What Is More Fair: Horizontal or Vertical Exhaustion?

In most continuous loss cases, multiple primary policies are on the risk for a given insured. The issue attorneys and insurance professionals often face is whether an excess insurer has an obligation to contribute to the defense and indemnity of a claim as soon as the limits of the directly underlying primary policy are actually exhausted (“vertical exhaustion”) or whether excess coverage is triggered when all primary policies are actually exhausted (“horizontal exhaustion”). See Kajima Const. Services, Inc. v. St. Paul Fire and Marine Ins. Co., 368 Ill. App. 3d 665, 669 (Ill. App. 1st 2006); Excess–Primary Insurer Obligations and the Right of the Insured, 69 Def. Couns. J. 315, 320-21 (July 2002). The answer depends on whether the excess policy is a “specific excess” policy or a “broad as primary” excess policy.


As stated above, a “specific excess” policy is triggered when the coverage of a specifically identified primary policy is exhausted. Olympic Ins. Co. v. Employers Surplus Lines Ins., 126 Cal. App. 3d 593, 598 (Cal. Ct. App. 1st 1981). When multiple primary policies cover an insured for the same claim and the applicable excess policy is of the “specific excess” type, “vertical exhaustion” can occur. A simple example of application of this rule is when an insured has a $100,000 primary policy from Insurer A. The insured has a “specific excess” policy from Insurer B tied to Insurer A’s primary policy with limits of $2 million. The insured is also covered for the same loss by a $1 million primary policy from Insurer C. Assume defense counsel for Insurer A negotiates a reasonable settlement of a claim in the amount of $500,000. Insurer C has no indemnification liability in this example notwithstanding its additional primary policy. That is because Insurer B’s policy automatically and contractually “kicked in” before Insurer C’s policy could apply. See Community Redev. Agency v. Aetna Cas. & Sur. Co., 50 Cal. App. 4th 329, 339-40 (Cal. Ct. App. 2d 1996).


A “broad as primary” excess policy covers “a loss which is covered under the policies of underlying insurance.” Housing Group v. California Ins. Guar. Ass’n, 47 Cal. App. 4th 528, 531 (Cal. Ct. App. 4th 1996). When an excess policy does not specifically identify a particular underlying coverage, all primary policy limits for a given year must be exhausted before excess coverage attaches. Olympic, 126 Cal. App. 3d at 600. This is statement of the “horizontal exhaustion” rule. Changing the hypothetical above so that Insurer B had a “broad as primary” policy as opposed to a “specific excess” policy, Insurer C’s indemnity obligation would amount to $400,000. Because the indemnity obligation of the excess policy would only be triggered by exhaustion of all “underlying insurance,” Insurer B would have no indemnity responsibility. See Community Redev. Agency, 50 Cal. App. 4th at 340.


What if you have applicable multiple primary policies and multiple excess policies with both “specific excess” and “broad as primary” language? How do allocate respective defense and indemnity responsibilities? The answer is that there is no bright-line rule. Vertical or horizontal exhaustion, which is more fair?


Horizontal exhaustion is more fair. In fact, the majority of states require horizontal exhaustion, in the absence of specific policy language, before excess policy coverage is triggered. See, e.g., Padilla Const. Co., Inc. v. Transportation Ins. Co., 150 Cal. App. 4th 984, 1000 (Cal. Ct. App. 4th 2007); Kajima Const. Services, Inc., 368 Ill. App. 3d at 670; Mayor and City Council of Baltimore v. Utica Mut. Ins. Co., 145 Md. App. 256, 309 (Md.App. 2002). See also Thomas J. Guilday & Catherine B. Chapman, Horizontal and Vertical “Stacking” and Exhaustion of Insurance Policies and Coverages, The Harmonie Group, June 2012, at 37.


Allowing vertical exhaustion should be discouraged because it allows the insured to unfairly manipulate the source of the claimant’s recovery. See U.S. Gypsum Co. v. Admiral Ins. Co., 268 Ill. App. 3d 598, 654 (Ill. Ct. App. 1st 1994). Primary policies are designed and priced to take the first risk of claims. It would be unfair to saddle excess insurers, who receive much less in premiums, with primary carrier duties merely at the insured’s election.


When facing inconsistent primary and excess policy exhaustion language, the first thing an insurance professional should do is analyze the language of all applicable primary and excess policies for each year. She should be looking for any language specifically describing or limiting underlying insurance coverage. If she finds the language, she should apply the “vertical” and “horizontal” exhaustion rules as applicable for each policy year. If, in a given year, no language exists or it is ambiguous, the best course is apply the “horizontal exhaustion” rule for that year. This method is consistent with the majority of the states and the fundamental rationale of Montrose Chemical Corp. v. Admiral Ins. Co., 10 Cal. 4th 645, 687-88 (Cal. 1995) (describing policy considerations leading Court to adopt the continuous injury trigger of coverage for the third party claims of continuous or progressively deteriorating damage or injury).

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