Drop-Down Coverage

Umbrella Policy Incorporates Underlying Duty to Defend Where Policy Agrees To “Continue In Force As Underlying Insurance” Upon Exhaustion Of Primary Policy

An Illinois appellate court, applying Illinois law, held that an umbrella policy which contained a provision stating that it would “continue in force as underlying insurance” upon exhaustion of the primary policy included a duty to defend, where the primary policy included a duty to defend. The court also held that payments by the policyholder could exhaust the limits of the insolvent primary insurer.

Sinclair Oil Corporation (Sinclair) owned and operated an oil pipeline near Hartford, Illinois between 1979 and 1990. Allianz Underwriters Insurance Company (Allianz) issued umbrella coverage to Sinclair from 1981-1982. The Allianz umbrella policy was issued in excess of a Home Indemnity Company (Home) policy.

Beginning in 2003, Sinclair and other companies were named as defendants in several underlying lawsuits alleging bodily injury and/or property damage, as well as regulatory matters relating to administrative orders issued by the USEPA and ILEPA. Sinclair’s resolution of some of the claims involved payments by Sinclair and Home. Home ultimately became insolvent before it paid out its limits.

Sinclair tendered the claims to Allianz for defense and indemnity, based on Sinclair’s position that the Home policy was exhausted, thereby giving rise to a duty to defend and indemnify on the part of Allianz. Allianz denied any coverage obligation, claiming its umbrella policy did not contain a duty to defend and the underlying limits had not been exhausted.

The Appellate Court agreed with Sinclair that the Allianz umbrella policy contained a duty to defend under a “drop down” provision. Specifically, the policy stated: “In the event of … exhaustion of the aggregate limits of liability applicable to the underlying insurance … by reasons of losses paid thereunder, this policy shall, subject to the terms and conditions of the underlying insurance … in the event of exhaustion continue in force as underlying insurance.” Allianz argued that, because the insuring agreement in the umbrella policy only contained a promise to indemnify Sinclair, Allianz could have no duty to defend under the “drop down” provision. The Appellate Court disagreed, find that because the underlying Home primary policy had a duty to defend, the Allianz umbrella policy had a duty to defend upon the exhaustion of the Home policy.

The Appellate Court also held that payments made by Sinclair must be taken into account in assessing whether the Home policy was exhausted, thereby triggering Allianz’s duty to defend: “It is important to emphasize that payments by the insured that exceed the underlying policy limits are also to be considered exhaustion. To require the payments to be made out of the primary insurer’s coffers would preclude excess coverage under an umbrella policy when the primary insurer has become insolvent or has wrongfully withheld payment.”  Sinclair Oil Corp. v. Allianz Underwriters Ins. Co., Case No. 5-14-0069 (Ill. App. Ct. April 7, 2015).

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