What is an excess layer and why should I care? For those who are not insurance experts, excess layers get introduced when a client wants a particularly high limit of insurance. Let’s say we are looking for $300 million of coverage. There are a couple of reasons why we would layer a policy of this size.
- Many underwriters can only write a certain amount of limit on any given risk. Several underwriters may be willing to do $50 million or even $100 million of cover for our imaginary risk, but we will need to use several in order to reach $300 million.
- The other reason to layer a policy is to reduce policy costs. The primary layer is the most likely to get hit if there is a claim, so your premium will be highest there. Layers “higher up” are cheaper than primary layers. In our imaginary scenario, let’s say the first, or primary, layer of insurance costs 3% for a $100 million policy, or $3 million in premium. As a result, the underwriter who is only offering coverage on claims bigger than $100 million might only cost 2%, or $2 million of premium for a $100 million excess layer, while the third only costs 1%.
Excess Layer Denies Coverage in Novolex Case
There is not a lot of case law with regards to representations and warranties policies. Therefore, it was with interest that we followed the 2019 case of plastics manufacturer Novolex, which experienced something unusual in the realm of reps & warranties insurance as a result of their most recent acquisition. Following what they claim was a breach that resulted in a loss of $278 million, their primary layer of coverage responded, while their excess layer refused.
Novolex held a four-layer policy totaling $150 million, and while three of the four layers have “honored their coverage obligations,” there are four carriers responsible for a $50 million tier who do not agree that they have to make a payment. At this point, the claim is heavily redacted, so the exact nature of their defense is not clear. But we know that Novolex is pursuing a ruling that would require these carriers to pay out their policy limits. This case has effectively rocked the world of reps and warranties insurance.
While we don’t know the exact reason for the denial of coverage, we do know that issues with excess markets crop up in all lines of insurance. Many of the same rules and challenges apply no matter the coverage line and, in light of Novolex, we turned our thoughts to how to avoid issues with excess layers for representations and warranties policies.
Anything but an Afterthought
One problem is that the excess layer may get less attention during both the placement process at the front end and the claims process at the back end.
Ideally, brokers should take care to award all layers the review and thoughtful planning that will ensure your excess market follows where your primary market leads.
In reps and warranties insurance this can be particularly problematic. Very often the primary policy is still being negotiated right up to the point of signing/closing a transaction and there is very little bandwidth for reviewing the excess layer wordings.
So what can we do to help make it as easy as possible to place and claim under an excess policy?
- More layers = more complexity: By definition, the more layers in an insurance placement, the more complex a claim is. But excess layers are just a fact of life when it comes to spreading risk. As we saw above, sometimes they’re used to build up limit on a big transaction, they’re used to reduce price, or they’re needed if the transaction is so risky that each underwriter is only willing to offer a very small amount of coverage.
- Under the microscope: A limit loss is the worst possible outcome. Paying out the entire limit, especially when that limit is a great deal of money, is something that will attract a lot of scrutiny and potential for disagreement from underwriters—not only different underwriting companies on different layers but even within the companies themselves. This certainly must have occurred in the case of Novolex.
- Keep communication consistent: Lawyers and brokers should be actively facilitating communication between the policyholder and underwriters at primary and excess tiers. Whether it’s communicating about the progress of a claim, a settlement discussion, provision of documents etc., the markets are more likely to be on the same page when they receive the same information at the same time. This can fall between the cracks when there are many different stakeholders involved in the claim because there is an assumption that someone else is doing it.
- Choose your words carefully: Are the policies for all tiers worded the same way? For every difference in wording between an excess market and primary market policies, there is a little hole that your claim can fall into.
For instance, a primary carrier could determine that only part of a limit should be paid out because of allocation or partial fault by the buyer. If the wording in the excess layer requires the primary “full limit” to be paid prior to their responding, they could argue that since the insured paid some of the loss, their policy had not been triggered at all. Ideally, as a rule of thumb, the shorter the excess policy the better. It should merely confirm that the terms and conditions are the same as the underlying policy and only speak to its particular limit and claims process.
It’s easy for the excess layer(s) to become an afterthought. Reps and warranties is, granted, very time-sensitive, but it is essential to keep all markets informed at the same time, ensure excess policy wording follows form, and nurture greater collaboration during the claims process to protect yourself against a Novolex-level situation.