Applying California law, the United States District Court for the Central District of California has held that a follow-form excess insurer was not bound by the primary insurer’s decision to pay a settlement because the settlement constituted uninsurable disgorgement that did not trigger the excess insurer’s policy.  Axis Reinsurance Co. v. Northrop Grumman Corp., No. 2:17-CV-8660 (C.D. Cal Nov. 16, 2018).

The insured settled with the Department of Labor in connection with amounts the insured allegedly was reimbursed in violation of ERISA.  The insured agreed to repay a portion of the settlement to the company’s savings plan.  The primary and underlying excess insurers indemnified the insured for the settlement payment.  The excess insurer took the position that it would not recognize any indemnification payments as exhaustion because the settlement payment did not constitute covered loss.  When the insured settled a second claim that exhausted the underlying insurance, it demanded payment of more than $9 million from the excess insurer.  The excess insurer paid but reserved its right to seek reimbursement for the portion of its payment attributable to the DOL settlement payment.

In the ensuing coverage litigation, the excess insurer moved for summary judgment that the DOL settlement payment did not properly exhaust the underlying insurance because it was not covered Loss. The court first held that, under Bank of the West v. Superior Court, 833 P.2d 545 (Cal. 1992), any settlement constituting disgorgement of ill-gotten gains is uninsurable as a matter of California law.  Accordingly, the court concluded that the DOL settlement was uninsurable under California law because it constituted disgorgement of amounts the insured received in violation of ERISA.

The court next held that the settlement payment did not properly exhaust the underlying insurance.  In so holding, the court relied on the excess policy’s exhaustion language, under which coverage is implicated only after the underlying insurers have paid the full amount of the underlying limits “for covered loss.”  Because the DOL settlement was not covered loss, the excess insurer’s policy should not have been implicated by the underlying insurers’ payments.

Finally, the court held that the excess insurer was not bound by the underlying insurers’ decision to cover uninsurable loss.  The court noted the underlying insurers’ independent decisions to pay under their policies did not change the plain language of the excess insurer’s policy limiting its obligations to payment of covered loss. Accordingly, the excess policy was prematurely triggered, and the excess insurer was entitled to recover the portion of its payment attributable to the DOL settlement payment.