights of the general contractor to pursue a separate action against the subcontractor, which gets sent right back to the subcontractor’s excess insurer (as its primary insurance was exhausted) for reimbursement. Under the above example, the subcontractor’s excess insurer still had a remaining $4M in coverage to reimburse the general contractor’s primary and excess insurer. This is known as a circular chain of events because the priority of coverage under horizontal exhaustion invariably results in a separate subrogation claim for reimbursement.
B. Vertical Exhaustion
Under the vertical exhaustion approach, the court will look primarily to the contractual indemnification and additional insured language, irrespective of the “other insurance” provision in the excess policy, to avoid the circular chain of events with the general contractor’s carriers pursuing a separate subrogation claim. Under the vertical exhaustion approach, the policies would be exhausted as follows relative to the $5M judgment:
1) $1M from the subcontractor’s primary policy; and
2) $4M form the subcontractor’s excess policy.
The subcontractor’s primary and excess policies would be exhausted BEFORE the general contractor’s primary policy comes into play. This is designed to avoid the the separate subrogation claim since the subcontractor’s insurance coverage is being exhausted first.
C. Priority of Insurance Coverage
The priority of insurance coverage can become a very significant consideration in sizable claims. There is a reason parties contractually negotiate insurance coverage in the contract. For this reason, during the contract negotiation, it is important to appreciate this consideration on the frontend. Consult with counsel and an insurance broker as to the following:
The contractual indemnification language – make sure it is enforceable in your jurisdiction;
The additional insured language and applicable insurance endorsements – make sure you get the right endorsement for ongoing and completed operations that covers issues wholly or partially caused by the subcontractor’s (or downstream party’s) negligence;
The primary and noncontributory language and applicable endorsements in the primary and excess policy-this modifies the “other insurance” provision from a priority of coverage standpoint and you want this in both the primary policy and excess policy; and
The “other insurance” language in the general contractor’s (or upstream party’s) policy — the objective is to maximize vertical exhaustion of coverage to avoid the circular chain of events discussed above so this may result in manuscript language to the general contractor’s “other insurance” language to reflects its priority.
Claims that involve or rely on construction insurance claim can become complex. But, insurance is crucial in order to properly assess risk, flow down risk, and manage risk. In order to evaluate associated risk, it requires consultation with lawyers and insurance brokers and understanding the type of claim exposure relative to the project, and maximizing value of insurance–primary and excess insurance–for which you are an additional insured.