After a large claim triggered coverage and exhausted both the primary and several layers of excess insurance, a dispute arose over whether the excess carrier had an obligation to reimburse incurred defense costs.  Houston’s 14th Court of Appeals held it did because its follow-form policy had not unambiguously declared its intent not to follow the wording of the primary policy on this issue.  Ohio Cas. Ins. Co. v. Patterson-UTI Energy, Inc., No. 14-22-00026-CV, 2022 WL 17097132 (Tex. App.—Houston [14th Dist.] Nov. 22, 2022, no pet. h.) (slip op.)

The analysis centered on the terms used by the two policies in their insuring agreements.  The excess policy generally followed the form of the primary policy except where its terms differed.  The primary policy used the defined term “ultimate net loss,” which included defense expenses.  The excess policy, on the other hand, used the term “loss,” which had its own definition of, “sums… you are legally obligated to pay as damages.”  It never mentioned the term “ultimate net loss” in any way – either to adopt or reject it.   Nor did it define the word “damages.”

The excess carrier argued that its adoption of a different term with a different definition was an implicit rejection of the general follow-form rule, and also argued the use of the word “damages” excluded defense costs because the common meaning of damages is distinct from defense costs.  The court of appeals rejected both arguments, holding the plain ordinary meaning of “damages” simply meant money claimed or ordered to be paid as compensation for loss or injury, and that the insured’s payment of its defense costs was a loss to the insured.  The court distinguished this interpretation from existing precedent discussing the term “compensatory damages.”

The excess carrier also argued that because its policy clearly stated it had no duty to defend, it could not possibly owe any defense costs.  Although the court agreed the duty to defend remained with the primary carrier, it held a duty to defend is distinct from a duty to reimburse the insured for incurred defense costs which were part of the covered “ultimate net loss.”

Editor’s note:  This unusual dispute and unusual ruling grew out of the unusual wording of the primary policy.  Typically, a primary liability policy either includes an unlimited defense duty or specifically states that the policy limit is eroded by defense expenses and that the duty to defend ends when the primary limit is exhausted.  Either of these types of primary policies leaves little room for the type of dispute seen here.  The “ultimate net loss” seen in this primary policy is more typical of excess policies, and we predict it is not that likely to have widespread repercussions.  Nevertheless, it is a cautionary tale from an underwriting perspective.

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