I.                   INTRODUCTION

Self insurance has become increasingly common, especially for the insured with substantial financial resources.  One of the common means of assuming risk is the use of a self insured retention (“SIR”).  The legal consequences of using an SIR are not always clear, and the law is still evolving with respect to their use, their interplay with traditional insurance, and the rights of insurers to claim a benefit to the insured’s retention.

This paper addresses four principal topics, as well as related and common issues that arise in dealing with SIRs.  First, this paper looks at whether SIRs are insurance in the classic sense.  This necessarily involves a discussion of the various forms of risk retention and the interplay of SIRs with traditional insurance.  Second, this paper examines the right of the insurer to make a claim against the insured for the insured’s failure to settle within the retention.  Third, this paper discusses whether a traditional insurer must drop down to cover an insolvent insured’s retained exposure.  Fourth, the trigger and allocation of multiple SIRs is explored.

II.                the sir as insurance

Will the courts treat self insurance as a form of traditional insurance?  The answer to this question will impact the relative obligations of traditional insurance parties and insureds in a variety of claim situations.  This issue may be analyzed with reference to five factors: (a) applicable statutes, (b) policy implications (e.g., who should bear the risk?), (c) whether the self insured entity has made a conscious decision to assume certain risks, and (d) whether the SIR is, in essence, a deductible.  See generally 1 COUCH ON INSURANCE § 10.1 (3d ed. 2000).

"Insurance" has been defined as a contract through which one party indemnifies another against loss due to certain specified contingencies.  See, e.g., State Farm Mut. Auto. Ins. Co. v Universal Atlas Cement Co., 406 So.2d 1184 (Fla. App. 1^st Dist. 1981), (court held that self insurance did not constitute other insurance because it was not such a contract, but the term "self insurance" has no precise legal meaning).  In a sense, all risks not otherwise insured are "self insured."

A.                The General Types of Self Insurance

True self insurance entails the retention of all risks.  A corporation that self insures must pay all judgments or settlements for all claims asserted against it, as well as the related loss adjustment expenses.  Risk retention groups, such as governmental pools, are typical participants in this form of self insurance.  See 15 U.S.C. § § 3901-3906 (West 2000) (permitting collective purchase of liability insurance through purchasing groups or self insurance through cooperatives known as risk retention groups).

Another form of self insurance that involves the retention of significant risk, although typically not complete retention, is a fronting policy.  Insureds use fronting policies to comply with various laws regarding financial responsibility, while retaining most or all of the insured’s risk.  In addition, the use of a fronting policy for the primary level of insurance allows the insured to more easily purchase excess insurance, as the excess insurers will know that their attachment point is determined by the application of standard insurance terms.  These policies do not indemnify the insured, as they usually are issued with a retained amount equal to the amount of the policy limits, and with policy language relieving the insurer of any defense obligation.  Thus, the insurer essentially functions as a surety, but the insurer’s obligations are guaranteed by a promissory note or some other financial instrument taken out by the insured.

Most commonly, however, businesses choose to manage a portion of their risk of liability through the use of SIRs or deductibles, which place responsibility for losses up to a certain amount upon the insured.  A traditional insurance policy or policies will provide coverage for losses above that amount.

B.                SIRs and Deductibles

The term "deductible" refers to a designated sum that is subtracted from the insurer's indemnity and/or defense obligation under the policy.  The insurer’s obligation does not ripen until the deductible is met by the insured.  Int’l Bankers Ins. Co. v. Arnone, 552 So. 2d 908 (Fla. 1989).  The declarations page of the policy typically states the amount of the deductible, although a variety of endorsements can be used.  Larger deductibles are often controlled by detailed endorsements, which set forth the amount, terms and operation of the deductible, including whether and to what extent the insured is obligated to control and pay defense.  Such larger deductibles blur the line between deductible and SIR.

An SIR is similar to a deductible because it represents a dollar amount of retention not covered by insurance.  An SIR, however, applies not only to judgments or settlements, but also to defense expenses.  The insured must exhaust the SIR, before the insurer will respond to the loss.  In addition to being a stated sum, an SIR can also be set forth as a percentage of the insured loss.  Most significantly, the insured with an SIR usually assumes responsibility for claims handling and will report to the insurer only those claims likely to exceed the retained limit.  By contrast, deductibles are tendered to the insurer, and the insurer provides for the defense of its insured.  Moreover, with deductibles, the insurer typically pays the amount of any judgment or settlement and then bills the insured for the deductible.

With SIRs, unlike deductibles, issues arise with respect to the appropriate satisfaction of the retained amount.  For example, in Royal Indemnity Co. v. Wyckoff Heights Hosp., 953 F. Supp. 460 (E.D.N.Y. 1996), the insured argued that its SIR was satisfied through the purchase of an annuity (which was used as part of the underlying settlement), where the future value of the annuity was equal to the amount of the SIR.  The insurer argued that the SIR had not been satisfied because the annuity cost less than the stated amount of the SIR.  The district court agreed with the insurer, holding that "a future payment with a present value of less than the SIR cannot here be used to satisfy [the insured's] contractual obligation." 

In Vons Cos., Inc. v. United States Fire Ins. Co., 92 Cal. Rptr. 2d 597 (Ct. App. 2000),  the court held that an SIR may be satisfied through other insurance available to the insured.  But see Gen. Star Nat’l Ins. Corp. v. World Oil Co., 973 F.Supp. 943 (C.D. Cal. 1997) (holding that, while insured may opt to purchase a "deductible buy back" policy, SIR "is generally a specific amount of loss that is not covered by the policy but instead must be borne by the insured").  See also Pacific Power & Light Co. v. Transp. Indem. Co., 460 F.2d 959 (9th Cir. 1972); Ryder Truck Lines, Inc. v. Carolina Cas. Ins. Co., 385 N.E.2d 449 (Ind. 1979) (two policies applied to same loss and were to prorate the loss after insured paid its deductible under one of the policies; thus, other insurance did not eliminate deductible obligation).

Some courts have found that deductibles, as opposed to SIRs, are satisfied through the availability of other insurance. For example, in Florida Ins. Guaranty Ass'n v. Jacques, 643 So.2d 101 (Fla. Dist. Ct. App. 1994).  A Florida court of appeal found that the insured's deductible for its general liability policy could be satisfied by payments made under the insured's business automobile insurance policy.  See also Cargill, Inc. v. Commercial Union Ins. Co., 889 F.2d 174 (8th Cir. 1989) (where two applicable policies both had deductibles, court required insurer with smaller deductible to respond up to amount of larger deductible before prorating).

Generally, SIRs, as opposed to deductibles, entail greater responsibility from the insured with respect to the indemnity and defense of claims.  Such greater responsibility also comes with greater power to control the handling of claims and the conduct of the insured’s defense.  This elevated control has resulted in conflicts between insureds and insurers, some of which are discussed in this paper.

C.                Are SIRs "Insurance" for Purposes of "Other Insurance" Clauses?

"Other Insurance" clauses limit the insurer’s liability in situations where two or more insurance policies cover the same loss.  Such clauses generally fall into three categories: pro rata, excess, and escape.  A "pro rata" clause, as the name implies, provides that the policy prorates a loss with any other applicable policy according to the respective policy limits.  An "excess" clause provides that if other valid and collectible insurance exists, the policy will be considered excess coverage and the other insurance will be considered primary coverage.  An "escape" clause purports to void the policy with respect to any risk covered by other insurance.

Most jurisdictions appear to hold that SIRs do not constitute primary insurance for purposes of an "Other Insurance" clause.  For example, in In re: Liquidation of Midland Ins. Co., Claim of ASARC  v. Superintendent of Ins. of the State of New York, 709 N.Y.S.2d 24 (N.Y. App. Div. 2000), the New York Supreme Court held that the insured need only pay the SIR beneath the excess policy in question, rather than all triggered SIRs.  The court did not believe that "the word 'insurance' in an 'Other Insurance' clause can be construed to encompass self insured retention."  Id. at 24.  Many other courts have reached similar conclusions.  See Saint John's Regional Health Center v. Am. Cas. Co., 980 F.2d 1222 (8th Cir. 1992) (applying Missouri law; pooled hospital liability fund is not "other insurance" within meaning of nurse's personal liability policy); Wake County Hosp. Sys. v. Nat'l Cas. Co., 804 F. Supp. 768 (E.D.N.C. 1992), aff'd, 996 F.2d 1213 (4th Cir. 1993) (applying North Carolina law); Georgia Mut. Ins. Co., Inc. v. Rollins, Inc., 434 S.E.2d 581 (Ga. Ct. App. 1993); Aetna Cas. & Sur. Co. v. James J. Benes & Assocs., Inc., 593 N.E.2d 1087 (Ill. App. Ct. 1992); Citgo Petroleum Corp. v. Yeargin, Inc., 690 So. 2d 154 (La. Ct. App. 1997) (self insurance does not constitute "other valid and collectible insurance"); Moore v. Nayer, 729 A.2d 449 (N.J. Super. 1999); Cone Mills Corp., 443 S.E.2d at 357; Hertz v. Robineau, 6 S.W.3d 332 (Tex. Ct. App. 1999) (automobile lessee's policy provided primary coverage because lessor's certificate of self insurance did not constitute "other insurance").

In a recent decision, the Supreme Court of Kansas found that SIRs were primary coverage and “other insurance” within the meaning of general liability policies.  Atchison, Topeka and Santa Fe Rwy. Co. v. Stonewall Ins. Co., 71 P.3d 1097 (2003).  The insured argued that SIRs were not insurance, relying on case law that restricted the definition of insurance to an agreement involving more than one party.  The Supreme Court of Kansas, in a lengthy opinion, discussed case law around the country, as well as the ALR article examining this issue (Examination of Self Insurance Against Liability as Other Insurance Within Meaning of Liability Insurance Policy, 46 ALR 4th 707).  The Supreme Court of Kansas discussed the fact that some courts applied a fact-based analysis, some courts used public policy, and some courts looked at the fact that SIRs must be “other insurance” on the ground that self insurers gain the dual benefit of avoiding premiums and of avoiding primary liability if they can force another insurance to pay on the ground that self insurance is not “other insurance.”  Citing Hillegass v. Landwehr, 499 N.W.2d 652 (Wisc. 1993).

The Supreme Court of Kansas discussed favorably an Illinois decision, Missouri Pacific RR Co. v. International Insurance Co. (MOPAC), 679 N.E.2d 801 (2nd Dist. Ill. App. 1997).  Noting that a slight majority of courts have decided that self insurance is not other insurance, the Supreme Court of Kansas found that public policy and fairness dictate that self insurance be considered other insurance.  As noted in MOPAC, “to hold otherwise, allows the insured to ‘manipulate the source of its recovery and avoid the consequences of its decision to become self insured . . . conduct we [find] unacceptable . . .’”  The Supreme Court of Kansas found the MOPAC reasoning persuasive, holding that the insureds’ SIRs in context of a progressive injury claim regarding noise-induced hearing loss, which triggered several policy periods, constituted “other insurance.”

Other courts have held that SIRs and certificates of insurance do constitute "insurance" for purposes of construing an "excess" clause in another insurance policy.  For example, in Nabisco, Inc. v. Transport Indemnity Co., 192 Cal. Rptr. 207 (Cal. Ct. App. 1983), the insured had a $50,000 SIR, and its excess insurance policy contained an "Other Insurance" clause that made it excess over "other insurance or self insurance."  The insured attempted to circumvent this clause by arguing that it was uninsured rather than self insured and that the excess insurance policy should be considered primary insurance with a duty to defend.  The court rejected that argument and held that the excess insurer had no duty to defend.  See also Air Liquide Am. Corp. v. Cont'l Cas. Co., 217 F.3d 1272  (10th Cir. 2000) (applying Oklahoma law; in lawsuit by owner of truck against employment agency that supplied driver of truck and against agency's insurer, court held that truck owner's fronting policy constituted "other collectible insurance," such that agency's policy provided only excess insurance); White v. Howard, 573 A.2d 513 (N.J. Super. Ct. App. Div. 1990) (car rental agency's decision to act as self insurer was functional equivalent of its writing an insurance policy to cover itself, and certificate of self insurance was equivalent of "other collectible insurance" within meaning of lessee's automobile policy); Nat'l Farmers Union Prop. & Cas. Co. v. Bang, 516 N.W.2d 313 (S.D. 1994) (coverage provided by self insurer is "other insurance" subject to the same provisions that would be imposed on a commercial insurer); and Boatright v. Spiewak, 570 N.W.2d 897 (Wis. Ct. App. 1997) (car lessor's self insurance was "other collectible insurance" within meaning of "other insurance" provision in lessee's policy).

It appears that decisions finding that SIRs are “other insurance” are based upon policy language that specifically mandates such a result (i.e., the policy is excess of “insurance or self insurance”), or upon the apparent intent of the self insured layer (e.g., a fronting policy).  Insurers, therefore, can proactively address their duties with respect to self insurance in the language of the other insurance clause by making self insurance the equivalent of “other valid and collectible insurance.”

1.                  Additional Decisions Finding SIRs are not Other Insurance

  The court in Home Indem. Co. v Humble Oil & Refining Co. 314 S.W.2d 861, (Tex. App. 1958), held that a certificate of self insurance did not constitute "other and valid collectible insurance" within the meaning of a liability insurance policy.  An employee driving one of his employer's vehicles on a personal trip was involved in an accident.  The employer, who qualified as a self insurer under the state financial responsibility law, and the employee's own insurer, whose policy contained an “other insurance” clause, contributed equally toward the settlement, but each party sought a return of its contribution.  The trial court concluded that qualified self insurance did not constitute other insurance within the meaning of the employee's policy, and the appellate court agreed, reasoning that the employer's self insurance did not indemnify the employee against loss, but operated for the benefit of the public generally.  The court reasoned that to relieve the insurance company of primary liability, "other insurance" within the meaning of an other insurance clause must be collectible by the policyholder, and the self insurer's statutory guaranty operated only to benefit the injured party, not the negligent driver, whose liability insurance indemnified him against loss even where it was the result of his own negligence.

In Universal Underwriters Ins. Co. v Marriott Homes, Inc. 286 Ala. 231, 238 So.2d 730 (1970), the court held that "other insurance" meant a policy of insurance like the one in which the phrase appeared, issued by an insurance company in exchange for a premium, and did not include an employer's self insurance against workers' compensation liability.  The court stated that it would be a contortion of the term insurance to hold that its meaning was broad enough to include "self insurance" and reiterated that provisions of insurance policies must be construed in light of the interpretation that ordinary persons would place on that language.  Under that rule, the court held that "other insurance" would be understood by an ordinary person as referring to another policy of insurance covering the same risks.  Finally, the court applied the rule that where an insurance clause is ambiguous, which the court found to be indicated by the fact that its meaning was in dispute, the clause must be construed most strongly against the insurer.

The courts regard the existence of another insurance clause to be important, however, the phrasing of an individual other insurance clause is sometimes not considered significant.  See, e.g., Pacific Power & Light Co. v Transport Indem. Co. 460 F.2d 959 (Or. App. 1972) (applying Oregon law) (where fact that one of two other-insurance clauses contained phrase "or self insurance" was not sufficient to distinguish the clause to avoid application of mutually-repugnant doctrine, although where there were two other insurance clauses, but only one contained phrase "or self insurance," that wording was apparently considered significant).  See also, United States Steel Corp. v Transport Indem. Co. 241 Cal. App.2d 461, 50 Cal. Rptr. 576 (3^rd Dist. 1966) (court apparently considered use of phrase "or self insurance" in one policy's other insurance clause sufficient to make deductible in another insurance policy assume primary liability).

2.                  Additional Cases Finding SIRs are Other Insurance

Professional liability insurance policy provided excess coverage over self insurance under fronting policy that had limits equal to deductible and was issued in order to utilize fronting insurer's claims-handling experience and ability to provide certificates of insurance; "other insurance" clause in professional liability policy stated that it was excess over all other insurance or self insurance.  Chicago Ins. Co. v. Travelers Ins. Co., 967 S.W.2d 35 (Ky. Ct. App. 1997), review denied 1998.

Car rental agency's decision to act as self insurer and secure applicable certificate was functional equivalent of its writing separate insurance policy covering itself, and certificate of self insurance was equivalent of "other collectible insurance" within meaning of lessee's automobile policy; thus, rental agency was primary liability insurer for accident involving lessee and had to reimburse lessee's insurer for first $15,000 paid in settlement of claim. White v Howard 240 N.J. Super. 427, 573 A.2d 513 (1990).

The court in Southern Home Ins. Co. v Burdette's Leasing Service, Inc. 268 S.C. 472, 234 S.E.2d 870 (1977), held that qualified self insurance constituted "other valid and collectible insurance" within the meaning of a liability insurance policy.  An employer, who was insured under a policy that provided it was "excess insurance over any other valid and collectible insurance," leased an automobile for an employee's use from a rental agency, which qualified as a self insurer under the state financial responsibility law.  When the employee was involved in an accident, the self insured agency refused to pay any portion of the $42,000 settlement, and the employer's insurer paid the claim in full.  The trial court ordered the agency to reimburse the insurer for $12,000, the amount stipulated to be the agency's share of the settlement if a judgment was rendered against it.  On appeal, the Supreme Court affirmed the order, holding that the rental agency's self insurance constituted "other valid and collectible insurance" within the meaning of the employer's insurance policy.  The court found that the purpose of the state financial responsibility law was to protect the public from injuries that negligent operation of the self insured's motor vehicles could cause.  The court noted out that technically, a self insurer was not an insurer at all, and in actuality, a self insurer provided a substitute for an insurance policy, but reasoned that the legislative intent behind the financial responsibility law was that self insurance substitute for liability insurance to the extent of the statutory policy limits.  Therefore, the court concluded, a self insurer must pay any claims that insurance policies described in the financial responsibility statute would otherwise cover.  The court noted that analogously, a self insurer under the workers' compensation law was required to pay claims that normally a workers' compensation insurer would pay under its policy.

In Hartford Casualty Ins. Co. v Budget Rent-A-Car Systems, Inc., 796 S.W.2d 763, (Tex. App. 1990) writ den., a self insured rental car company's liability coverage constituted "other valid and collectible insurance" within meaning of excess insurance clause of renter's liability policy.  Thus, renter's own liability insurance was excess, and rental car company was not entitled to reimbursement from renter's liability carrier for rental car company's contribution to settlement action by automobile accident victim; nor was rental car company entitled to reimbursement for attorney's fees incurred in defending action, where rental car company had duty under rental agreement to defend renter. 

Self insurance provided by car lessor was "other collectible insurance" within meaning of "other insurance" provision making liability coverage provided by lessee's policy excess over other collectible insurance.  Boatright v. Spiewak, 214 Wis.2d 507, 570 N.W.2d 897 (Ct. App. 1997).

III.             Can an Insurer Sue an Insured for Failure to Settle under the SIR?

Where a loss is likely to exceed the amount of an SIR, the issue arises as to whether the insured or its insurer should have control over settlement decisions.  Faced with a settlement demand at or about the amount of the SIR, the insured may wish to take its chances at trial in a case where there is a possibility of obtaining a defense verdict, because its indemnity obligation is capped.  The insurer, however, would want the matter settled so as to avoid exposing its coverage.  Does the insured with an SIR have a duty to accept a settlement offer within the amount of the SIR in order to avoid exposing the insurer to liability?

The California Supreme Court has held that the insured does not have a general duty to settle.  Moreover, such a duty cannot be predicated upon an implied covenant of good faith and fair dealing.  Commercial Union Assurance Cos. v. Safeway Stores, Inc., 610 P.2d 1038 (Cal. 1980).   The insured, however, may not ignore a reasonable settlement offer within the SIR.  Id. at 920-21.  Further, the "cooperation" clause in a policy may require the insured to contribute its SIR to settle a third-party action.  The insured cannot induce the insurer to settle a claim in excess of its SIR and then refuse to contribute the amount of the SIR.  Harbor Ins. Co. v. City of Ontario, 282 Cal. Rptr. 701 (Cal. App. 1991). 

Some insurers attempt to protect themselves against an insured's unreasonable failure to accept a reasonable settlement offer by including the following language in their defense and/or "cooperation" clauses: "The Insured will use diligence and prudence to settle all claims and suits which reasonably should be settled, provided, however, the Insured will not make or agree to any settlement for any sum in excess of the Underlying Insurance without the Company's prior written approval."

Other, similar language has been enforced.  See Continental Casualty Co. v. Roper Corp., 527 N.E.2d 998 (Ill.App.1988) (enforcing policy provision reducing policy coverage to amount which would have been payable under settlement rejected by insured, thereby rendering insured liable for any excess).

But such policy language should be clear in stating its impact on the insured.  See Int'l Ins. Co. v. Dresser Indus. Inc., 841 S.W.2d 437, 440- 44 (Tex.App.1992) ("guiding principles" for primary and excess insurers adopted by contract did not subject insured to duties of primary insurer because they did not address its special status as insured and because they limited the coercive steps excess insurer over fronting policy could take).

The other side of this issue is whether an insurer may agree to a settlement without the insured's consent where the insured has a substantial deductible or SIR that must be applied to the settlement.  Some policies expressly grant the insured the right to control acceptance or rejection of settlement demands.  In such cases, the policy language will be upheld.  Other policies give the insurer the right to settle a suit involving a loss that might exceed the SIR.  For example, in New York City Housing Authority v. Housing Authority Risk Retention Group, Inc., 203 F.3d 145 (2d Cir. 2000) (applying New York law), the court of appeals, construing a liability insurance policy provision authorizing the insurer to settle if there was a reasonable chance that the loss would exceed the SIR, held that a court should employ an objective standard in determining whether there was a reasonable chance and should limit its inquiry to information available at the time that the decision to settle was made.

In the absence of controlling contract language, however, the general rule is that standard liability policy language regarding the insurer's right to settle claims outweighs the insured's interest in minimizing its financial obligation. See, e.g., Hendrix v. City of New Orleans, 562 So. 2d 1164, 1166- 67 (La. Ct. App. 1990); Am. Home Assurance Co. v. Hermann's Warehouse Corp., 563 A.2d 444, 448 (N.J. 1989); Orion Ins. Co., Ltd. v. Gen. Elec. Co., 493 N.Y.S.2d 397, 402-03 (N.Y. Sup. Ct. 1985), aff'd sub nom., U.S. Aviation Underwriters, Inc. v. Gen. Elec. Co., 509 N.Y.S.2d 778 (N.Y. App. Div. 1986); Nationwide Mut. Ins. Co. v. Public Serv. Co. of N.C., Inc., 435 S.E.2d 561, 564 (N.C. Ct. App. 1993); Austin Co. v. Royal Ins., 842 S.W. 2d 608, 610-11 (Tenn. Ct. App. 1992).  Of course, the terms of the settlement must be reasonable, *1021 and the insurer's conduct, including the decision to settle, must be in good faith.  See Mitchum v. Hudgens, 533 So. 2d 194, 196-97 (Ala. 1988); Shuster v. S. Broward Hosp. Dist. Physicians' Prof'l Liab. Ins. Trust, 591 So. 2d 174, 176-77 (Fla. 1992); Nat'l Sur. Corp. v. Fast Motor Servs., Inc., 572 N.E.2d 1083, 1087 (Ill. App. Ct. 1991); Bleday v. OUM Group, 645 A.2d 1358 (Pa. Super. Ct. 1994).

Some jurisdictions do not follow the general rule.  For example, in Alabama, the insured has the right to control the acceptance or rejection of settlement offers if it has a "direct financial stake" in the litigation. See, e.g., St. Paul Fire & Marine Ins. Co. v. Edge Mem’l Hosp., 584 So.2d 1316 (Ala. 1991).  Similarly, in Transport Indemnity Co. v. Dahlen Transport Inc., 161 N.W.2d 546 (Minn. 1968).  The Minnesota Supreme Court held that, where a settlement will affect a policy's retrospective premiums (i.e., premiums calculated annually based upon the insured's past loss history), the insurer bears the burden of proving that the settlement is reasonable because the retrospective premium arrangement gives the insured an interest in the amount of the settlement.

One California Court of Appeal reasoned that the duty of good faith was mutual, so an insured ought to commit its own funds to protect an excess carrier on the same basis that a primary insurer is obliged to commit its funds to protect an insured against excess exposure.  Transit Casualty Co. v. Spink Corp., 156 Cal.Rptr. 360 (Cal.App.1979).  But the California Supreme Court disapproved of that result in Commercial Union Assurance Cos. v. Safeway Stores Inc., holding that an insured has no obligation to commit its own funds for the protection of its excess insurer.  610 P.2d 1038 (Cal.1980).  It reasoned that, while the duty of good faith was mutual, that duty was only one to respect the other party's reasonable expectations of benefits, and that the expectations were not symmetrical:

One of the most important benefits of a maximum limit insurance policy is the assurance that the company will provide the insured with defense and indemnification for the purpose of protecting him from liability. Accordingly, the insured has the legitimate right to expect that the method of settlement within policy limits will be employed in order to give him such protection.

No such expectations can be said to reasonably flow from an excess insurer to its insured.   The object of the excess insurance policy is to provide additional resources should the insured's liability surpass a specified sum. The insured owes no duty to defend or indemnify the excess carrier; hence, the carrier can possess no reasonable expectation that the insured will accept a settlement offer as a means of "protecting" the carrier from exposure.  The protection of the insurer's pecuniary interests is simply not the object of the bargain.

In fact, the primary reason excess insurance is purchased is to provide an available pool of money in the event that the decision is made to take the gamble of litigating.

Id. at 1041-42 (citations omitted).

In this court's view, if the insurer had such expectations of protection by the insured, it should have made those expectations clear by appropriate policy language.  The Safeway reasoning and result have been followed in  International Ins. Co. v. Dresser Indus., Inc., 841 S.W.2d 437, 444-46 (Tex.App.1992).

In Dresser Indus., the insured operated as a self insurer, retaining complete management and control of the defense of claims and lawsuits.  This arrangement was negotiated under a fronting policy.  The judgment in the underlying products liability lawsuit penetrated International’s excess coverage.  International did not approve of the manner in which Dresser handled and defended the underlying lawsuit.  More specifically, International brought a declaratory judgment action seeking a determination that it was not obligated to pay the underlying judgment because Dresser failed to settle the lawsuit within the primary fronting limits.

Analyzing these issues under Texas law, the Court of Appeals of Texas first found that Dresser had no contractual obligation to settle the underlying claims based on the Special Claims Handling Agreement with the fronting insurer.  Next, the court refused to find a common law duty running from Dresser to its excess insurer with respect to settlement of the underlying lawsuit.  The court specifically declined to recognize such a common law duty in the absence of supportive precedent, finding that Dresser did not owe a duty to International to make reasonable attempts to settle the underlying lawsuit within the primary or self insured limits.

Ultimately, it appears there is little support in the case law for allowing an insurer to sue an insured for the insured’s failure to settle a claim within a stated SIR.  The case law, however, suggests that clear contractual language providing for such a right would be enforced.  California, at least, has recognized duties under the cooperation clause that suggest the insured cannot ignore settlement possibilities.

IV.              Must an Insurer Drop Down to Cover an Insolvent Insured’s Exposure?

The interplay between an SIR and the primary and excess insurance above it is cast into doubt when the insured becomes insolvent.  To the extent that an insurer's obligations are triggered by the exhaustion of the SIR, the insolvency raises questions as to whether that insurer's obligations are triggered and as to whether the insurer must "drop down" to fulfill the insolvent insured's obligations.

A number of decisions have addressed the effect of the insured's insolvency on the obligations of an insurer whose policy is excess to an SIR or deductible.  Generally, where the policyholder is unable to pay the deductible due to insolvency, the insurer must pay covered losses up to its full policy limits and then seek reimbursement of the deductible amount from the insolvent insured. With an SIR, however, the insured is liable to pay the amount of its retained limit directly to the claimant.  Thus, the insurer is typically not obligated to pay the amount that the insolvent policyholder retained.  Consequently, the insurer is not required to "drop down" and assume the insolvent insured's liability.  See Amatex Corp. v. Aetna Cas. & Sur. Co., 107 B.R. 856, 858--59 (E.D. Pa. 1989), aff'd without opinion, 908 F.2d 961 (3rd Cir. 1990); McNeal v. First State Ins. Co., Nos. 85-3927, 85- 4087, slip op. at 5 (E.D. Pa. 1986), aff'd without opinion, 822 F.2d 53 (3rd Cir. 1987).  This general rule, however, is often in conflict with bankruptcy law and the practical implications of resolving claims.

In In re Firearms Import and Export Corp., 131 B.R. 1009 (S.D. Fla. 1991), the court addressed the issue of how an unpaid SIR is treated in bankruptcy proceedings.  The insurer argued that it was not obligated to pay its policy limits because the insured had not paid its SIR, and, in the alternative, that the unpaid SIR should be treated as an administrative expense entitled to priority in the bankruptcy estate rather than as an unsecured claim.  The court held that payment of premiums on commercial liability policies constituted material and substantial performance of the contract, so that any failure to fund the SIR was insufficient to relieve the insurer of its coverage obligations.  It further found that the insurer's claim for the unpaid SIR was not entitled to administrative expense priority and was classified as a general unsecured claim.

As a contrast to the above decision, in Amatex Corp. v. Aetna Casualty & Surety Co., 107 B.R. 856 (E.D. Pa. 1989), the debtor argued that the insurers should pay the entire amount of the policies and then be relegated to an unsecured claim against the debtor for the amount of the SIR.  The court disagreed and held that the insurer was liable only for those amounts in excess of the SIR, finding that "the [SIR] is therefore not an amount that is owed by the Debtor to [the insurer] but, rather, represents the threshold of [the insurer's] liability to the Debtor" and that the "Debtor must exhaust its [SIR] and must seek indemnification from its primary insurance policies before looking to the [insurer] for indemnification."

In a recent case, the United States Bankruptcy Court For the Middle District of Florida examined the insured/debtors’ liability to its insurance company with respect to the satisfaction of an SIR, once the insured had filed for bankruptcy protection and was not in a position to satisfy the SIR.  In re:  OES Environmental, Inc. 2004 W.L. 2997485(B.R.N.D. Fla. 2004).  The insured/debtor argued that its SIR should have administrative priority status, similar to the payment of an insurance premium which is made post-bankruptcy petition.  The court disagreed, finding that the satisfaction of an SIR is not similar to the payment of a premium because it is “without dispute that the insurance coverage is already provided for by the insurance company.  There is no quid pro quo with the satisfaction of the SIR as between the insured and the insurer.”

In OES Environmental, the insurer argued also that, under the terms and conditions of the policy, there was no duty to indemnify or defend until the SIR had been exhausted.  P.Y. Lein International v. Hyundai Marine and Fire Insurance Company, 1997 W.L. 703778 (N.B. Cal. 1997).  Again, the court disagreed, finding that the language of the insurance policy regarding the SIR did not use the term “exhausted” but merely stated that the SIR is “borne by” the debtor.  Moreover, in In re Amatex Corp., 107 BR 856 (E.D. Penn. 1989), the court held that the insured was obligated to defend and indemnify the insured/debtor for the portion of settlement exceeding the SIR, irrespective of the insured/debtor’s inability to pay the claimed retention amount.  The court also quoted from In re Amatex, including language relevant to the nature of self insurance:

Self insurance has been defined as the practice of setting aside a fund to meet losses instead of insuring against such through insurance.  A common practice of business is to self-insure up to a certain amount, and then to cover any excess with insurance.  ([Citation omitted]

Self insurance is best compared to the familiar “deductible” referenced in most insurance policies.  It is common knowledge to anyone who has ever filed an insurance claim subject to same that the deductible must be exhausted before the liability of the insurer begins.

Giving this meaning to the term “self-insurance” and noting that the $25,000 in question is referred to as the amount of “self insured” retention in the Stonewall policy several times in the text of that policy.  It is clear to this court that Stonewall is liable for only those amounts in excess of the self insured retention.  The self insured retention is therefore not an amount that is owed by the debtor to Stonewall but, rather, represents the threshold of Stonewall’s liability to the debtor.  We therefore declare that the self insured retention amount set forth in the Stonewall policy is a limitation on Stonewall’s liability under the policy.

In an opinion more explicit with respect to the drop-down issue, the Appellate Court of Illinois found that an insured in solvency or bankruptcy did not require a liability insurer to provide drop-down coverage and pay self insured retention.  Home Insurance Company of Illinois v. Hooper, 691 N.E.2d 65 (1st Dist. 1998).  The result, however, appears to be the same as the bankruptcy decisions discussed above, in that the insured’s actual payment of the SIR was not a condition precedent to the insurer’s obligation to pay damages.  The insurer, however, was not required to provide drop-down coverage, in that it was liable only for that portion of any tort judgment or settlement in excess of the SIR up to the policy limits.  The wide majority rule, therefore, appears to be that an insurer is not required to provide drop-down coverage in the context of the insured’s insolvency.  The insured, however, is not required to satisfy the SIR before the insurer is obligated to provide coverage.  The courts will simply limit the insurer’s ultimate liability by reducing any resulting settlement or judgment by the amount of the SIR.  Of course, with respect to claims that exceed policy limits, this limitation of liability is of no practical importance.

Outside Bankruptcy Court jurisdiction, at least one court has invalidated a policy provision requiring the insured's payment of its SIR as a condition precedent to the insurer's obligation to pay.  In Home Ins. Co. of Illinois v. Hooper, 691 N.E.2d 65 (Ill. App. Ct. 1998), the court found that such a provision violated public policy embodied in a statute requiring liability and indemnity policies to state that insolvency or bankruptcy of the insured shall not release the insurer from payment of damages for injuries.  See also Rummel v. Lexington Ins. Co., 945 P.2d 970 (N.M. 1997)  (excess insurer's responsibility was not affected by insured's insolvency, underlying insurer's refusal to pay, or underlying insurer's settlement for less than its policy limits).

If the insurance is essentially an excess policy over an SIR, the typical "drop down" holdings should be applicable.  This arguably would prevent drop down absent some deficiency in policy language.  See, e.g., McNeal v. First State Ins. Co., 1986 WL 4477 (E.D. Pa. April 10, 1986) (excess insurer not required to pay portion of settlement amount due from SIR when insured filed for bankruptcy after settling).

If the insurance follows a model of reinsuring a portion of the insured's liability, insolvency of the insured should neither increase nor decrease the insurer's liability.  In such a situation, the court must fashion an equitable way to distribute the proceeds among claimants, none of whom are entitled to direct payment by the insurer.  See McQueen v. Great Northwestern Packing Co., 262 N.W.2d 820 (Mich. 1978).

The issue of guaranty fund liability impacts the treatment of SIRs.  In R.J. Reynolds Co. v. California Ins. Guar. Ass'n, 1 Cal. Rptr.2d 405 (Cal. App. 1991), Reynolds contracted with Multi-Marketing Inc. (MMI) to conduct a marketing program.   MMI was required to provide liability insurance to Reynolds for all liability arising from this program.   MMI purchased insurance from Mission Insurance Company, which later became insolvent.   Reynolds provided a truck, as to which it was insured under a policy issued by Aetna.  The Aetna policy was retrospectively rated.   An accident occurred, and Mission was unable to respond.   So Aetna paid over $800,000, for which Reynolds was required to pay a retrospective premium of $200,000.  Reynolds sought to recover this amount from the California Insurance Guaranty Association.  The California Court of Appeal ruled that, pursuant to the association's governing statute, Reynolds was obligated to pursue all other insurance, including the retrospectively rated Aetna policy.    Reynolds argued that this amount was, in substance, an SIR, but the court did not accept that argument. Accord North Dakota Ins. Guar. Ass’n v. Anway Inc., 462 N.W.2d 142 (N.D. 1990) (even policy that is pure fronting arrangement will be treated as other insurance for guaranty fund purposes).

V.                 How are Multiple SIRs allocated?

Where a loss involves multiple claims of injury, progressive injury or injury with indefinite dates of occurrence more than one SIR may be implicated.  This is a significant issue because the triggering of multiple SIRs increases an insured's financial exposure.

Most general liability policies are "occurrence" based policies, meaning the available policy limits and the SIR amounts are applied "per occurrence."  Thus, the available limits and the application of the SIR depend on the interpretation of whether there has been one occurrence or multiple occurrences.  This issue is significant where there is a series of small losses, because a finding that each loss is a separate "occurrence" would result in the total losses falling within the SIR(s).

The determination of the number of occurrences depends on the particular facts of each situation and on the policy language.  See, e.g., Norfolk & W. Rwy. Co. v. Accident & Cas. Ins. Co. of Winterthur, 796 F.Supp. 929 (W.D. Va. 1992), aff'd in part, appeal dismissed in part, 41 F.3d 928 (4th Cir. 1994) (railroad's alleged negligence in failing to protect its employees from hazards of noise exposure involved multiple "occurrences"; thus, railroad could not aggregate all claims so as to limit its obligation to one SIR); North Bay Schools Ins. Auth. v. Indus. Indem. Co., 10 Cal. Rptr.2d 88 (Ct. App. 1992) (separate acts of vandalism and arson committed by several people involved three separate occurrences, triggering three SIRs). 

Where a loss involves progressive injury over a number of policy periods (e.g., asbestos or environmental claims), some courts require the insured to pay one SIR per occurrence, per policy year.  See, e.g., Public Serv. Co. of Colo. v. Wallis and Cos., 986 P.2d (Colo. 1999) (numerous "occurrences," each of which spanned multiple policy periods, required insured to pay one SIR per occurrence per policy year); Ill. Cent. R.R. Co. v. Accident and Cas. Co. of Winterthur, 789 N.E.2d 1049 (Ill. 2000) (insured required to horizontally exhaust one SIR for each policy triggered); North  States Power Co. v. Fid. and Cas. Co. of New York, 523 N.W.2d 657 (Minn. 1994) (insured liable for full retained limit for each policy period triggered).

In Keene Corp. v. Ins. Co. of N. Am., 667 F.2d 1034 (D.C. Cir. 1981), however, the court examined an asbestos claim involving a single occurrence that triggered multiple policies.  In that situation, the court found that the insured was entitled to only one policy limit and could not stack policy limits.  In addition, the insured would not be responsible for uninsured periods:

As stated above, each policy has a built-in trigger of coverage. Once triggered, each policy covers Keene's liability.  There is nothing in the policies that provides for a reduction of the insurer's liability if an injury occurs only in part during a policy period. As we interpret the policies, they cover Keene's entire liability once they are triggered. That interpretation is based on the terms of the policies themselves.  We have no authority upon which to pretend that Keene also has a "self insurance" policy that is triggered for periods in which no other policy was purchased.  Even if we had the authority, what would we pretend that the policy provides?  What would its limits be?  There are no self insurance policies, and we respectfully submit that the contracts before us do not support judicial creation of such additional insurance policies.  Hartford argues that this allocation of liability allows Keene to "enjoy the benefits of insurance coverage which it has never paid for."  The contrary point, however, is more accurate:  For an insurer to be only partially liable for an injury that occurred, in part, during its policy period would deprive Keene of insurance coverage for which it paid.  With each policy, Keene paid for insurance against all liability for bodily injury.  The policies do not distinguish between injury that is caused by occurrences that continue to transpire over a long period of time and more common types of injury.  Nor do the policies provide that "injury" must occur entirely during the policy period for full indemnity to be provided.

See also, California Pac. Homes, Inc. v. Scottsdale Ins. Co., 83 Cal. Rptr.2d 328 (Ct. App. 1999) (where single occurrence triggered eleven policy years, insured was required to pay only one SIR).

The majority view on the number of SIRs an insured must satisfy for a single occurrence is that an insured must satisfy the SIR for each triggered policy period.  See Public Serv. Co. of Colorado v. Wallis and Cos., 986 P.2d 924, 942 (Colo. 1999) (reversing lower court’s holding that because one occurrence arose from each hazardous waste site insured need only satisfy one SIR per site:  “the fiction in which we engage to find one continuous occurrence across the policy years is useful only for allocating liability – it does not negate the jury’s determination that an occurrence took place at each site in each of the covered years, triggering each of the policies.  Thus, because the terms of each…policy requires [the insured] to exhaust one SIR per occurrence and because the jury found an occurrence in each year, [“the insured] must exhaust one SIR per site per year”]; Olin Corp. v. Insurance Co. of N. America, 972 F. Supp. 189, 202 (S.D.N.Y. 1997) (rejecting insured’s argument that it was liable for only a single deductible, holding that the insured must pay a deductible each triggered year for environmental claim); Missouri Pacific Railroad Co. v. International Ins. Co., 679 N.W.2d 801, 810-11 (Ill. App. Ct. 1997) (noise induced hearing loss and asbestos bodily injury claims; insured must exhaust a full SIR per occurrence per policy period before it may look to coverage under the insurers’ policies); Northern States Power Co. v. Fidelity and Cas. Co. of New York, 523 N.W.2d 657, 664 (Minn. 1994) (environmental property damage claims gave rise to one occurrence during each policy period and, thus, insured must satisfy SIR for each triggered policy period).  But see California Pacific Homes, Inc. v. Scottsdale Ins. Co., 83 Cal. Rptr.2d 328, 333 (Cal. Ct. App. 1999) (applying California law, the court allowed the insured to “pick and choose” the policy to respond to insured’s construction defect claim rejecting insurers’ argument that insured must exhaust SIR under all five policies in which alleged property damage took place before obtaining coverage from any insurer); In re Prudential Lines, Inc. 158 F.3d 65, 86 (2d Cir. 1998) (each asbestos bodily injury claim represents a single occurrence subject to a single deductible; insured can select a single policy to respond fully to the insured’s claim).

With respect to deductibles, some courts have applied an allocation formula to the insured’s obligation, rather than requiring the insured to exhaust the entire retained amount.  This method has been applied where multiple policies covering multiple years are triggered.  See Peco Energy Co. v. Boden, 64 F.3d 852, 857 (3rd Cir. 1995);  Lafarge Corp. v. Hartford Cas. Ins. Co., 61 F.3d 389, 401 (5th Cir. 1995); and Detrex Chem. Indus., Inc. v. Employers Ins. of Wausau, 746 F.Supp. 1310, 1325-26 (N.D. Ohio 1990).  In these cases, the courts have determined the insured's obligation by applying a ratio that is calculated from the percentage of loss sustained in each policy year compared to the total loss.  The courts have applied the resulting ratios for each year to the corresponding deductible.

At least on New York court has applied an allocation formula to SIRs.  In Olin Corp. v. Ins. Co. of North America, 986 F.Supp. 841 (S.D.N.Y. 1997) (New York law),  property damage claims for cost of cleanup of groundwater pollution, which occurred gradually over period of years before and after pollution exclusion was added to general comprehensive liability insurance policies, would be prorated by requiring insured to pay portion of cost attributable to years during which insured was self insurer.

The application of an allocation formula, however, may not be consistent with the view that SIRs are not “other insurance.”  For example, in Montgomery Ward & Co., Inc. v. Imperial Cas. & Indem. Co., 81 Cal. App.4th 356, 97 Cal. Rptr.2d 44 (2nd Dist. 2000), the court held that SIRs in comprehensive general liability policies were not "underlying insurance" or "primary insurance" to which rule of horizontal exhaustion could be applied.  As a result, the insured was not required to satisfy SIRs under every potentially applicable policy in effect at any point during period of continuous or progressive environmental contamination.  This holding, however, was made in the context of policies that expressly stated they were excess over a specifically described SIR and would cover claim when that particular SIR was exhausted.

As with any coverage issue, policy language plays a crucial role.  This is true where the policy is claim-based, instead of occurrence-based.  In Trahan v. Savage Industries, Inc., 692 So.2d 490 (La. Ct. App. 1997), the policy defined the SIR to apply to "each claim."  The court held that the injured plaintiff's claim and his wife and children's loss of consortium claims each constituted a separate claim and that each claim triggered a separate SIR.

In Atchison, Topeka and Santa Fe Rwy. Co., discussed in the previous section, the Supreme Court of Kansas held that the insured was required to exhaust the SIR for each triggered policy period before it could seek recovery from the insurers under the policies.  71 P.3d at 1133-34.  Applying an “all sums” approach to allocation, the Supreme Court of Kansas, in discussing application of the SIRs stated as follows:

We have concluded that the SIRs are other insurance under the policies, and thus primary insurance.  We further recognize that primary coverage attached upon the happening of an occurrence which we have determined to be the failure of Santa Fe to provide protection for its employees.  An excess policy covers the loss over and above that provided by the primary insurance.  We agree with the rationale expressed in MoPac that the insured must exhaust its SIRs per annual policy period.  We further agree that the concept of joint and several liability is not consistent with the term “all sums” in the policies.  It also clearly contradicts the fundamental insurance agreement to indemnify the insured for injuries during a specified policy period.  We cannot ignore the stated terms of the policies, nor the reality of SIRs as primary insurance where the expectation and intent is to provide excess coverage.  We cannot determine with certainty if the SIRs are sufficient to cover the damages for each year in question.  Thus, this case must be remanded for the trial court to make that determination, and if the SIRs are not sufficient, to allocate the damages attributable to the excess coverage for that annual policy period.

In summary, it appears that the majority rule is that progressive injury and multiple claim scenarios will require satisfaction of all triggered SIRs.  Again, however, any determination must be made on a case-by-case basis, examining the relevant policy language.  Moreover, insureds will certainly make arguments, analogous to the argument that SIRs are not “other insurance,” that the satisfaction of a single SIR complies with the spirit of the agreement with the insurer(s).

VI.              remarks

The developing issues with respect to SIRs seem to have an important common element.  There is an ongoing debate whether SIRs are, indeed, insurance in its traditional sense.  The answer to that question impacts the priority of coverage, the insured’s obligation to its insurers, the ability of insurers to hold insureds accountable for the handling of underlying claims, and the ultimate financial impact of claims that span multiple policy periods.  As with any coverage issue, practitioners should carefully examine the policy language at issue, as well as any incidental contracts between the insurer and insured (e.g., fronting arrangements and their associated claims handling contracts).  The best approach to a party’s obligations under an SIR is to have policy language that explicitly states the operations and conditions of the SIR.  In the absence of such explicit language, however, practitioners will have to rely on applicable case precedent, as well as the policy considerations that argue in favor of a particular result.  This paper attempts to provide some guidance with respect to applicable precedent and potential arguments, although each of the principal issues addressed in this report could easily warrant a much longer article and discussion.  Counsel should not rely on this paper as the last word on any of these issues, but should conduct their own independent research.

For insurers, the best approach is to steer clear of the traditional definitions of insurance when attempting to define obligations under an SIR.  The traditional notion of insurance implies contractual obligations running between two or more parties, as well as risk spreading among multiple players.  These elements are simply not present in an SIR.  As a result, insurers should focus, instead, on the type of public policy arguments found in some of the case law discussed in this paper.  These arguments would include such things as the unfairness of allowing the insurer to escape its obligation under an SIR, where the insured has already obtained a benefit from not paying an insurance premium for the retained amount.  In addition, insurers could argue that the concept of an SIR is found in its title.  In other words, an SIR is not equivalent to the absence of insurance; instead, it is, indeed, “self insurance.”