Court Applies "Horizontal Exhaustion" Rule Where Remaining Primary Policy Has A Self-Insured Retention And The Insured Had Tendered Under Another Policy Year

Court Applies "Horizontal Exhaustion" Rule Where Remaining Primary Policy Has A Self-Insured Retention And The Insured Had Tendered Under Another Policy Year


California courts have held that a self-insured retention, or SIR, is not "insurance." In a case involving a continuing loss that triggered multiple policies, does an excess insurer above an exhausted primary policy have a duty to "drop down" to defend when the remaining primary policy has a self-insured retention? The court said "no" in Padilla Construction Co. v. Transportation Ins. Co., 2007 WL 1404322, stating that the rule of "horizontal exhaustion" of primary insurance applies where the excess policy required exhaustion of any underlying insurance.

The insured contractor was sued for construction defects spanning four successive primary liability policies. The first and last primary policies were the only primary policies available, as the middle policies were issued by insurers that had become insolvent. Unlike the first policy, the last policy issued by Steadfast had a $25,000 SIR. The insured also had an umbrella policy issued by Transportation, excess of the first primary policy.

The insured requested only the first primary insurer to defend. When the first primary policy was nearing exhaustion due to payment on other claims, the insured asked Transportation to defend under the excess policy. Transportation declined. Upon exhaustion, the first primary insurer withdrew from the defense. The insured then assumed its own defense and later entered into a settlement, to which Steadfast contributed.

Coverage litigation ensued between the insured and Transportation. The trial court ruled in Transportation's favor. The Court of Appeal examined the "other insurance" clause in Transportation's umbrella policy, which provided that it was excess over any unexhausted primary and underlying policies regardless of whether they were listed on the schedule of underlying insurance.

Initially, the Court noted that SIRs are not considered insurance. The question then was whether the Steadfast policy's $25,000 SIR meant there was no "other insurance" to pay dollars one through 25,000. In other words, could the excess insurer be forced to defend until the SIR was satisfied.

The Court rejected this idea, noting that it would create the anomaly of an excess insurer having to defend before the primary insurer had a duty to defend. The Court noted that premiums charged by primary insurers were 12 to 15 times the premiums charged by excess insurers, reflecting a primary insurer's "primary duty of defense" versus the excess insurer's "secondary" duty to defend that attached only upon exhaustion of primary insurance. The SIR was part and parcel of the Steadfast primary policy and could not be separated in the manner advanced by Steadfast. Steadfast therefore had a duty to defend under its primary policy, before Transportation under the umbrella policy.

The Court reinforced the application of the rule of "horizontal exhaustion" of primary coverage, even where there are gaps in primary coverage during the period of loss or where there is a primary policy with an SIR. The rule was applied even where the insured had selected another policy year to pay. The Court also did take pains to cite case law indicating the opposite result if the excess policy specifically described the underlying policy and promised to cover a claim when that specific primary policy was exhausted.