Case A:
An insured is sued in a personal injury action. Its primary insurer undertakes to defend the action, but the excess carrier disclaims coverage. The insured and its primary carrier enter into settlement negotiations with the plaintiff, but the excess carrier refuses to participate in those discussions. The insured and primary carrier reach an agreement with the plaintiff, according to which (a) the primary carrier pays the plaintiff $46,500 of its $50,000 policy limit, and (b) the plaintiff executes a partial release in favor of the insured, releasing the insured from any liability not covered by its excess insurance, and specifically reserving the plaintiff's rights to attempt to collect any award in excess of $50,000 from the disclaiming excess insurer's policy.
Case B:
After a fatal accident, and in anticipation of litigation, the prospective defendant's primary liability insurer (with a per occurrence limit of $100,000) makes the following pre-suit settlement with the wrongful death claimant: (a) the primary insurer pays the claimant $70,000 out of its $100,000 limit, (b) the claimant releases the insured from making any further payment C other than from the insured's excess insurance policy C as a result of any judgment that might be entered in the anticipated wrongful death suit, and (c) in the event of a judgment in excess of $100,000 in the anticipated wrongful death suit, the insured and its excess carrier are to receive a credit in the amount of the full $100,000 primary limit. The insured's excess carrier (with a $1,000,000 limit) is aware of and participates in the negotiations, but is not a party to the agreement. Instead, the excess carrier explicitly reserves its right to contend that it has no liability. The claimant then files a wrongful death suit, which is "defended" by the primary carrier. The "defense" consists of consenting to entry of a judgment for plaintiff in the amount of $150,000. The plaintiff thereafter looks to the excess carrier to satisfy the $50,000 of the agreed judgment in excess of the $100,000 primary limits.
In Case A, many would see no problem in finding that the primary policy's limits had been exhausted by the settlement, despite the fact that the primary carrier did not actually pay its entire limit in cash. That was, in fact, the result in one case.[iv] Case B, however, is another matter.
In Case B, the insured and primary insurer colluded with the plaintiff to "set up" the excess carrier. The apparent intent was for the plaintiff and defendant to avoid all litigation risk, the primary carrier to save thirty percent of its policy limits and avoid defense costs, and the excess carrier to be stuck with a judgment after a sham defense. Not surprisingly, in a case on those facts, it was held that the primary carrier's settlement extinguished any potential liability of the excess carrier.[v]
Several reported cases deal with the same basic legal issue: whether a partial settlement of a claim for less than the primary carrier's limits may constitute "exhaustion" of those limits, at least for the purpose of triggering an excess insurer's indemnity obligation. The two cases posited above are at polar extremes of the issue, but there are numerous possible permutations between the relatively innocent settlement approved in the first example and the transparent conspiracy criticized in the latter case. Whether such partial settlements are enforced as intended depends on both the specific terms of the settlement agreement and other aspects of the forum's general body of insurance law.
