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February 21, 2001

This is one of a series of articles under the by line “Butler on Bad Faith” originally published in Mealey’s Litigation Report: Insurance Bad Faith, Vol. 14, #20, p. 32 (February 21, 2001). © Copyright Butler 2001.

I.   The Issue

An insured causes damage or injury that results in a third party claim for continuous loss spanning three years. The third party makes a claim under the policy in effect at the time of the loss. The policy covers the same three years as the loss and provides $300,000.00 for each year. In other words, the policy provides a total of $900,000.00 aggregate coverage over three years. We will assume the claim is settled for $300,000.00.

Is it proper for the insurer to pay the claim under a one year period of the policy or must it be spread over more than one year? On one hand, by settling the claim under the first year of the policy for $300,000.00, the insurer will exhaust the policy limits for that year, thereby eliminating the duty to defend any other claims that may arise under that year of the policy period. The insured then is exposed to other such claims without coverage. On the other hand, if the $300,000.00 settlement is spread over the three years of the policy period, $100,000.00 to each year, the insured will have the benefit of the settlement of the particular claim, and have some coverage remaining for all three years of the policy.

II.   Analysis of Loss Allocation

A logical starting point is to consider how the courts have handled allocation of losses over the triggered years.

Carter-Wallace Inc. v. Admiral Insurance Company, 712 A.2d 1116 (N.J. 1998), addressed the issue of allocation in the context of determining whether a defendant’s excess policy provided coverage. In Carter-Wallace, the plaintiff, a manufacturer of pharmaceuticals, contaminated a landfill. The plaintiff spent approximately $9 million dollars cleaning up the landfill and then sought reimbursement from its insurance carriers, including Commercial Union Insurance Company. The comprehensive general liability policy issued by Commercial Union was in effect for three years, 1969—1972, and was a third-layer excess policy. Carter-Wallace, 712 A.2d at 1121. The loss spanned a period of seventeen years, 1966 through 1982.

The issue at trial was whether the plaintiff was entitled to benefits under the Commercial Union excess policy. This depended, of course, on how the loss was allocated to the underlying policies. The trial court found that the first and second layers of coverage had not been exhausted over the entire seventeen years and, therefore, Commercial Union’s third layer excess policy was not reached. This was because the trial court misinterpreted the public policy stressed by the Supreme Court of New Jersey in Owens-Illinois, Inc. v. United Insurance Co., 650 A.2d 974 (N.J. 1994), that the risk should be allocated over the years of exposure in accordance with the amount of risk assumed.

On appeal, the New Jersey Superior Court, Appellate Division held that the trial court erred in interpreting Owens-Illinois to require “horizontal exhaustion” of the underlying policies across the seventeen years of the loss before the excess policy that spanned three years could be reached. Carter-Wallace, 712 A.2d at 1121. The appellate court remanded the case leaving the trial court to create an alternative allocation scheme. The Supreme Court of New Jersey certified the issue.

The Supreme Court began its analysis by discussing the “continuous trigger theory” of liability under commercial general lines policies in effect during a progressive loss. Carter-Wallace, 712 A.2d at 1122. This theory was adopted by the Supreme Court of New Jersey in Owens-Illinois, Inc. v. United Insurance Co., 650 A.2d 974 (N.J. 1994), where the court held that:

when progressive indivisible injury or damage results from exposure to injurious conditions for which civil liability may be imposed, courts may reasonably treat the progressive injury or damage as an occurrence within each of the years of a CGL policy. 138 N.J. at 478—479 (emphasis provided).

The Carter-Wallace court went on to explain that this theory applied to personal injury claims, such as asbestos exposure claims, as well as property damage cases, such as toxic tort cases. Carter-Wallace, 712 A.2d at 1122. See Owens-Illinois, Inc., v. United Insurance Co., 650 A.2d 974 (N.J. 1994) and Astro Pak Corp. v. Fireman’s Fund Ins. Co., 284 N.J. Super. 491, 499, 665 A.2d 1113 (App. Div.), cert. denied, 143 N.J. 323, 670 A.2d 1065 (1995).

Because the “continuous trigger” theory requires that multiple policies provide coverage for losses, the court in Owens-Illinois also had to address the issue of allocating the appropriate share of the loss to the policies involved. The Owens-Illinois court considered and rejected joint and several allocation of the loss between policies. Owens-Illinois, 650 A.2d at 990-991. Under the joint and several theory, the policyholder selects one year of a continuous injury and exhausts coverage, forcing the carriers to sue each other for contribution. Carter-Wallace, 712 A.2d at 1122. When fashioning an acceptable allocation method, the Carter-Wallace court explained that the concern in Owens-Illinois was the efficient use of resources to deal with continuous losses, spreading costs throughout industries that create these losses and the “demands of simple justice.” Carter-Wallace, 712 A.2d at 1122. (Emphasis added). Additionally, the Owens-Illinois court stated that “any allocation should be in proportion to the degree of the risks transferred or retained during the years of exposure” and that the formula should “allocate the losses among the carriers on the basis of the extent of the risk assumed, i.e., proration on the basis of policy limits, multiplied by the years of coverage.” Owens-Illinois, 650 A.2d at 994. See Armstrong World Indus., Inc. v. Aetna Cas. & Sur. Co., 20 Cal. App. 4th 296, 26 Cal. Rptr. 2d 35, 57 (1993).

The example provided in Owens-Illinois assumed a loss spanning nine years broken down into three three-year periods. Based on the coverage provided in each three year block, the court calculated a proportion for each carrier’s burden. See also Chemical Leaman Tank Lines, Inc. v. Aetna Casualty & Surety Co., 978 F. Supp. 589 (D.N.J. 1997). The more coverage available in any one year or block of time, the greater the proportion of indemnity risk assigned to the block of time. Owens-Illinois, 650 A.2d at 995. Thus, when looking at the reasoning applied by the Carter-Wallace and Owens-Illinois courts, it appears that the courts favor spreading the losses that occur over the triggered policy periods in the context of third party continuous loss cases which results in more available coverage for the insureds.

Another important case is Stonewall Ins. Co. v. Asbestos Claims Management Corp., 73 F.3d 1178 (2nd Cir. 1995). There, the United States Court of Appeals for the Second Circuit addressed the issue of how to allocate payment of asbestos injury losses where multiple policies provided coverage over the period of the continuous injuries in a declaratory action between an asbestos products manufacturer and its insurers. Stonewall differs from Carter-Wallace and Owens-Illinois because, here, the court decides in favor of pro rata allocation even when the decision adversely affects the insured. In addition to holding that the losses would be prorated among the insurers by multiplying the settlement by a fraction comprised of the number of years that the policy was in effect over the number of years the claimant was injured, the court also held that for the years when the insured was uninsured the insured would be responsible for the pro rata share attributable to such a period. Stonewall Ins. Co., 73 F.3d at 1203. In reaching the decision in favor of pro rata allocation, the Stonewall court relied on the Owens-Illinois opinion and reasoned that failing to allocate a loss over the policy period ignores the insurer’s obligation to pay for subsequently discovered damages related to that policy period. Stonewall Ins. Co., 73 F.3d at 1204 citing Owens-Illinois, 650 A.2d at 988-89.

The decision in Stonewall to extend the allocation of the loss to periods where the insured was uninsured was objectionable to the insured because there was a considerable span of time where they were uninsured for the loss. The insured argued that, since the policies obligated the insurers to pay “all sums” for which the insured became liable during the policy period, consideration should not be given in the allocation to how long the insurer was on the risk. Stonewall Ins. Co., 73 F.3d at 1203. The insured contended that the loss should be prorated only between the insurers, not the insurers and the insured. The Stonewall court rejected the insured’s reasoning. In doing so, the court noted that unless the risk was allocated between the insurers and the insureds, the insureds would obtain a windfall compared to insureds who purchased insurance for the entire loss period. Additionally, the court stated that if the insured was “permitted to choose the policy it prefers for indemnification of the entire injury, this would be unfair to an insurer who was on the risk for a short period.” Stonewall Ins. Co., 73 F.3d at 1203. But see J.H. France Refractories Co. v. Allstate Ins. Co., 626 A.2d 502 (Pa. 1993).

The Stonewall case shows that, even when pro rata allocation of the damages over the continuous loss policy period is detrimental to the insureds because it results in less coverage, courts still will apply the theory in the interests of fairness and efficient use of resources to settle such claims. Furthermore, it appears an insurer can argue successfully that if the continuous loss starts before, or ends after, the policy period at issue, the loss should be spread beyond the policy period when determining how much of the loss is covered by the policy. Similarly, an insured’s argument that the policy should cover the entire loss because the policy period is encompassed within the larger loss period should fail.

III.   Allocation to Avoid Bad Faith

The cases discussed above show there is a body of law that favors allocation of a continuous loss when policies cover multiple years. Therefore, an insurer should lean toward the “continuous trigger theory” and allocation of the loss over a multiple year policy period when settling claims in order to avoid potential bad faith claims. In light of the policies of fairness, efficient use of resources, and spreading losses throughout the offending industries, articulated by the Carter-Wallace, Owens-Illinois and Stonewall courts, it appears that an insured may have a solid basis to bring a bad faith action against a carrier who allocated a continuous loss to one year of the policy, exposing the insured to subsequent claims from that year. The supporting policies articulated by the Carter-Wallace, Owens-Illinois and Stonewall courts apply to the hypothetical issue addressed above. It would be difficult for an insurer to successfully argue that it is an “efficient use of resources” to exhaust coverage for one year of the policy by failing to allocate a loss over the span of the policy period when the insured will be left with no coverage for that year.

The Stonewall court stressed that it would not be fair to make an insurance company pay for an entire loss when some of the loss occurred either before or after its policy was in effect and that claimants who elected to be uninsured or underinsured for a period of time should not be rewarded by requiring the insurer to pay for the entire loss under these circumstances when holding in favor of pro rata allocation. Therefore, it does not appear likely that an insurer could successfully argue that a continuous loss should be paid under one year of a multiple year policy when the effect would be to punish an insured who purchased coverage that spanned a period of time by leaving it without coverage for the year where coverage was exhausted. Additionally, if the loss in question continued past the policy period in question, the insurer could not argue on the one hand that the loss should be allocated and prorated to consider the years when its policy was not in effect, but that the insurer should be able to pay the loss under one year of the covered period? This certainly seems inconsistent.

In Florida, the standard for evaluating whether an insurer has committed bad faith in first and third party cases is “whether the insurer acted fairly and honestly toward its insured with due regard for the insured’s interest.” General Star Indem. Co. v. Anheuser-Busch Companies, Inc., 741 So. 2d 1259 (Fla. 5th DCA 1999). Additionally, Fla. Stat. § 624.155, which sets out the prerequisites for filing a civil remedy notice against an insurer for bad faith, provides under subsection (1)(a)(1) that a civil action against an insurer is permitted if the insurer violates Fla. Stat. § 626.9541(1)(i), known as the unfair claims settlement statute. According to the terms of Fla. Stat. § 626.9541(1)(i)(1), unfair claim settlement practices include:

A material misrepresentation made to an insured or any other person having interest in the proceeds payable under such contract or policy, for the purpose and with the intent of effecting settlement of such claims, loss or damage under such contract or policy on less favorable terms than those provided in, and contemplated by, such contract or policy.

Other states’ legislation may, of course, be different. However, the broad statutory language in Florida’s bad faith statutes emphasize that the prudent insurer should consider whether continuous losses settlements should be apportioned before finalizing any settlement to avoid allegations of bad faith for failure to allocate.